Portfolio Updates – Going Into Week 35

I recently added my macro spreads, which are automatically updated, HERE. This will be so much easier to view in real-time and for those who understand how to use them effectively, only a single scroll down is required to get a firm grasp on the health of the U.S economy. Nonetheless, I am guilty of not including the yield curve yet which I am working on, which would take some time on top of other typical weekend errands. Not to forget, I would also be including basic economic data in terms of prices, housing, business, monetary policy and consumer front, which is vital juice in a trader’s vein. Down the road, this site would loyally serve me as a one-stop shop for all crucial macro data in aiding me for my portfolio management activities.

 YTD U.S Sector Performance

Back to recent market developments, I need not reiterate Marketwatch’s or Bloomberg’s’ market headlines. S&P500 has scraped to record highs, 2874.69 pts despite YTD trade tensions – related volatility which coincided with the 10-year yields falling from 3.127% down to 2.816% as of Friday’s close. The Financial sector ETF, XLF constipated on a YTD drag of meagre 0.82% gain, winning the coveted 2nd runners up for worst performer behind Staples and Materials. Tech and Consumer Discretionary sector have been shouldering the burden of carrying the market throughout the year while Financials, Industrials and Materials have been sitting by the sideline bleeding for various reasons. Industrials and Materials have been decapitated YTD with Trump’s trade tariffs blade whilst Financials were facing a gradually flattening yield curve on top of a mindlessly wandering 10-year treasury yields below the 3% level. However, credits have to be given to the defensive line-up of Energy, Healthcare, Real Estate, Staples and Utilities (eRUSH) who stepped up to the plate and offered to carry the broader market higher heading into 2018H2. As the Consumer Discretionary & Tech (CDT) partnership started losing steam in July, eRUSH (with the exception of Energy due to its dependency on oil prices) quickly took over the helm and ushered the S&P higher – which gets me worried especially when the aggressive sectors did not impose leadership although Financials and Industrials did prod its RUSH compatriots with good earnings beat and medium-term memory loss of its market participants on the trade tensions. Thus, albeit me myself being bullish in the medium term, I’m wary of the shorter term dangers lurking, especially in a low volume trading month like August and an unpredictable September coming up. However I’m not taken by surprise with the eRUSH participation as this behavior is typical of late-cycle market environment. As the chart below shows, the RUSH quartet truly lived up to the adage of “Sell in May and Go Away” – the sellers rushed away in May and prices found a bottom before money flow helped pumped the defensives into a reversal and came to the support of CDT who took a slight breather in the current earnings season . XLE exerted much energy – which lived up to its name – Energy sector, from April to end of May but it was typical of a post-Red Bull effect where it remained range-bound and lacking any energy whatsoever from June to present.

Please refer the tickers to the table above to know which sector it belongs to.

 

On the Q2 earnings front, companies have reported earnings growth of 24.6% and revenue growth of 9.9%. Analysts are expecting earnings to stay within double digits of 20% for the rest of the year but their outlook have waned for H12019 where earnings growth are within single digits at an average of 7.6% and revenue growth of 5.4%. So far, out of 74 S&P500 companies that have announced their Q3 guidance, 55 of them have negative forward guidance where at 74%, is higher than the 5 year average of 72%. Forward 12 month valuations are still above the 5 year average at 16.6 compared with 16.2 average. In addition, 79% have reported positive EPS surprises while 72% reported positive revenue beats. Some key facts to note:-

  1. S&P500 companies with more global exposure reported higher earnings and sales growth in Q2 2018. IT, Materials and Energy came out tops in this metric. For example, on EPS beats, companies with global exposure outperformed with 29.4% earnings growth compared to the more domestic-oriented companies at 22.2%.
  2. If the 79% EPS beats remain till end of earnings season, this will be a record high since Q3 2008. Q1 2018 remains second at 78%. Healthcare, Telecom and IT were the biggest contributors.
  3. Percentage of companies beating revenue estimates is at 72% which is well above the 5-year average at 58% but below the 1-year average at 73%. Top 2 are Healthcare and IT while the bottom two are Energy and Staples.
  4. 24.6% EPS growth is the 2nd highest since Q32010. Top 3 sectors are Energy, Materials and IT.
  5. 9.9% of revenue growth is the highest sinceQ32011. Energy, Materials, IT and Real Estate were the biggest contributors.
  6. Energy is expected to top both earnings and revenue growth for Q3. Financials are expected to pick-up for EPS growth in Q3. Same goes for IT, Telecom and Materials.

 

The Energy Trade, Hedged-Financials & Staples Swing Trade Heading into Q4

Energy Sector ETF

I expect money to continue flowing into defensive sectors and will position myself as such. In fact, I am already in Energy by taking the rebound after the false break of the 200EMA and a bullish harami slightly above $72.22. Apart from my bullish perspective on commodities based on Austrian cyclical analysis, capacity utilization pick-up, inflation outlook on top of a solid technical backdrop of the commodity index ETF, I deduced that the sell-off to $71.70 was not fundamentally justified and the volume spike on the last long red candle was an exhaustion move. Moreover, the energy sector had solid earnings growth of 125.1% YoY with 5 of 6 sub-industries enjoying double digit growth at 23.2%, which is the second best performing sector in this earnings season.

I have always seen the “Trade War” as an artificial pump to the USD with Trump being the chief manipulator by wanting to engineer a stronger dollar. It is easy to determine what to trade if we know whether a manipulated scenario can last forever or merely temporary and what the consequences are if the “control” is removed. With the whole world being interconnected with very minimal trade barriers and with globalization tearing walls apart, it is challenging for one man – Donald Trump to get his way with whatever he wants. As such,it can be profitable to position oneself against the manipulated movement if we are certain for a fact that when the incident is forgotten and free market forces reign again, prices will snap back to where it initially wanted to go. Hence what is needed after this is just a dose of patience to wait for the signal. With the S&P500 remaining range-bound despite this, I also deduced that if we take away all this manipulation and noise, it wants to go higher, same with the dollar which should be lower than where it went to and commodities should be higher than where it is now. So this leaves us with the timing – and a few months before the mid-term elections would be the sweet spot to position ahead of a possible strong Q4 seasonal move to the upside should the macro environment remain robust. With all this analysis on top of my macro spreads, I decided to reduce the risk further by trading option spreads to increase my probability of profit.

My portfolio is further diversified with an aggressive addition of the Financials sector – which got me further interested after a movement in sympathy to the downside in conjunction with the Turkish crisis. My take is that after Jerome Powell’s speech in Jackson Hole, the Fed will be behind the curve again in inflation which means that the 10-year yields will have some room despite being in no-man’s land due to 2018 volatility. In addition, when Jerome mentioned that there is no overheating risk to the economy and that inflation will remain subdued in the near future – this is a sign that they are willing to be reactive, just like how the Fed has been operating in the past. I vividly recall back in 2003, the core inflation rate fell to 1.1%, lowest in 40 years. They were so afraid of deflation that they hiked at a gradual pace and were always behind the curve – prompting a bubble in the housing market. Core CPI fell to the lowest in 2010 at 0.6% and Ben Bernanke swiftly responded with QE that took the CPI inflation up to 2% from 2011 till current times, where it is now at 2.4%, the highest since September 2008.

In fact this Financials trade is a follow up to my long commodity-related positions (such as XLE, CLR, etc) as a pick-up in inflation would trigger an increase the 10-year Treasuries and prompt the Fed to further tighten. However, in the interim, although one may argue that the Financials have already priced in the Fed rate normalization path, I would say that the subdued movement of the XLF is more sentiment related (high beta with the broader S&P500) and with solid earnings (expected to be among the top 2 in Q3 earnings growth) and revenue growth (Topped Q2 revenue at 3% surprise growth) apart from a strong seasonal factor this coming October. Nonetheless, I have hedged my position with a long in VIX as I am betting on the 10-year yields to hit new highs which is bullish for Financials.

Staples is trending beautifully with a typical 4-5 candles correction and I have been trading this sector since May going in and out till it broke above the 200EMA at the end of July and stayed above ever since. My conviction is based on macros – sector rotation based on cyclical analysis and also on the fact that it was the worst performing sector heading into Q32018. I sensed that this was the perfect opportunity to gain some exposure before it becomes hot news.

Nonetheless, heading into Q4, I would confidently be more aggressive then especially when the seasonal swing probabilities re-appear after a summer trading lull.

On a final note, although I may have some strong views, I remain nimble and agile like a cat. I would never hesitate to change my plans and re-execute my portfolio if macro developments throw my themes out of the window. I would adjust within a heartbeat if it’s suicidal not to.

Till next time.

Over and out,

Ramone

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