Mid-Month Update: More Upside Anticipated, but It will be a Struggle
By: Christopher Mistal
October 15, 2015
To recap, we issued our Seasonal MACD Buy Signal after the close on October 5. On the following day new long positions in DIA, SPY, QQQ and IWM were established in the Almanac Investor ETF Portfolio and remaining defensive positions were closed out. We also closed out short stock positions in the Stock Portfolio. On Tuesday of this week we put our proprietary stock selection process through its paces to unearth sixteen new long stock trade ideas. All of our recent long trade ideas can be considered on dips below their respective buy limits. Thus far, the market has been assisting us in establishing these new positions. It has taken a moment to digest its recent move and the prospects for the balance of the fourth quarter. 
Current investor sentiment readings do appear to be setting up in support of a year-end rally. According to Investors Intelligence latest Advisors Sentiment survey, the percent of bullish advisors has rebounded nicely to 36.5% after hitting a multi-year low of 24.7% at the end of September. Bearish and correction advisors are currently at 31.2% and 32.3%, respectively. This is a healthy amount of skepticism which leaves room for the market to work its way higher.
Sadly the current fundamental situation is not a positive, but many of the weak and/or tepid data is backwards looking. For starters, this week’s September Retail Sales figures were a disappointment coming in at a seasonally adjusted rate of just 0.1% when compared to August. Motor vehicle sales were the brightest part of the report and accounted for the gain. Apparently lower fuel prices are helping some, just not as much as many had expected. I suspect the market’s wild ride in September was the largest reason consumers held back, at least partially. Holding onto some additional cash after making a major purchase while the news is full of negative stock market headlines does seem rational.
Walmart (WMT) warning of lower earnings and revenue also does not help. But, let’s not overlook the main reason why earnings are expected to fall at the world’s largest retailer; they are going to give many of their employees a raise. Yes this will hurt profits in the near-term, but it is a good thing over the longer-term. Their employees are consumers too. Higher earnings will likely lead to higher spending and possibly happier employees. Walmart has a tremendous amount of competition here and abroad in the “affordable” product category. A cleaner, more customer friendly shopping experience should help Walmart reclaim must of the ground it has lost in recent years.
Recent inflation data is also something to be concerned about, although it is something of a double-edged sword as the lower it goes, the lower inflation expectations go and the less likely the Fed is to raise rates. The Fed meets again later this month and it would be absolutely shocking for them to make any move this month. Actually, it would be surprising if more than ten words are changed from September’s statement. Recent jobs market data has softened, notably average hourly earnings. This combined with the recent plunge in the Consumer and Producer Price Indices (CPI & PPI) suggest the Fed might actually have to take rates negative.
[Inflation Chart]
To put recent inflation data into perspective, the six-month exponential moving average (EMA) of year-over-year CPI and PPI (not seasonally adjusted) from 1980 to present are plotted above. The solid black line represents the Fed’s “2% target.” Not-seasonally-adjusted data was selected for its purity. There is enough statistical magic in CPI and PPI that adjusting it is just overkill. The 6-month EMA smooths the spikes and valleys in the data series and produces a reliable trend. 
As of the most recent September readings, PPI is not that far from its low reached in September 2009 while CPI is on the verge of going negative. It would seem the Fed has just a few options at this point; leave rates alone and wait, consider taking rates negative or possibly more QE. A final possibility could be to just undue several decades of tweaks designed to mask inflation. The Fed was aggressive in fighting deflation a few years ago, so it is only reasonably to assume they will do so this time around. Cheap money has fueled record dividends and share buybacks which has been bullish for stocks. A short-term stock market bump is the most probable outcome as long as the Fed does not raise rates.
Technically, there is still one divergence in the charts of DJIA, S&P 500 and NASDAQ that needs to be rectified before the rally can resume in earnest. DJIA and S&P 500 have traced out a “W” or “1-2-3” bottom pattern nicely and have reclaimed their respective 50-moving averages, and held them. Today’s NASDAQ gains have finally lifted it above its 50-day moving average (solid magenta line in next chart), but it now needs to climb above its mid-September closing high to successfully complete its bottom. A close above 4900 would do it, but then NASDAQ will need to contend with resistance at its 200-day moving average (solid red line in next chart), currently at 4918.
[NASDAQ Daily Bar Chart]
We are bullish again after spending much of the summer on the defense however, our current bullish stance is not a strong as it was last year at this time or at the start of previous “Best Six Months.” Economic data this time around is mixed at best and borderline gloomy at worst while typical pre-election-year forces have failed to prop the market up this year. Most economic data tends to be backward looking while the stock market tends to look forward. Earnings are expected to rebound next year and the Fed is most likely going to remain accommodative in the face of recent labor market and inflation data. We do expect the market to make a run back towards its recent record highs sometime during the “Best Six Months,” but we do not see a tremendous amount of upside potential after that.