Posted | by David Moenning |
Assuming The Worst (Again) image

One of the bullish arguments that has been bandied about by many analysts (including yours truly) is that the major indices have been hanging tough lately and remained, until yesterday at least, a stone's throw away from all-time highs. This despite the Impeachment headlines, the ongoing trade war, the unrest in Hong Kong, the worries over BREXIT, and recent economic data from places like Germany which were just plain ugly.

Until yesterday, the thinking had been that the majority of the bad news was well worn. And the stuff that was new - i.e. the Dem's Impeachment Inquiry - wasn't likely to upset the apple cart to any great degree due to the assumption that a conviction in the Senate is a low probability bet.

So... Lots of folks (me included again) assumed that with the major averages a stone's throw from the Promised Land, it meant that Ms. Market was likely discounting better days ahead.

Well, until the ISM Manufacturing data was released, that is.

In case you don't follow the myriad of economic data points released each month, let's take a moment to review this indicator. According to Investopedia, the ISM's Purchasing Managers Index is, "an index of the prevailing direction of economic trends in the manufacturing sector. It consists of a diffusion index that summarizes whether market conditions, as viewed by purchasing managers, are expanding, staying the same, or contracting. The purpose of the PMI is to provide information about current and future business conditions to company decision makers, analysts, and investors."

Cutting to the chase here, the ISM Manufacturing Index slid 1.3 points in September to 47.8, which was (a) below the consensus estimate for a 1.0-point gain to a reading of 50.1, (b) below the all-important 50-line (the line of demarcation between growth and contraction) for a second straight month, (c) the sixth straight decline, and (d) the lowest level for the index seen since June 2009. Super.

The Economics team at Ned Davis research summarized the report nicely by writing, "The decline in activity was widespread across industries, with 15 of the 18 ISM industries reporting contraction, and only three expanding. It was the smallest share of expanding industries since April 2009. Respondents’ comments reflected "a continuing decrease in business confidence" and singled out global trade as the most significant issue.

The key is that while this particular index is a survey and as such can be easily influenced by sentiment/news/headlines, the September reading was a surprise - and not a good one.

The bottom line is that when taken with the recent data from across the pond as well as places like China, traders were forced to sit up and take notice. And instead of assuming everything would be hunky dory going forward, there was a sudden fear that economic conditions might get worse before they get better.

Some of the analyst comments on the report expressed just such a concern.

The Takeaways

From Ned Davis Research: The data "...reflect[s] a deepening contraction in the manufacturing sector. The reading registered a negative signal in our Recession Watch Report, making it the second of ten indicators in that report to do so."

From Torsten Slok, chief economist at Deutsche Bank: "There is no end in sight to this slowdown. The recession risk is real."

And from Chris Rupkey, chief financial economist at MUFG: "The lights haven't gone out on the economic outlook yet, but they are certainly growing very dim."

Suddenly, The Glass Is Half Empty

In other words, instead of seeing the market's glass as at least half full and looking ahead to a post-trade war world, traders decided to take the other side of the trade yesterday and voted with their feet. And in the blink of an eye, a triple-digit gain on the DJIA turned into a rout to the downside.

And with the world markets following suit overnight and the ADP headline suggesting that employment growth is slowing, it appears that the new game is to assume the worst and brace for a second straight Q4 debacle. Insert long sigh here.

But the bottom line is this is the way the world works in the world of algo-driven and high-speed trading markets. One minute things look good/bad, and the next, well, you know the drill.

My View: Don't Take The Bait

The good news is we've seen this movie before and in the end, the hero doesn't die. As such, my current thinking is to employ the very same buy-the-dip strategy that I've been yammering on about for months now.

My key assumptions here are as follows:

  • The U.S. Consumer doesn't panic - This keeps the U.S. economy moving ahead (albeit at a slower pace) and we avoid recession
  • Washington remains deeply divided and votes along party lines - This means the chances of the President being removed from office for the first time in history are low
  • BREXIT happens (or not) - and is a non-event for markets
  • Central Bankers continue to ease rates around the world
  • A trade deal is likely to get done - and sooner rather than later. This could easily turn economic sentiment on a dime

Finally, let's keep in mind that according to Barron's the manufacturing sector represents only 12% of US GDP. So, as long as Mom & Pop don't pull in the spending reins, my view is the economy and, in turn, corporate profits, can keep on keepin' on.

Thought For The Day:

Before you can win, you have to believe you are worthy. -Mike Ditka

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research

HCR Focuses on a Risk-Managed Approach to Investing
What Risk Management Can and Cannot Do

Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: none - Note that positions may change at any time.

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