• With Q3 books closed and Q3 earnings season on the horizon the Trader Team had its monthly meeting to discuss the latest market trends. Certainly a more cautious tone across the board for the analysts as a rising tension from earnings peak concerns, trade, interest rates, and geopolitical issues take hold. But opportunities are still abound and the potential for volatility around earnings has the team excited about the next couple of weeks.

CHART Market Thoughts

• As I discussed quite a bit last week, the breakout in interest rates at the long end of the curve is significant because it was not sparked by extreme participation in new money flows into equities. In other words, it didn't follow the risk parity model -- which is also the robo-advisor model: long bonds and stocks, with adjustable ratios, but dependent upon one being the hedge for the other.
• The key here now is that bonds and stocks are selling off together (like they did in February). That forces a cash-raising spiral until it exhausts itself. Earnings season is a buffer because Q3 growth for the US domestic economy was very strong, and was maybe the peak impact period for the fiscal stimulus, when you include psychological variables (confidence, willingness to "bet on the future", etc). So, it will be tough for people to sell stocks too much into those prints because they're likely to be really good for a lot of sectors.
• In front of us, we have major catalysts, including the US midterm elections, which may turn out to be decisive in terms of the extent to which the White House will have a path to enable more fiscal stimulus to further bolster markets and the economy in front of the start of the presidential election campaign season, which will get going 2H 2019.
• The breakout higher in rates is likely driven by both inflation fears and supply fears, rather than growth hopes. In other words, between the Treasury and Fed, we will see over $1.5 Tln in supply hit the US bond market in 2019. With 3.7% unemployment and fiscal stimulus and tariffs both pushing inflation potential higher, it has just been tough for people to find conviction enough to step in front of the bond market selling over the past few days.

BLUEX Market Thoughts

• Q3 wrapped up with the Dow Jones outperforming its peer Major indices, with a notable laggardness among Small and Midcaps throughout September. Such weakness in the "more speculative" asset classes snowballed into some early October distribution. Currently the Small Caps (IWM) sit -7% off their YTD highs, trying to hold onto its 200-day moving average for support. Mid-Caps (MDY) have lost approx. -4.5% off its YTD highs, also trying to find support along its 200-day ma's.
• The Nasdaq broke below its 50-day moving average and sits -5% off its YTD highs, while the S&P is currently holding onto its own 50-day ma.
• Sector action for Q3 showed strong leadership in the Healthcare sector, followed by gains among Industrials and Technology.
• Significant laggards throughout the quarter included Basic Materials, Energy, Utilities, and Financials. On a more relative basis compared to the S&P, look for Q4 to start off with continued strength among Healthcare, Industrials, and Telecom.
• The Energy sector is showing improvements on the heels of Crude prices rising throughout September.
• The more "interest-rate sensitive" groups have been mediocre at best YTD, so expect more of the same among Financials, Utilities, Reits, and Telecoms.
• Staples have lost their upward momentum against rising inflationary pressures and competing bond yields.
• Overall, there's an "inter-market" shift here into the final quarter of the year that could lead to further weakness across the board. The one caveat as always that could help improve conditions is the upcoming earnings season reactions.
• Rising interest rates along with inflationary pressures evidenced by a rising in Commodity prices (DBA, DBC) and Crude/Gasoline (USO/UGA) can be blamed for the recent distribution, but don't ignore the fact that Small and Midcaps (IWM, MDY) have been lagging for about 3-weeks now. When these more "speculative" asset classes lag their larger cap peers (i.e. Dow Jones breaking to fresh new highs, while IWM and MDY broke below 50-day ma support), it was a warning signal that the market was becoming more "risk averse" shifting into Q4.
• Financials (XLF, XRE, IAI) typically get the benefit of higher interest rates (higher lending/borrowing fees), but interest rate-sensitive groups like Utilities (XLU), Reits (IYR, XLRE), Telecom (IYZ), Homebuilders (XHB, ITB), and even Staples take a hit due to higher debt costs as well as competing yields (10-year Bond yields at 3.19%; Staples XLP dividend yield is 2.81%).
• Recent AAII Sentiment showed a significant increase in "bullish sentiment" above its historical average going into Q4. Clearly those surveyed are skewed towards the Dow Jones as their leading indicator.
• As for trading opportunities, I've been meddling with Shorts these last few days which have paid off nicely and helped offset lost profits/risk on existing Swing Long positions. For the most part, any Long position that's showing signs of aggressive distribution below key support, trendlines, moving averages, have been worth salvaging. Bottom line, best to free up some cash as the market goes through what appears to be a corrective pullback phase ahead of next week's start up in Earnings Season (Banks JPM, C, WFC, PNC, FRC report Friday, Oct 12).

SCALP Ideas

• Pot Stocks: Group has continued to provide tremendous daily and swing trading opportunities.
  • The Hydropothecary Corp (HYYDF) is up 81% since I highlighted it in the last Strategy Meeting.
  • While certainly a solid performance, it has nothing on Tilray (TLRY), which is up 160% over the same period and now sports a market-cap of $13 billion. At one point, TLRY was trading at a +$25 billion mkt-cap. So, while there is certainly a mania going on in pot, there is clearly real money flowing into the group, as it takes more than just a stream of day trading money to sustain multiple companies with $5-10 billion market-caps: (TLRY $13 bln mkt-cap; CGC $11.6 bln; ACBFF $10 bln; CRON $1.7 bln).
  • The latest name in the group to jump on the radar is Pyxus Intl (PYX), which I highlighted as a swing trade on Sept 28 at $22.85. The stock didn't do much for several weeks, but since Thursday it has soared from $24 to over $45.
• Yield Radar:
• Have seen fixed income come under considerable pressure on the breakout in interest rates. There are a few names on my radar that I may be looking to pick up in the Yield Portfolio. One is the DCP Midstream 7.95% Series C Fixed/Float Cumulative Preferred, which recently began trading in the Grey Market (temp ticker is DCPUU; currently trading at $24.42 vs $25.00 par). Here are some of the things I like about this deal:
  • attractive yield of almost 8%...
  • very strong DCF (approx. $165 mln per qtr vs less than $15 mln per qtr in Preferred obligations).
  • the Preferred is actually rated, which you don't usually see on deals with 8%+ coupons (S&P rates it B).
  • security has a fixed-to-float feature (3-month LIBOR +4.882%), which makes it more attractive in a rising interest rate environment.

Some EVENT Earnings Thoughts

• Just taking a look around at some of the pre-earnings reports and it certainly feels a lot like the Q2 earnings season. The idea being that expectations are pretty lofty with analysts looking for earnings to grow 21% y/y. On average, earnings usually beat by 3% across the board which means market participants will want to see an implied growth in the neighborhood of a 24%.
•  The main beat though is going to be driven by four areas which includes energy, materials, financials and IT. The problem with that is that the energy beat can be argued that it is priced in and is coming up against more favorable comps.
• Materials are interesting because they have been in a sideways pattern since the Q2 earnings reports despite a strong round of results and another high set of expectations.
• Financials will be a key sector and are seeing a similar pattern to materials with some more upside potential. But the expectations around loan growth and revenue are a more subdued than the bottom line growth. If the financials fail to impress in the early goings of earnings than that will lead to the need for some heavy lifting for the rest of the market.
• 21 out of S&P 500 have reported Q3 results and 90% have beaten. Consumer Discretionary (6 reports) have had the largest upside surprises with Staples and IT (6 each) coming inline with +3% expectations. Industrials (3) have lagged peers with only a 1% upside surprise on earnings.
• The expected earnings growth rate for S&P companies is approx 21.2% y/y according to S&P Cap IQ.
• Energy companies are expected to benefit from favorable prior year comps, similar to what we saw in Q2.
• CapIQ Expectations by Industry: As we can see, the majority of the gains are coming from four areas with Energy and Materials once again expected to provide the biggest gains. This is similar to the Q2 expectations. Energy was provided a boost but that can also be attributed to the steady strength we have seen in crude. Meanwhile, materials continue to lag the overall markets despite expectations for better earnings.
  • Y/Y EPS above 21%- Energy (92%), Materials (42%), Financials (39%), IT (23%)
  • Y/Y EPS growth expected to be lower than 21% median- Communication (-34%), Utilities (3%), Real Estate (3.6%), Consumer Staples (5%), Healthcare (10%), Consumer Discretionary (11%), Industrials (16%).

Sector Breakdown