WHAT’S NEXT?

Stocks advanced globally after the US and China reached a fresh truce in the trade war and agreed to resume talks towards a deal..  Gold and Treasuries retreated and oil is surging trading at the highest level in six weeks, entering into a new bull market.

Second quarter earnings season is about to commence.  Overall profits are expected to decline about 2.6%, the biggest drop since 2016.   The best performing sector—technology—is in the midst of the worst quarterly profit slump also since 2016.  Bloomberg writes earnings for this sector fell 3% in the first three months of year, are expected to decline another 11% in the second quarter and then decline 6.7% in third.

Goldman Sachs writes the technology sector is up about 26% for the year and is now facing even greater headwinds from trade, regulation and valuation.  At current levels, Goldman writes “the S & P tech sector carries a valuation premium of two standard deviations above its 10 year average across a range of metrics.”

Wow!  Talk about being set up for potential failure if earnings decline by a rate greater than expected or do not rebound in early 2020 as forecasted.

In my view, the sharp drop in interest rates and the incessant rise in technology shares are closely correlated.  Interest rates are the largest variable of valuation models.  By definition lower interest rates dictates greater potential equity value.

It is generally accepted that both the bond market and technology stocks are greatly influenced by algorithmic/momentum trading, representing almost 90% of volume where in my view values have now become deeply distorted.

I have written at length about the unprecedented amount of negative yielding debt.  While the overvaluation of tech shares is not at the levels of the bond market, I ask what happens if both the bond market and technology stocks start to unwind at the same time?

What are the potential catalysts?

June’s core CPI rose to a five month high which is suggesting the Fed may not have as much room as previously believed.

And then there is trade?  In either case a trade deal or no trade deal is potentially bearish for tech shares.  If there is a trade deal interest rates should rise because a major potential drag to growth is no longer present.  Higher interest rates by definition require higher corporate cash flow to support valuations.

If there is no deal, technology is perhaps the sector that will experience the greatest fallout, a scary environment when valuations are “stretched” at best.

What will happen this holiday shortened week?  The economic calendar is robust and because many may be on vacation the response too many top tier data point may be accentuated, specifically Friday as to when June’s employment data is released.

Last night the foreign markets were up.  London was up 1.83%, Paris up 0.83%  and Frankfurt up 1.23%.  China was up 2.22%. Japan up 2.13% and Hang Sang was closed.

The Dow should open significantly higher on the trade truce.  The 10-year is off 4/32 to yield 2.02%.

kent
The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. The information contained herein has been compiled from sources believed to be reliable; however, there is no guarantee of its accuracy or completeness. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. The material provided in Daily Market Commentaries or on this website should be used for informational purposes only and in no way should be relied upon for financial advice. Please be sure to consult your own financial advisor when making decisions regarding your financial management. Members of FINRA and SIPC, Capitol Securities Management is a privately owned full-service retail brokerage and investment advisory firm headquartered in Richmond, Virginia. For nearly 30 years, we have been serving the needs of our investors. Today, more than 200 Capitol Securities Management investment professionals and support staff serve approximately 18,000 customer accounts from Southern Florida to the New England coast.