Communication Services - Strong Thursday Rally

The stock market rallied strongly again Thursday as the S&P 500 increased 0.78%, the Nasdaq increased 0.98%, and the Russell 2000 was up 0.43%.

As you can see from the chart below, the Dow was the last of the 4 major indexes to reach a new record after the January peak. It was up 0.95%. Under Armour was the biggest winner in the S&P 500 as it increased by 6.6%.

The biggest news out of the company is it will be laying off 400 workers. Wells Fargo announced it will be laying off 5% to 10% of its workers in the next 3 years.

That amounts to 13,250 to 26,500 workers. The firm is still reeling from its scandals and wants to adopt digital self-service capabilities. Red Hat was the biggest loser as it fell 6.5% because of the revenue miss I discussed in a previous article.

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Surprisingly, even though it seems like the S&P 500 has been doing amazingly, the 14-day RSI is only at 63.63 which isn’t as high as the recent peak in late August or anywhere close the January peak. That’s because it still includes the decline every day in the first week of September. If the market keeps increasing for 5 more days, it will have an extremely high RSI.

The CNN Fear and Greed index is already showing a bearish signal as it increased from 71 to 74 putting it one point away from extreme greed. It’s now at greed. After Micron’s earnings report, we now have 8 firms with their Q3 results out. 7 out of 8 firms beat their EPS estimates and 4 out of 8 beat their sales estimates.

EPS growth is below Q2’s rate, but still strong.

Communication Services - New Sectors Shift FANG

The best sectors were consumer staples and technology which increased by 1.16% and 1.17%.

The only down sector was energy which fell 6 basis points. This week is the last one with these sectors. As you can see from the chart below, technology, consumer discretionary, and telecom will lose their weighting and the communications sector will be created.

This is a great choice because the telecom sector is only Verizon, CenturyLink, and AT&T. With their acquisitions, they aren’t only telecom giants anymore.

Tech is a difficult sector to define because every company uses the internet now. This is the biggest change in the way sectors are organized since 1999.

Let’s review the major movers. Facebook, Alphabet, Twitter, A&T, Verizon, CenturyLink, Netflix, PayPal, Electronic Arts, Activision Blizzard, Disney, and Comcast will be in the communication services sector.

Apple and Microsoft are the only big tech momentum names that will remain in the tech sector. Apple will go from 16% of the tech sector to 20% because of this move.

If you’re buying the tech ETF, you’re now getting more of Apple. Amazon will stay in the consumer discretionary sector and have a massive weight because it’s almost as big as Apple and its sector will be about 7% smaller than tech.

It seems like the communication services sector will do well, but this change can be a sign that these firms have gotten too big which is disconcerting.

Communication Services - Best Quarter To Date Contributions

The table below reviews the quarter to date action as we come close to the end of Q3 with the sectors just about to change. As you can see, even though tech didn’t have the best quarter, it contributed the most to returns because it is the biggest sector.

Healthcare and industrials were up the most as they increased by 12.26% and 11.4%. The only down sector was energy which fell 0.86%. Apple was by far the biggest contributor to S&P 500 returns this quarter because it is the biggest company and provided 18.38% in returns.

That’s a contribution of 9.71%. Microsoft contributed 6.07% to S&P 500 returns.

You can see the woes of social media in the biggest losers list. Facebook was by far the worst contributor because it has the right combination of size and poor performance.

16.09% in losses gave it a -4.09% contribution. Twitter fell an astounding 32.4% this quarter. On Thursday, both were up as Facebook increased 1.82% and Twitter was up 1.12%.

Communication Services - Sales & Margins

Just three charts can tell you a lot about the fate of the market. As you can see below, sales growth, pre-tax margins, and after-tax margins are shown.

Record margins are the result of the tax cuts because pre-tax margins have been flat in the past few quarters. A pre-tax record in margins was hit this cycle, but it was in 2015.

The obvious interpretation of that data is that the tax cuts are driving the great results. While that is partially true, the top chart showing accelerated sales growth proves that’s not the only driver of earnings growth.

Sales growth is at its fastest rate since 2012. The problem for 2019 is sales growth comparisons will be tougher and there won’t be a tax cut to boost margins and the economy again.

It seems like everything to make 2018 as great as possible was done and all we’re left within 2019 is going to be higher rates and a global economic deceleration.

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Communication Services - Yields Soar Further

Treasury yields have been spiking in the past few weeks along with stocks.

The 10-year yield is now at 3.08% which is only 3 basis points from its cycle high. The 2-year yield is at 2.82% which is its cycle high. The curve has now steepened to 26 basis points.

This pushes off the next recession for at least a few months. This explains why analysis of the yield curve which implies a recession is certainly going to happen when it’s very flat, is mistaken. The curve can stay where it is or steepen for a few quarters without an inversion.