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Protecting Against a Bear Market

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S&P 500 has rallied significantly since the beginning of 2019 and is up 16% year-to-date. The market is getting excited due to the Fed’s dovish stance. Although we do not usually want to fight the Fed, we believe that there are more risks and we expect volatility to increase and this bear market rally to end soon.

Here are few things that concern us.

Declining World Trade Volume: According to CPB World Trade Monitor data trade volume is plunging at the fastest pace in a decade. In February world trade volume decreased 1.7% month‐to‐month and world industrial production decreased 0.1% month‐to‐month.

Subprime Auto Loans: At the end of 2018, more than 7 million Americans were 90 days past due, on their auto loan payments, according to the Federal Reserve Bank of New York. That total represents an all-time high—and a further spike could send troubling ripples through the broader economy. This is happening at a time where the unemployment rate has been the lowest that we have ever seen.




South Korea GDP contraction: The South Korean economy contracted by 0.3% quarter-on-quarter in the January-March period this year, according to an advance estimate released by the country’s central bank. South Korea primarily exports high value goods to other countries with technical equipment and machines being 42% of their exports in 2017. When we see high value goods’ demand contracting, it usually signals more trouble ahead.

Divergence between large and small caps: Although we have seen S&P 500 approach its old high Russell 2000 is still 8% below the high that was made in August 2018. Although the divergence by itself is not a valid signal, it serves as a tell of the overall health of the market. In the chart below, the last time we saw this divergence was in September/October 2018 and the S&P 500 lost about 20% from October to December 2018.


Current Earnings and Forward Guidance: As of this writing 215 S&P 500 companies have reported their Q1 numbers where 79% beat EPS estimates and 62% beat revenue estimates. Analysts had significantly reduced the earnings estimates for Q1 hoping that things will pick up in Q2 and Q3. Apparently, the forward guidance provided by some of the blue-chip companies do not make us believe that the earnings will be better in the near future.

Some of the notable warnings came from the semiconductor industry: Texas Instruments (TXN), Xilinx (XLNX), Intel (INTC) all came up with a disappointing guidance. What is especially worse is that the slowdown occurred in their data-center business which was supposed to be recession-proof. Semiconductor ETF (SMH) was driven to record high valuation by momentum chasers and it is time for them to come down to reasonable valuation.

3M (MMM) has been around since 1902 and its revenues are highly correlated with the general health of the economy. Revenue reported in the 3M earnings release for the first quarter of the year came in at $7.86 billion. This is down from the company’s revenue of $8.28 billion reported

in the first quarter of the previous year. Analysts were expecting revenue of $8.02 billion for the period.

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Protecting Against A Bear Market



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