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After an impressive summer rally, the recent stock market rise is losing steam, giving way to worries over tighter monetary policy and economic slowdowns. Greg Bonnell talks with Phil Davis, founder, philstockworld.com about the risks to the markets and his outlook for the year.
Transcript
Greg Bonnell: Welcome to MoneyTalk. I’m Greg Bonnell sitting in for Kim Parlee this week. Of course, summer is fast coming to an end, and the summer rally that we’ve seen in equities is being put to the test. So what will the markets do as we head into the fall? Joining me now is Phil Davis, founder of philstockworld.com. Phil, great to have you with us. Want to start off with the audience explaining your discipline. You’re not a technical analyst. You studied the fundamentals, and yet you do use charts a lot in your work. Explain your process to us.
Phil Davis: Oh, sure. Hi, Greg. We’re fundamentalists, and what we do is basically we will analyze the top 10 positions on the NASDAQ and the top 20 positions on the S&P. On the NASDAQ, the top 10 are about 60% of the index. On the S&P, they’re 45% of the index. So when you know what those companies are going to do — in fact, we call the NASDAQ the AppleDAQ because Apple’s 20% of the NASDAQ now, so really, it only matter what Apple does. So we analyze the positions, and then we come up with a fair value for the total index. And then we use those values, and we apply what is — it’s similar to a Fibonacci sort of system to it that allows us to see the bands we expect for the highs and the lows around the fair value that we have for the index. Of course, we’re also going to take into account the macros and what’s going on otherwise. But it’s not TA. We just put it on a chart to illustrate where things are going. But it’s really numbers. We did it on a spreadsheet in the old days.
Greg Bonnell: Spreadsheet in the old days. You are putting on the charts now. We actually have a chart now that we can show the audience about some of those bands you’re talking about, the S&P. We’re going to throw it up, and of course, walk us through this. I’m seeing a couple lines here. Strong bounces, weak bounces. Explain it all to me.
Phil Davis: Mm-hmm. Well, we have something called the 5% rule. And the 5% rule is saying that the market tends to move in 5% increments. As I said, it’s sort of an offshoot of Fibonacci retracements, but more for the computer age. In other words, it’s not natural movements. These are computerized movements, because 90% of trading is computers these days. Once we establish our baseline, which in this case is 4,000 on the S&P, we then show the moves up and down from 4,000. Now, in this case, not a coincidence at all. We topped out at 4,800, which is 20% above the 4,000 line. And then if we divide that, the 800-point gap by 5, you have five blocks of 160 points in which it moves. The first two are going to be the strong bounce — the weak bounce and then the strong bounce, each 160 points apart. Those are the lines that we consider, based on other factors, to be the top of the range, because we just don’t see the valuations justifying a move higher, nor are the macros at this time being supportive of a higher move. So it’s like a river that’s going to go a certain way, and you can predict it very well. But then, if it rains a lot, you’ve got to say, okay, well, maybe it’s going to go a little more this way or a little more that way. That’s what this is. It’s basically — there’s a flow of what people are willing to pay for stocks, but then those are affected sometimes by a frenzy in the NASDAQ, or if people think things are getting better, they think the Fed is going to loosen. Whatever it is, it adjusts people’s trading patterns, but only within a certain range. You still don’t expect the river to make a sudden right turn and go to another town. It doesn’t work that way.
Greg Bonnell: That’s a great way to explain it. As you said, even though you had this chart and walked us through the method, you’re not a technician. You study the fundamentals. So let’s talk about the fundamentals. What we were worried about in the first half of the year that spurred that sell-off, we’re still worried about those same things. So heading into the fall, what do we need to be mindful of?
Phil Davis: What do we need to be mindful of? Let’s see. Obviously, first — the biggest thing that you have is that in the Ukraine, you’ve got a nuclear plant where the employees are working at Russian gunpoint because the Russians took over the plant and are forcing all the workers to stay and make sure the thing doesn’t blow up. That’s an accident waiting to happen, literally. COVID could come back. The recession is coming. Whether it’s going to be a mild recession or a big recession, we don’t know yet, so we’re watching our numbers very closely, especially employment data and retail data. We’re paying attention to what the consumers are doing. China’s property market is possibly going to completely collapse, which will then bring the banks down. And if the banks start — and then that can be contagious across the world. Things like that. Just a couple of things that could go wrong.
Greg Bonnell: Okay, so those are some pretty big issues, and obviously the kind of thing that keeps people awake at night. And yet through the summer rally, it seemed that investors wanted to trade through that. Are we at risk again of another serious pullback after this bit of a bounce we’ve had since June?
Phil Davis: Absolutely. I mean, like I said, our fair value line on the S&P is 4,000. So now we’re only at 41 something. I don’t know where we close today, but we’re about 4,130, 4,140. So now we’re just around where we call the weak bounce line. And frankly, this is a range we predicted a year ago. These are the same lines we’ve been using all year because this is what we said would happen this year. So we’re happy, frankly. And in fact, that’s how we’ve been trading this range. So should it go down? Yeah, it could go back down to 4,000 and retest it. It depends what happens in Jackson Hole this weekend because the dollar is super strong right now. That’s putting downward pressure on the markets. And theoretically, at Jackson Hole, I expect the Europeans to be like, hey, dude, the euro has to be worth at least a dollar, so let’s do something about that. If that’ll weaken the dollar a little bit, I think over the weekend that we should get a bit lower for dollar, a little talk it down, and that will take a little pressure off. So I don’t think we going to have a fall below the 4,000 line. I think we’ll stay in this top end of the range, unless anything worse does happen.
Greg Bonnell: Phil, if we put on our optimist hats — and I agree with you there’s no shortage of things to worry about in this world. But if we put on our optimist hats, what could go right for us as investors through the rest of this year?
Phil Davis: Well, I mean, the dollar weakening isn’t really something going right, but it would help the markets. Inflation could calm down. The Fed could calm down about inflation and say, we’re only going to have to tighten 50 points next meeting, maybe 25 after that. Soon as people hear the word “25” coming out of the Fed’s mouth, they’re going to be rolling back into the stocks. The new vaccines coming out in September could actually make a huge dent in COVID, and we can sort of put that in the past. That would be huge, especially if China can start opening back up. That would be gigantic. If we start filling these jobs in a meaningful way — like especially if it’s — in the US, we have a huge problem with people who are not in the labor force. If people join the labor force and go back in — which is likely to happen, because with inflation, people who aren’t working need to start working, even if it’s in your family. You just might need that extra money. If we bring in more people into the labor force and fill up these jobs, that’s the best way to get it done, and that could cause a nice move up in the strength of the economy.
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