Inside The Stock Market ...trends, cross-currents, and outlook
S&P 500—Valuation Check-Up
In late January we speculated how long it would take for the S&P 500’s bloated valuations to reach more reasonable levels. The S&P 500 now trades back where it was in January and the seven-month break included some of the best growth rates most have ever seen. We found ourselves asking: Did chubby Mr. Market shed any pounds as he pedaled away on his stationary bike?
VLT Turns Up Again??
A “moderate-risk” S&P 500 VLT BUY signal was triggered at the end of August, but it’s not all good news. Any upturn in the VLT while the indicator is in positive territory also sets up a pattern known to veteran market analysts as the “Killer Wave.”
Real Rates And The Federal Deficit
We previously mentioned the increasing focus on the real short-term interest rate as an important measure of the Fed’s policy stance. In truth, we wish the Fed had paid more attention to this measure during this cycle.
The Commodity Bull That Equity Investors Missed...
While the bottom-line impact may ultimately be the same, there’s one thing we find more demoralizing than getting the direction of an asset wrong: getting the direction right and not getting paid for it.
Fondly Remembering The Year 2000...
Many equity investors have suggested there’s no comparison between today’s expensive market and the bubble peak of Y2K, pointing out that today’s Technology titans are “real companies” with massive revenue underpinnings.
Technical Difficulties
Traditional breadth measures have yet to show end-of-cycle thinning of the ranks, but some secondary measures suggest that process may be underway.
Breakout Or Fake-Out?
The S&P 500 has fully erased its January and February losses, but there’s probably a market message in the fact that it took so long to do so.
Beware The Policy “Narrative”
It’s been amusing to watch the narrative surrounding Fed policy evolve as the market has rallied.
Beware The Breakout
The S&P 500 finally erased the losses from its nine-day swoon in January and February.
Company Leverage And The Impact Of Rising Interest Rates
Higher corporate leverage and rising short-term interest rates have not yet led to problems in the credit markets, but investors should be mindful of potential risks.
“Unlevered” Treasuries Aren’t A Bubble
It’s been popular to argue that U.S. government bonds are a bubble while U.S. equities are not. But even if we agreed, the potential cyclical total return losses in Treasury bonds are a fraction of those likely to occur in an equity bear market.
Service Sector Slowdown?
While service industries have minimal direct exposure to trade disputes, they will begin to suffer from knock-on effects if the tensions continue to escalate.
Is The Trade War Short-Term Bullish?
We believe the U.S. free-trade initiatives of the last 25 years have been wildly bullish for the stock market.
A Market Breadth Mystery
It’s difficult to knock a stock market in which Small Caps and major breadth measures are making frequent new highs, however, there are performance anomalies that suggest liquidity is no longer sufficient to “float all boats.” Recent underperformance of the Equal Weighted S&P 500 is a case in point, at the same time, the current dichotomy in market breadth pales in comparison to the 1999-2000 episode.
Assessing The Correction
How do today’s cyclical conditions stack up with those accompanying other stock market declines?
Y2K All Over Again?
We’ve been reticent to draw links between the current bull and that of the late 1990s; we felt the last phase of the earlier episode was so extraordinary it was unlikely we’d see anything similar again in our lifetimes. But statistical parallels are on the rise, including the attempt by the S&P 500 to recoup its 2018 correction losses.
A Launching Pad??
A few clients pointed out that the longest-ever recovery from an intermediate correction (Apr. 1994–Feb. 1995) became the base from which the S&P 500 would eventually triple over the next five years. We’re not equipped to address that possibility in an objective fashion, so we’ll let you be the judge.
The Flags Are A-Flappin’!
The S&P 500 is on the verge of reversing its early-2018 losses and, if achieved, it would initially be accompanied by six “Red Flags”—which are based on key market indexes failing to record new highs in the 21 trading days preceding a new S&P 500 high. The last time the tally reached “six” was in May 2015—occurring at the final high before an S&P 500 loss of nearly 15% over the ensuing nine months.
Negative Feedback?
To summarize (and oversimplify), here are some of the frequent client responses to our prevailing “cautiously bearish” stance:
Trade-War Thematic Group
Trade wars or trade tensions, quietly started in 2017, hadn’t captured the market’s attention until early March this year—as demonstrated through a review of internet keyword search data of “Trade War” and “Tariff.” We present our Trade War thematic group which captures U.S. companies that could suffer the most from a trade war between the Trump administration and the rest of the world.
Apple Back Tickling 4%
Apple has added 10% to its market value since the end of January, and this action has pole-vaulted the Cupertino firm back into the rarefied air of the “4% Club” (S&P 500 weighting) for the fourth time in six years.
Foreign Stocks “De-Coupling”
Market action has been broader and better than we expected given monetary conditions, and Small Cap strength seems to lend credence to contention that rates aren’t yet high enough to bite.
An Old Chart Whose Time Has Come?
No, it’s not a 1990s-like love affair with the stock market. But it’s surely a sign of the times when TV pundits seem to have dropped even passing references to valuation when spinning their mostly bullish market yarns.
A New ISM “Composite”
Over the past year, we’ve highlighted three mechanical market models based solely on components of the ISM monthly manufacturing report (Charts 1-3).
Inflation Warning Flags?
After yet another benign figure on wages for June, the idea that inflationary pressures might be a problem for the stock market seems far-fetched.
Trouble Is “Spreading”
Junk bond option-adjusted spreads (OAS) have remained relatively tight throughout the stock market pullback and recovery (Chart 1), assuring some bulls that the action is nothing more sinister than a “healthy and overdue” correction.
Where’s The Spring In The Step?
Old age alone may not kill the bull, but it can make it more susceptible to an array of life-threatening maladies.
Multiple Personality Disorder?
Market behavior is always nebulous enough to generate diverging opinions, but lately it’s been sufficiently strange to give rise to a diverging set of facts.
The Bulls And Bears Agree!
Yes, bulls and bears now hold their respective positions for the same reason—i.e., the U.S. economy is exceptionally strong. The stock market is accommodating this rare bipartisanship with sufficient reason to support either position.
Shun ETFs With Largest Inflows
We found that ETFs with the largest one-month, two-month, and three-month fund inflows underperformed going forward. When further broken down by sub-asset class strategies, this pattern is pronounced among equity ETFs, while fixed income ETFs do not appear to be affected by fund flows.
Analysts, Summon Your Inner-Angler!
Quantitative investment firms are increasingly touting the cross-disciplinary backgrounds of their research staffs, with prior high-level experience in areas such as medical research and engineering not uncommon.
A Smart-Money Split
The Supply/Demand category carries the smallest weighting among the five factor groupings in the Major Trend Index, and this weighting is further diminished by the fact that its components rarely line up in a way which loudly proclaims that an “accumulation” or a “distribution” phase is underway. Today is just another of those typically inconclusive times.
What The Curve Does And Doesn’t Tell Us
The gap between the 10-year Treasury yield and the federal funds rate has narrowed sharply in the last year but remains a long way (~110 basis points) from inverting.
Is Market Breadth Misleading?
The stock market has narrowed, but not in the way we envisioned—nor in a way that’s consistent with most historical bull market tops. Small Caps and market breadth measures are traditionally the first to wilt when monetary tightening begins to hit the stock market. Instead, they are the leaders.
Is The Bull Just Napping?
Old age has certainly put no limitations on the bull’s exploits, so we should be cautious in reading too much into its meandering recovery path. However, it’s possible that action since the February low is not a recovery process but rather a countertrend bounce within a larger downtrend.
What A Difference A Year Makes
Early this year we chatted with the retired founder of a Midwest investment management and research firm. After living and breathing markets for six decades, this bearded and iconoclastic character had avoided financial publications, Bloomberg, CNBC, and the like for more than a year.
EM Country Rotation Based On A Stock Factor Model
Back testing shows stock-level factor alpha can be captured at the country level. With the rapid growth of single-country ETFs, this may prove an efficient, practical alternative to individual stock selection.
Cycle Collision?
The coming months form a bearish cross-section of two of the most prominent calendar anomalies: “Sell In May,” and the Presidential Election Cycle (in which the mid-term year is statistically the weakest). Between the two, we’d have to rate the former as more powerful and statistically persistent.
Staples Still Stomped Upon
Consumer Staples has historically been the sector most resistant to intermediate stock market corrections, exhibiting an average “downside capture” of less than 40% during all such declines dating back to 1989.