Research.LeutholdGroup

Technology stocks have outpaced the overall market during the last five years, and by an accelerating margin since the end of 2016. Naturally, they have become market darlings, replete with stories about remarkably innovative products with phenomenal growth potential.

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The S&P 500 trailing Price-Earnings (P/E) multiple is currently higher than 84% of the time since 1950. Appropriately, high valuations have become a concern for many investors. Although the market’s high P/E profile has reduced future return potential, at least historically, it does not necessarily suggest significant downside risk.

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As it often does, Friday’s jobs report will likely set the tone for the financial markets during the next few weeks. Since the January report, the employment numbers have been reassuring. A rise in the labor force has allowed solid job gains to coincide with a flattening in the unemployment rate near 4%, leaving an impression the labor market still has significant slack. 

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In the last few years, movements in the U.S. dollar have played a huge role in shaping the character of the recovery and the behavior of the financial markets. During the first half of this recovery, the trade-weighted U.S. dollar index (DXY) remained in a narrow range, but since 2014, its volatility has substantially increased.

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We first published the accompanying chart in March of this year. The PP ratio had just spiked sharply upward in the previous three months, as it did near the end of the dot-com era in 2000. Since, as shown, the PP ratio has been largely marking time during the last four months even though technology certainly has not lost its popularity.
 

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On a trailing earnings basis, the S&P 500 has been highly-priced above a 20x PE multiple (or below a 5% earnings yield) for most of the last two years. What does this suggest about future return potential, and perhaps more importantly, about the potential for negative returns? Although the absolute valuation of the stock market does impact future return potential, it has not been particularly useful in assessing the chance of losing money in the stock market. 

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Inflation/overheat worries have eased recently. The advance in the 10-year bond yield has stalled just below 3%, the upward trend in commodity prices paused once the U.S. dollar began rising in April, and wage inflation has failed to break above 3%. Indeed, the latest employment report left a goldilocks impression with a solid jobs gain, a rise in the labor force participation rate, and only a modest increase in wages. 

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Most traditional recession indicators remain uneventful. The recovery is old by calendar standards, the unemployment rate is low, and the Federal Reserve has begun to tighten monetary policy. 

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The contemporary character of the Main Street economy has often been a harbinger of future investment returns. Specifically, the mindset of private economic players (i.e., are they confident enough to engage in aggressive behavior or are worries dominating economic decisions) and the degree of resource slack (the unemployment rate) have often provided a good indication of how the financial markets may perform during the next five years! 
 

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The contemporary character of the Main Street economy has often been a harbinger of future investment returns. Specifically, the mindset of private economic players (i.e., are they confident enough to engage in aggressive behavior or are worries dominating economic decisions) and the degree of resource slack (the unemployment rate) have often provided a good indication of how the financial markets may perform during the next five years! 
 

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The contemporary character of the Main Street economy has often been a harbinger of future investment returns. Specifically, the mindset of private economic players (i.e., are they confident enough to engage in aggressive behavior or are worries dominating economic decisions) and the degree of resource slack (the unemployment rate) have often provided a good indication of how the financial markets may perform during the next five years! 
 

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Considering how this bull market began, while it may not be widely recognized, it has simply been too quiet now for too long. The accompanying chart illustrates that the last eight years have been among the four calmest and quietest of all stock markets during the post-war era!

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Another interesting echo, today, of the 1990s’ dot-com era, is how much the S&P 500 Technology sector has come to dominate price momentum (MOM) within the stock market. Like the late 1990s, stock market winners have become synonymous with technology. 
 

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Another interesting echo, today, of the 1990s’ dot-com era, is how much the S&P 500 Technology sector has come to dominate price momentum (MOM) within the stock market. Like the late 1990s, stock market winners have become synonymous with technology. 
 

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Another interesting echo, today, of the 1990s’ dot-com era, is how much the S&P 500 Technology sector has come to dominate price momentum (MOM) within the stock market. Like the late 1990s, stock market winners have become synonymous with technology. 
 

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Perhaps the stock market is taking its cue from the NBA back-to-back champion, Golden State Warriors (and winners of three of the last four titles). They employ an aggressive and entertaining “Offense-First” style of play driven by multiple all-stars firing “threes” with rapid abandonment from distances normally reserved for long touchdown passes!

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Haven’t we seen this movie before? Technology takes over the stock market late in a recovery cycle, seemingly making the bull ageless, pushing portfolios toward a more concentrated new-era exposure, stimulating investor greed bolstered daily by watching a chosen few (FANGs) rise to new heights, and convincing many that tech is really a defensive investment against late-cycle pressures which trouble other investments. 

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This year started with strong expectations for economic growth. A substantial tax cut and evidence the global recovery had finally synchronized significantly raised expectations for both the pace of economic growth and corporate earnings results.. 

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Since its early-2011 peak, gold has been a disappointing investment. Despite significant bouts of international turmoil and periodic renewed-crisis fears, the salve often provided by the shiny metal has eluded investors.

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Since its early-2011 peak, gold has been a disappointing investment. Despite significant bouts of international turmoil and periodic renewed-crisis fears, the salve often provided by the shiny metal has eluded investors.

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The jobs report this morning was spectacular! A 223K gain in payroll employment, a 15K upward revision to past months’ numbers, a drop in the underemployment rate to 7.6%, a decline in the unemployment rate to 3.8%, and a respectable monthly rise in wages of 0.3%! 

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Equity investors face a dilemma. Since the economy and profitability are doing well, should cyclical stocks be emphasized, or with the recovery getting old and because valuations are high, should defensive stocks be favored?..

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Here are a few unrelated concepts to chew on this week. No major overriding theme. Just a bunch of interesting “one-offs!”

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Fundamentally, the economic recovery has never been this good. U.S. real GDP growth is forecasted to rise by almost 4% in the current quarter, there is regular healthy job creation, the unemployment rate has fallen below 4%, household income gains are solid, profits are spectacular, confidence measures among both businesses and consumers are near historic highs, and for the first-time, economies about the globe are in a synchronized recovery!

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As the Federal Reserve keeps raising interest rates and the 10-year U.S. Treasury yield nears a seven-year high, investors wonder what yield level will bite the stock market? This may be the wrong question...

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Momentum investing is an investment strategy focused on profiting from a continuation of existing trends in the stock market. Stock prices which rise are more likely to keep rising. Buying stocks with strong positive price momentum (Mo) has long been a popular strategy. 

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Two indicators based on recent movements in the 10-year U.S. Treasury yield and the U.S. Dollar Index suggest economic momentum is likely to slow in the next several months while inflation continues to rise. That is, these indicators suggest the potential for a whiff of stagflation yet this year...
 

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Many investors are betting robust earnings this year will allow the stock market to regain its mojo. Earnings results should be spectacular, boosted by both a synchronized global recovery and by a sizable tax cut. However, the question for stocks is not whether companies will deliver, but rather, whether the stock market will respond? 

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Investors often face quandaries. Always present is whether the markets will rise or fall? Currently, a few perplexing issues are interesting and deserve some pondering. Is new leadership evolving in the stock market? Should you buy regulated or nonregulated FANGs? Why are energy stocks doing so well in Emerging Markets and so poorly in Developed Markets? 

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It’s not a question of IF, but rather WHEN. The U.S. output gap finally closed late last year, the unemployment rate is on the cusp of breaching 4%, and the pace of economic growth both here and abroad remains healthy. Wage inflation is going to rise above three percent soon! Maybe tomorrow, maybe later?

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Although struggles within the stock market are capturing most of the attention, stress signals are being whispered across the financial markets.

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The biggest risk facing investors today is the start of the next recession. In a few months, this recovery will enter its 10th year and challenge the longest ever in U.S. history. Just prior to the next recession, the stock market will likely enter a bear market while credit quality deteriorates significantly. Although volatility and corrections are always present in the financial markets, recession is what is feared most.

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Throughout most of this bull market, there has been too much panic. In the minds of investors, a return to the 2008 crisis or the second coming of the Great Depression was always just around the corner. In the last couple years, however, the U.S. economy has returned to full employment, the output gap has closed, real GDP growth has moved away from being stuck at slightly above 2% to perhaps trending closer to 3%, and the global economic recovery has synchronized in a positive way.
 

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Bull markets do not age by the clock but rather by their character and often end with investor aggressiveness and the comfort of popularity. In the latter stages of a bull market, confident investors usually prefer hares (i.e., aggressive, fast moving, high beta investments that have been highly successful and are therefore wildly popular), while tortoises (i.e., conservative, high quality, defensive stocks that only widows, orphans, and worrywarts would own) become universally panned!

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Just as a well-diversified portfolio is comprised by a variety of assets with uncorrelated returns, investment strategies often evolve from seemingly unrelated thoughts or perceptions. Individually interesting but essentially unrelated concepts sometimes expose a picture not otherwise considered...

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Tariffs have been the focus so far this week, but tomorrow morning all eyes will turn to the jobs report. Will there be another “hot” wage number or will wage inflation cool, easing recent concerns about higher inflation? 

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During the last couple years, cyclical sectors within the stock market have significantly outperformed defensive sectors. Robust economic growth and rising earnings expectations have driven investment flows toward economically-sensitive stocks. Moreover, many defensive stock market sectors have struggled with rising yields. If the stock market keeps rising, cyclical leadership may continue...

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Significant U.S. tax reform and a synchronized global recovery have stoked expectations for corporate earnings in 2018. By all accounts, corporate performance this year is poised to be spectacular. But, will this ensure solid performance from the stock market? 

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Calm returned to the financial markets last week after both the stock and bond markets were rattled by a rare inflation scare. Perhaps the sharp but brief 10% correction in the U.S. stock market was enough to launch yet another upward leg in the ongoing bull market? 
 

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Throughout 2017, positive economic reports boosted the stock market without aggravating inflation fears or yield pressures. Recently, however, good economic reports are starting to worsen inflation indicators, force bond yields higher and pressure the stock market. That is, good news is proving bad for the financial markets...

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