Summary: GDP growth in the first quarter was, by various measures, among the best since the end of the recession. Real GDP grew 3.0%, the second highest growth rate in the past 5 years. GDP excluding inventories grew 2.5%, the third highest rate of growth in the past 8 years. Personal consumption grew 3.0%, the highest growth rate in 5 years.
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First quarter GDP figures were released Wednesday morning. The Wall Street Journal summed up the consensus opinion: "US Economic Growth Nearly Stalls Out".
Summary: new price highs are usually bullish as all investors are in a profitable position and not in need of selling. We don't like to be cautionary when price is bullish, but the reality is that prior moves to new highs have failed in the past year and several measures of breadth, sentiment and volatility suggest that is likely to be the case again now.
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New bull market highs were formed by several indices this week. For the week, NDX was up 4.2%; it was the clear leader. SPY gained 1.8% and RUT gained 1.2%. NDX and SPY made new highs; RUT and DJIA did not.
Overseas, EEM continued to lead, gaining 2.7%. Europe gained 1.2%.
After rallying 5 weeks in a row, crude took a break, losing 0.9%.
The broader Nasdaq Composite Index (COMPQ) closed at a record high for the first time in 15 years.
Making new highs shows a bullish trend. The recent challenge for the market has been sustaining momentum from one week to the next. NDX, for example, has still not been up two weeks in a row since mid-February.
Over the last several weeks, SPY has lost 2%, gained 2%, lost 1% and now gained nearly 2%.
To be succinct, the question going forward remains the same as it has been in recent weeks: will the market show bullish strength by becoming and staying overbought and thus trending higher, or will it continue the pattern of giving back most (or all) of those gains in subsequent weeks?
Starting with NDX, the picture looks very bullish. NDX traded in a 3 month range from November to January (yellow shading). It had been in a higher range the past 3 months, until Friday's breakout higher. It is overbought for the first time since February (top panel). The February breakout continued higher nearly 4%; optimistically, that could be the set up now as well.
Summary: Failed sell offs lead to failed rallies. This has been the recurrent pattern for the past four months. There is unlikely to be a sustained move higher until there is a more complete sell off lower. Risk remains to the downside.
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Stocks rose strongly a week ago, then promptly fell back lower this week. This has become a regular pattern in 2015. For the week, SPY and RUT lost 1%. NDX lost 1.6%.
Overseas, Europe fell 2.2%. Emerging markets were the relative strength winner, losing only 0.4%.
Crude gained more than 8%. It has now risen 5 weeks in a row.
The set up coming into the week was this: the indices were at the top of their recent range and not yet overbought. As we said then, a test of strength was at hand, as bullish markets become and remain overbought while trend-less ones fail at moments like these.
In the event, the markets once again failed.
Our bottomline remains as follows: failed sell offs lead to failed rallies. This has been the recurrent pattern for the past four months. There is unlikely to be a sustained move higher until there is a more complete sell off lower. Risk remains to the downside.
This pattern is most easily seen on the weekly timeframe. RSI became overbought during the prior multi-year run higher (yellow shading, top panel); since December, every rally has failed with lower momentum. But, instead of resetting with a larger sell off, the dips have been short and shallow (pink shading). This has produced a trend-less market.
Every month, we review the latest BAML survey of global fund managers. Among the various ways of measuring investor sentiment, this is one of the better ones as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $600b in assets.
The data should be viewed mostly from a contrarian perspective; that is, when equities fall in price, allocations to cash go higher and allocations to equities go lower as investors become bearish, setting up a buy signal. When prices rise, the opposite occurs, setting up a sell signal.
To this end, fund managers became very bullish in July, September, November and December, and stocks have subsequently sold off each time. Contrariwise, there were some relative bearish extremes reached in August and October to set up new rallies. We did a recap of this pattern in December (post).
Summary: In April, fund managers maintained their global allocation to equities at one of the highest levels since the bull market began. It has been 1 standard deviation over the long term mean for three months in a row. Under similar circumstances in the past, long equities has had a poor risk/reward profile over the next month or so. Eurozone and Japanese equities are both 1.3 standard deviations overweight. US and emerging markets are out of favor and are contrarian longs.
Let's review the highlights.
Fund managers maintained their cash levels at 4.6%. While this is relatively high on a historical basis, note that cash levels haven't been much below 4.5% since early 2013. We consider current levels to be neutral.
Summary: US markets once again look set-up to continue higher, as they have multiple times in the past four months. Each time in the past, however, they have instead reversed lower. Equities may continue higher this week - they are not overbought - but it seems unlikely that the largely trend-less environment has ended once and for all. Sentiment and volatility suggest unfavorable risk/reward on a one-month timeframe.
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Following the disappointing NFP release, equities rebounded strongly. For the week, SPY and DJIA were up 1.7%. NDX led, gaining 2.5%. The leader the past few weeks, RUT, has become the laggard, gaining just 0.7%.
Once again, ex-US markets were even stronger. Both Europe and emerging markets gained nearly 4%.
Rebounding optimism on worldwide growth contributed to a nearly 5% rise in crude. This was a tailwind for US equities.
There was a potential change in market character this week. SPY rose 3 days in a row for the first time since February 18 (recall that it rose for another two weeks). Moreover, in 4 of the past 5 weeks, the high has been made on a Monday and the markets sold off the rest of the week. This week, in comparison, the low was at the open on Monday and the markets gained the rest of the week.
In other words, the markets are showing less weakness and indecision and more strength for the first time in more than a month.
The question is, will there be follow through higher. And the bottomline is this: US equities have been set up for higher prices, just as they are now, multiple times over the past four months and each time they have instead reversed lower. It's possible equities move higher this week but it seems unlikely that the period of sideways, trend-less trading has come to an end.
Let's review the indices.
RUT closed the week back at its late March ATH; this might be resistance at the start of next week. The trend in RUT is clearly higher, but the advance is getting lethargic. The candles over the past 2 weeks overlap each day and momentum is barely positive (top panel). Price is in the middle of a rising wedge. On weakness, support from the wedge bottom rail is 2% lower, near 1240.
In May 2014, we started a recurring monthly review of all the main economic data (prior posts are here).
In the past year, the consensus view has been that growth in wages and employment would soon accelerate and that this would lead to a meaningful increase in inflation above the Fed's 2% target. Our monthly review of the data has consistently shown this expectation to be premature.
The irony now is that economic data has seemingly turned negative over the past month. We think this weakness is transitory, mostly driven by the huge drop in energy prices which has lowered inflation and depressed "nominal" price growth. "Real" growth remains positive.
More importantly, the fact that monthly data can swing between extremes underscores the importance of focusing on the trend. And the trend in the majority of the macro data remains positive.
This post updates the story with the data from the past month. Highlights:
March was the first month in the past 12 where employment gain was less than 200,000. Including March, the average monthly gain in employment during the past year was 260,000, the highest since 1998
Despite a trend of improving employment, there hasn't been any notable sustained acceleration in wages
Real personal consumption (70% of GDP) grew 3.0% in February, the second highest rate of growth in 4 years. Core durable goods and industrial production grew 3.1% and 3.5%, respectively
New home sales were the highest in 7 years
However, the inflation rate continues to decelerate. It is near its lowest level since 2009
Our key message has so far been that (a) growth is positive but modest, in the range of ~3-4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely. This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels.
Let's review each of these points in turn. We'll focus on four categories: labor market, inflation, end-demand and housing.
Employment and Wages
The March non-farm payroll (126,000 new employees) was disappointing. It was the first monthly print under 200,000 in a year. It hadn't been above 200,000 that many months in a row since 1993-95.
In the past 12 months, the average gain in employment was 260,000, the highest since 1998.
Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 200,000. That has been a pattern during every bull market. So while the March print of 126,000 was lower than expected, it fits the historical pattern. A low print was long overdue.
Today, the BLS released its monthly report on labor, commonly referred to by its acronym, NFP (non-farm payroll). This is the single most followed statistic about the state of the economy, giving onlookers a regular view into employment and wage growth.
Employment fell dramatically in March, missing expectations by 120,000. Equity futures dropped 1% in the half hour following the release of the report.
The drop in employment should not have taken many by surprise. Let's explain why and what today's miss means for the economy and the stock market.
There are three things to know about the NFP data.
The first is this: it's common for the monthly prints to be volatile. Today's report was nothing unusual at all.
The chart below looks at the 1980s-2000s. It has been a regular feature of monthly reports to vary from zero to over 400,000-500,000. Even during the 1990s bull market, NFP was negative in 1995, 1996 and 1997. It was close to 100,000 several times in 1998 and 1999. 2002-07 was the same, with multiple months near or under 50,000 during the heart of the bull market.
There are two myths associated with stock repurchase programs (buybacks). The first is that companies with large buybacks consistently outperform the market; they don't. The second is that buybacks are responsible for most of the market's earnings growth; it's not even close to being the case.
It is true that buybacks are an important source of demand and that it has pushed the market indices higher. So it's noteworthy that the amount of money being spent on buybacks has been declining since the start of 2014. That US equities have struggled to move higher over the past 5 months might well reflect, in part, the diminishing inflows from stock buybacks.
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One of the things that everyone knows is that the stock market has been driven by stock buybacks. So it's noteworthy that the companies doing buybacks have not been outperforming the S&P in the past 18 months.
For most of 2014, the S&P index (blue line) outperformed the buyback index (red line). So far in 2015, their performance has been exactly equal. Both have vastly underperformed the Nasdaq 100 (green line).