Saturday, June 17, 2017

Weekly Market Summary

Summary:  Most of the US indices made new all-time highs this week. SPY is making 'higher highs' and 'higher lows' and is above all of its rising moving averages; this is the definition of an uptrend. Moreover, the cumulative advance-decline lines made new highs this week, indicating that breadth generally remains supportive. Net, there appears to be little reason to suspect the indices have reached an important top.

That said, NDX has opened a noteworthy crack in US equities. NDX has fallen 4.5% in the past week. In the past 7 years, falls of more than 4% in NDX have preceded falls in SPY of at least 3%. That doesn't sound like much, but it would be the largest drop so far in 2017. A key watch out now is whether NDX weakens further and breaks both its 50-d as well as its mid-May low; if so, then SPY is likely to follow with its first 5% correction since the US election. These are the consistent historical patterns. Moreover, by at least one measure, bullish sentiment is at a 3-1/2 year high.

* * *

Our overall message continues to be that (a) trend persistence in equity prices, together with decent underlying macro data, is likely to lead US indices higher over the next several months and probably through year-end; and (b) an interim drawdown of at least 3-5%, sooner rather than later, seems to be odds-on.  A number of studies supporting this view were recently detailed here.

This week, SPY, DJIA, NYSE and RUT all closed at new all-time highs (ATH) on Tuesday. SPX has made 23 new ATHs this year. NDX, meanwhile, has closed above its 50-dma for more than 130 days in a row, the longest such streak since 1995 (from Bespoke). Both of these are clear indications of strong trend persistence. Enlarge any chart by clicking on it.


Tuesday, June 13, 2017

Fund Managers' Current Asset Allocation - June

Summary: Global equities have risen 5% in the past 3 months and nearly 20% in the past year, yet fund managers continue to hold significant amounts of cash, suggesting lingering doubts and fears. They have become more bullish towards equities, but not excessively so: less than half expect better profits and a better economy in the next 12 months.

Allocations to US equities dropped to their lowest level in 9 years in April and remain nearly this low in June: this is when US equities typically start to outperform. In contrast, weighting towards Europe and emerging markets have jumped to levels that suggest these regions are likely to underperform.

Fund managers remain stubbornly underweight global bonds. Current allocations have often marked a point where yields turn lower and bonds outperform equities.

For the first time in seven months, the dollar is no longer considered highly overvalued. Since November, the dollar has fallen 4%. A headwind to dollar appreciation has dissipated.

* * *

Among the various ways of measuring investor sentiment, the BAML survey of global fund managers is one of the better 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. We did a recap of this pattern in December 2014 (post).

Let's review the highlights from the past month.

Overall: Relative to history, managers are overweight equities and cash and very underweight bonds. Enlarge any image by clicking on it.
Within equities, the US is significantly underweight while Europe is significantly overweight. 
A pure contrarian would overweight US equities relative to Europe and emerging markets, and overweight global bonds relative to a 60-30-10 basket. 


Monday, June 12, 2017

Higher Environmental Standards Are Not Killing Jobs or Economic Growth

Summary: Higher environmental standards are being blamed for job losses in mining and manufacturing. A few months ago, foreign trade was to blame. Both reasons are wrong: 80% of these job losses are due to new technologies, not trade or environmental standards.

It's hard to argue that reducing carbon emissions has been economically harmful: the US is in the midst of its longest streak of jobs growth in its history. Coal employment fell 75% in the 20 years before the Environmental Protection Agency was even founded. Solar jobs are now 3 times greater than coal jobs, and growing fast. Cities like Pittsburgh have shed manufacturing jobs but gained three times as many "new economy" jobs in healthcare and technology. For these reasons, many Fortune 500 companies - including Exxon-Mobil, Chevron and Conoco - support efforts to curb emissions. American voters support the Paris Agreement by a wide 5:1 margin.

It's true that China is the world's largest source of annual CO2 emissions and home to many of Earth's most polluted cities. But China's emissions are overwhelmingly a function of its enormous size and its booming exports to the rest of the world. On a consumption basis, China's emissions are 20% more than the US but its population is 330% larger.  About 30% of China's emissions are due to consumption in the US and elsewhere.

The uncomfortable truth is that the US and the EU are the largest polluters in history. They are responsible for well over half the cumulative buildup of greenhouse gases in the atmosphere. The consumer habits of the average American creates emissions that are twice that of the average European, nearly 4 times that of the average Chinese and 18 times that of the average Indian.

* * *

Higher environmental standards are being blamed for job losses in mining and manufacturing. A few months ago, foreign trade was to blame. Both reasons are wrong: 80% of job losses in these areas are due to new technologies (article). We discussed this in a recent post here.

It's hard to argue that reducing emissions in the US has been economically harmful: regulations are far more stringent now than at any other time yet the US is in the midst of its longest streak of jobs growth - 79 straight months - in its history. The current economic expansion is the 3rd longest in history. Enlarge any chart by clicking on it.



Monday, June 5, 2017

Today Is Not Just Like 1987

Summary:  Today is not just like 1987.

* * *

In 1987, the stock market crashed.



Saturday, June 3, 2017

Weekly Market Summary

Summary:  All of the main US indices made new all-time highs this week. The indices appear to be supported by strong breadth, with 7 of the 10 SPX sectors also making new highs. This post reviews several studies that suggest price momentum is likely to carry the indices higher over the next several months and through year-end. That does not preclude an interim drawdown of at least 5% - we regard that as very likely, sooner rather than later - but any weakness has a strong probability of being only temporary.

* * *

SPX, NDX, COMPQ, DJIA and NYSE all made new all-time highs (ATH) again this week. The lagging small cap index, RUT, closed less than 1% from its ATH. The primary trend remains higher.

The new highs for the US indices were accompanied by ATHs in a majority of sectors: technology, industrials, consumer discretionary, utilities, staples, healthcare and materials. With broad indices like the NYSE (which includes 2800 stocks) and 7 of 10 sectors at new ATHs, it's hard to say that healthy breadth is lacking (more on breadth in a new post here).

SPX has risen 8 of the past 10 sessions. The only two loses were a mere 0.05% and 0.12%. The recent persistence of trend has been fairly remarkable and is likely to continue to provide a tailwind for equities.

Our overall message from last week remains unchanged and is paraphrased below:

SPX has risen 7 days in a row; that type of trend persistence has a strong tendency to carry the markets higher over the next week(s). Investors should not expect the bull market to be near an important top. Markets weaken before they reverse, and the existing trend has yet to weaken at all.  
That said, the month of June is seasonally weak and there are a number of reasons to suspect it will be again this year, not the least of which is the FOMC meeting mid-month. Markets anticipate the federal funds rate will be hiked for a 4th time: the prior three rate hikes have coincided with notable drawdowns in equities (as well as a fall in treasury yields). 

In February, we reviewed "a number of compelling studies suggesting that 2017 will probably continue to be a good year for US equities": that post is here.

This week, can add several more studies that further bolster the bullish case for equities over the next several months. That does not preclude the potential for an interim drawdown, but any weakness has a strong probability of being bought for at least a retest of the prior high.

Let's review.

First, when SPX has risen at least 6 days in a row, as it did last week, then SPX has closed higher 10 to 20 days later in 90% of instances since 2012. As the chart below shows, the typical pattern is for SPX to consolidate or retrace some of its gains in the middle of this period (corresponding to the next week and a half), followed by a higher high (from @Twillo using data from indexindicators.com). Enlarge any chart by clicking on it.


Friday, June 2, 2017

June Macro Update: Employment, Retail Sales and Housing Soft

SummaryThe macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

One concern in recent months had been housing, but revised data shows housing starts breaking above the flattening level that has existed over the past two years. A resumption in growth appears to be starting. That said, housing starts grew only 1% in the past year. Permits are up only 2%. This data bears following closely.

That leaves two watch outs. The first is employment growth, which has been decelerating from over 2% last year to 1.6% now. It's not alarming but it is noteworthy that expansions weaken before they end, and slowing employment growth is a sign of some weakening that bears monitoring.

The second watch out is demand growth. Real retail sales excluding gas is in a decelerating trend. In April, growth was just 1.6% after having grown at more than 4% in 2015. Personal consumption accounts for about 70% of GDP so weakening retail sales bears watching closely.

Overall, the main positives from the recent data are in employment, consumption growth and housing:
  • Monthly employment gains have averaged 186,000 during the past year, with annual growth of 1.6% yoy.  Full-time employment is leading.
  • Recent compensation growth is among the highest in the past 8 years: 2.6% yoy in 1Q17. 
  • Most measures of demand show 2-3% real growth. Real personal consumption growth in April was 2.6%.  Real retail sales (including gas) grew 2.2% yoy in April, making a new ATH.
  • Housing sales made a 9-1/2 high in March. Sales grew 1% yoy in April. Starts grew 1% over the past year.
  • The core inflation rate is ticking higher but remains near the Fed's 2% target.
The main negatives have been concentrated in the manufacturing sector (which accounts for less than 10% of employment). Note, however, that recent data shows an improvement in manufacturing:
  • Core durable goods growth rose 6.0% yoy in April. It was weak during the winter of 2015-16 but has rebounded in recent months. 
  • Industrial production rose 2.2% in April, helped by the rebound in mining (oil/gas extraction). The manufacturing component grew 1.9% yoy in April.
Prior macro posts are here.

* * *

Our key message over the past 5 years has been that (a) growth is positive but slow, in the range of ~2-3% (real), 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.

Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes. Enlarge any image by clicking on it.



A valuable post on using macro data to improve trend following investment strategies can be found here.

Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.


Employment and Wages

The May non-farm payroll was 138,000 new employees minus 66,000 in revisions.  In the past 12 months, the average monthly gain in employment was 186,000. Employment growth is decelerating.

Monthly NFP prints are normally volatile. Since the 1990s, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low print of 50,000 this March, 86,000 in March 2015 and 43,000 in May 2016 fit the historical pattern. This is normal, not unusual or unexpected.


Thursday, June 1, 2017

Using Breadth To Anticipate Market Inflection Points

Summary:  When equity indices move higher, you will often hear commentators suggest the rise is suspect because leadership is narrow. "Breadth is lagging," "small caps are lagging," "breadth is diverging" or "the indices are lying because the average stock is underperforming" are common warnings.

It's conventional wisdom that new highs in the stock market should be confirmed by "healthy breadth." In other words, you want to see a large number of stocks in uptrends as the index price moves higher. Similarly, small cap stocks should outperform the relatively fewer number of large cap stocks as breadth broadens.

All of this sounds intuitively correct: a broader foundation should equal a more solid market. Conversely, a narrowing market should be a warning of a likely market top. This is how most pundits use breadth to anticipate market inflection points.

But there are two problems with this view on breadth.

Most importantly, the conventional wisdom about "healthy breadth" being critical for future stock market returns is empirically false. Indices have typically been driven higher based on a small number of stocks contributing disproportionately large gains. Over the past 20 years, just 4% of stocks have typically accounted for almost 70% of annual gains in the SPX.

Moreover, most market drops over the past 15 years, including those with declines of more than 10% or 20%, have started when 80-90% of stocks have been in an uptrend. In fact, over the past 5 years, the SPX has gained more than 3 times as much over the following month when breadth was weak compared to when breadth was "healthy." Risk/reward has been more than twice as favorable when breadth has been weak as when it was healthy. The conventional wisdom on breadth and future market returns has been exactly wrong.

The second problem is that stock pundits' views on breadth conflict with their views on investor sentiment.  Important market tops are defined by excessive investor bullishness: "everyone" is a bull by the end of a bull market. But think about what this means for breadth: if investors are bullish, they should be less selective about which stocks they own. They should seek to own the riskiest, highest beta stocks in the market. This means that market tops should be defined by broad, not narrow, breadth. By the time breadth is "healthy", investors are overwhelmingly bullish and the market tops.

No single indicator is sufficient in assessing market inflection points. Using breadth has serious drawbacks.  But this post suggests a far more logical and useful methodology for using breadth to anticipate market inflection points than "lagging breadth," "breadth divergences, " or outperformance by small caps stocks.

* * *

It's conventional wisdom that new highs in the stock market should be confirmed by "healthy breadth." In other words, you want to see a large number of stocks in an uptrend, trading above their moving averages, as the index price moves higher.

Yet, consider the following:
At the October 2007 peak in the stock market, almost 85% of stocks were above their 50-dma. The index dropped 10% in the next month and 50% in the next year. 
In April 2010, almost 95% of stocks were above their 50-dma and 200-dma. The index dropped 15% in the next two months. 
In May 2011, 80% of stocks were above their 50-dma and more than 90% above their 200-dma. Just three months later, the index was 20% lower and feared to be in a new bear market. 
These are not isolated examples where breadth was considered "healthy" and the index was near a significant top. Others are highlighted below. In the past 15 years, almost every significant market drop was preceded by an overwhelming majority of stocks in the SPX being in an uptrend. An exception was the initial 10% fall in August 2015. Enlarge any chart by clicking on it.

Sunday, May 28, 2017

Weekly Market Summary

Summary:  US equity markets made new all-time highs again this week. By Friday, SPX had risen 7 days in a row; that type of trend persistence has a strong tendency to carry the markets higher over the next week(s). While a period of higher volatility than what has been seen so far this year is odds-on, investors should not expect the bull market to be near an important top. Markets weaken before they reverse, and the existing trend has yet to weaken at all.

That said, the month of June is seasonally weak and there are a number of reasons to suspect it will be again this year, not the least of which is the FOMC meeting mid-month during which markets anticipate the federal funds rate will be hiked for a 4th time. The prior three rate hikes have coincided with notable drawdowns in equities (as well as a fall in treasury yields).

* * *

SPX, NDX and COMPQ all made new all-time highs (ATH) again this week. Including dividends, the DJIA also made a new ATH for the first time since March 1. The primary trend remains higher.

The new highs for the US indices were accompanied by ATHs in several large sectors: technology, industrials, utilities and staples. The consumer discretionary sector had its highest ever weekly close.  The healthcare sector is within 0.5% of its March high. Likewise, the very broad NYSE is just 0.2% from a new ATH. With 6 sectors and the NYSE at or near new ATHs, it's hard to say that healthy breadth is lacking.

Notably, SPX has now risen 7 days in a row. In the past 5 years, this has occurred only 5 other times, 4 of which were during the 2013 boom. In all 5 instances, SPX closed higher again within the next 5 days by a median of 0.7%. By Day 5, SPX was higher 4 of the 5 times.

For a larger sample size, consider the strong performance after SPX has risen 6 days in a row. SPX closed higher either 10 or 20 days later in 9 of 10 instances since 2012. Risk/reward (defined as max gain versus max loss) during the next 10 days and the next 20 days was 6 times. Clearly, trend persistence overwhelmingly led to further gains and favorable risk/reward (table from Twillo using data from indexindicators.com). Enlarge any chart by clicking on it.


Tuesday, May 23, 2017

The Worry About Indexing is Overblown

Summary:  Investors are clearly shifting away from actively managed funds to those based on index strategies. Only time will tell, but this has the look of a durable, secular change in investment management. But much of the perceived threat to market stability of indexing is overblown. Overall, the stock market is still dominated by active management. And while the number of index products has clearly exploded, 96% of these are of insignificant size.

* * *

Bloomberg recently reported that the number of indexes has exploded and now exceeds the number of stocks in the US.  Enlarge any chart by clicking on it.


Wednesday, May 17, 2017

Fund Managers' Current Asset Allocation - May

Summary: A tailwind for the rally since February 2016 has been the bearish positioning of investors, with fund managers persistently shunning equities in exchange for holding cash.

Fund managers have become more bullish, but not excessively so. Profit expectations are near a 7-year high and global economic growth expectations are near a 2-year high.  However, cash balances at funds also remains high, suggesting lingering doubts and fears.

Of note is that allocations to US equities dropped to their lowest level in 9 years in April and remain equally low in May: this is when US equities typically start to outperform. In contrast, weighting towards Europe and emerging markets have jumped to levels that strongly suggest these regions are likely to underperform.

Fund managers remain stubbornly underweight global bonds due to heightened growth and inflation expectations. Current allocations have often marked a point of capitulation where yields reverse lower and bonds outperform equities.

For the sixth month in a row, the dollar is considered the most overvalued in the past 11 years. Under similar conditions, the dollar has fallen in value in the month(s) ahead.

* * *

Among the various ways of measuring investor sentiment, the BAML survey of global fund managers is one of the better 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. We did a recap of this pattern in December 2014 (post).

Let's review the highlights from the past month.

Overall: Relative to history, managers are overweight equities and very underweight bonds. Cash weightings are neutral. Within equities, the US is significantly underweight while Europe and emerging markets are significantly overweight. A pure contrarian would overweight US equities relative to Europe and emerging markets, and overweight global bonds relative to a 60-30-10 basket. Enlarge any image by clicking on it.


Sunday, May 7, 2017

Weekly Market Summary

Summary: US equities rose for a third week in a row, to new all-time highs. Trend persistence like this normally leads to higher highs in the weeks ahead. It's true that volatility has dropped to significant lows and that volatility risk is to the upside. But timing this "mean reversion" is tricky: SPX could rise several percent before VIX pops higher. It's not a stretch to say that US equities have been focused on this weekend's French election the past several weeks; there is, therefore, a "sell the news" event risk to be on the watch out for.

* * *

Trend
  1. NDX and COMPQ made new all-time highs (ATH) again this week. SPX made a new ATH on a closing basis, eclipsing the prior high from March 1. The primary trend is higher. 
  2. SPX ended the week overbought (as measured by the daily RSI(5)).  Upwardly trending markets are partially defined by their ability to become and stay overbought. This is a positive sign so long as it persists.
  3. After becoming overbought, the rising 13-ema is normally the approximate first level of support on weakness. This moving average has not been touched in the past two weeks, a positive sign of trend persistence. That level is approximately 2380 (a chart on this is here). 
  4. SPX has now risen 3 weeks in a row. This is a positive sign of momentum. SPX has a strong tendency to make a higher high after rising 3 weeks in a row (blue lines in the chart below).
  5. All of the above said, markets undulate higher. Even the most persistent trends suffer setbacks, however temporary. The current uptrend is now one of the three longest since the low in 2009; if past is prologue, a 5% correction is odds-on by the end of June. That should be the expectation of swing traders heading into summer. Read last week's post on this here. Enlarge any chart by clicking on it.



Friday, May 5, 2017

May Macro Update: Two Watch Outs Are Retail Sales And Employment Growth

SummaryThe macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

One concern in recent months had been housing, but revised data shows housing starts breaking above the flattening level that has existed over the past two years. A resumption in growth appears to be starting.

That leaves two watch outs. The first is employment growth, which has been decelerating from over 2% last year to 1.6% now. It's not alarming but it is noteworthy that expansions weaken before they end, and slowing employment growth is a sign of some weakening that bears monitoring.

The second watch out is demand growth. Real retail sales excluding gas is in a decelerating trend. In March, growth was just 2.0% after having grown at more than 4% in 2015. Personal consumption accounts for about 70% of GDP so weakening retail sales bears watching closely.

Overall, the main positives from the recent data are in employment, consumption growth and housing:
  • Monthly employment gains have averaged 187,000 during the past year, with annual growth of 1.6% yoy.  Full-time employment is leading.
  • Recent compensation growth is among the highest in the past 8 years: 2.6% yoy in 1Q17. 
  • Most measures of demand show 2-3% real growth. Real personal consumption growth in 1Q17 was 2.8%.  Real retail sales (including gas) grew 2.7% yoy in March.
  • Housing sales grew 16% yoy in March. Starts grew 9% over the past year.
  • The core inflation rate is ticking higher but remains near the Fed's 2% target.
The main negatives have been concentrated in the manufacturing sector (which accounts for less than 10% of employment). Note, however, that recent data shows an improvement in manufacturing:
  • Core durable goods growth rose 6.4% yoy in March. It was weak during the winter of 2015-16 but has slowly rebounded in recent months. 
  • Industrial production rose 1.5% in March, helped by the rebound in mining (oil/gas extraction). The manufacturing component grew 1.0% yoy in March.
Prior macro posts are here.

* * *

Our key message over the past 5 years has been that (a) growth is positive but slow, in the range of ~2-3% (real), 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.

Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes. Enlarge any image by clicking on it.



A valuable post on using macro data to improve trend following investment strategies can be found here.

Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.


Employment and Wages

The April non-farm payroll was 211,000 new employees minus 6,000 in revisions.  In the past 12 months, the average monthly gain in employment was 187,000. Employment growth is decelerating.

Monthly NFP prints are normally volatile. Since the 1990s, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low print of 79,000 last month, 84,000 in March 2015 and 24,000 in May 2016 fit the historical pattern. This is normal, not unusual or unexpected.


Better Sales And Profit Growth Are Behind Good 1Q17 Results, Not Financial Engineering

Summary: S&P profits are up 22% yoy. Sales are 7.2% higher. By some measures, profit margins are at new highs. This is in stark contrast from a year ago, when profits had declined by 15% and most investors expected a recession and a new bear market to be underway.

Bearish pundits continue to repeat claims that are more than 20 years old: that "operating earnings" are deviating more than usual from GAAP measurements, and that share reductions (buybacks) are behind most EPS growth. These are both wrong. Continued growth in employment, wages and consumption tell us that corporate financial results should be improving, as they have in fact done.

Where critics have a valid point is valuation: even excluding energy, the S&P is now more highly valued than anytime outside of the 1998-2000 dot com bubble. With economic growth of 4-5% (nominal), it will likely take excessive bullishness among investors to propel S&P price appreciation at a significantly faster rate.

* * *

A little over 60% of the companies in the S&P 500 have released their 1Q17 financial reports. The headline numbers are good. Overall sales are 7.2% higher than a year ago, the best annual rate of growth in more than 6 years. Earnings (GAAP-basis) are 22% higher than a year ago. Profit margins are back to their highs of nearly 10% first reached in 2014.

Before looking at the details of the current reports, it's worth addressing some common misconceptions regularly cited by bearish pundits.

First, are earnings reports meaningfully manipulated? This concern has been echoed by none other than the chief accountant of the SEC, who has complained about non-GAAP earnings numbers being "EBS", or "everything but bad stuff." Enlarge any image by clicking on it.


Monday, May 1, 2017

Weekly Market Summary

Summary: US equities ended the month of April above or near new all-time highs. There are no significant extremes that suggest the trend higher will suddenly end. But the upcoming "summer months" are normally marked by lower price appreciation and larger drawdowns. Into this period, it is notable that SPX's streak without a correction of 5% or more is nearing the longest of the 8 year old bull market.

* * *

US indices closed above or near new all-time highs (ATH) last week. In the past two weeks, SPX has gained 2.4% while NDX and RUT have each gained more than 4%. The set up for these gains was detailed here.

Overall, the trend in equities remains higher, supported by breadth, sentiment, volatility, macro and seasonality. All of that said, the first correction of at least 5% is increasingly likely to take place in the next two months.

Let's recap where markets currently stand as the month of May begins.

Trend: NDX and COMPQ made new ATHs this past week, as did RUT. On a total return basis, SPX is also at a new ATH. The primary trend is higher. After becoming overbought (top panel), the rising 13-ema is normally the approximate first level of support on weakness (green line and arrows). Enlarge any chart by clicking on it.



Tuesday, April 25, 2017

Fund Managers' Current Asset Allocation - April

Summary: A tailwind for the rally since February 2016 has been the bearish positioning of investors, with fund managers persistently shunning equities in exchange for holding cash.

Fund managers have become more bullish, but not excessively so. Profit expectations are near a 7-year high and global economic growth expectations are near a 2-year high.  However, cash balances at funds remains high, suggesting lingering doubts and fears.

Of note is that allocations to US equities dropped to their lowest level in 9 years in April: this is when US equities typically start to outperform. In contrast, weighting towards Europe and emerging markets have jumped to levels that strongly suggest these regions are likely to underperform.

Fund managers remain stubbornly underweight global bonds due to heightened growth and inflation expectations. Current allocations have often marked a point of capitulation where yields reverse lower and bonds outperform equities.

For the fifth month in a row, the dollar is considered the most overvalued in the past 11 years. Under similar conditions, the dollar has fallen in value in the month(s) ahead.

* * *

Among the various ways of measuring investor sentiment, the BAML survey of global fund managers is one of the better 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. We did a recap of this pattern in December 2014 (post).

Let's review the highlights from the past month.

Cash: Fund managers' cash levels dropped from 5.8% in October 2016 to 4.9% in April. Recall that 5.8% was the highest cash level since November 2001. Cash remained above 5% for almost all of 2016, the longest stretch of elevated cash in the survey's history. Some of the tailwind behind the rally is now gone but cash is still supportive of further gains in equities. A significant further drop in cash in the month ahead, however, would be bearish. Enlarge any image by clicking on it.


Sunday, April 23, 2017

Weekly Market Summary

Summary: A week ago, a number of notable short-term extremes in sentiment, breadth and volatility had been reached, suggesting a rebound in equities was ahead. In the event, US equities gained 1% and both NDX and COMPQ made new ATHs.

But new uptrends are marked by indices impulsing higher as investors quickly reposition and chase price. Momentum quickly becomes overbought. Neither of these has happened, at least not yet. Some clarity from the French elections this weekend could free equities to move higher. Should SPX instead rollover, breaking the recent low on April 13 and head to the 2300 area, it's a good guess that a stronger rebound will follow: there are several indications that short-term investor sentiment has already become too bearish.

* * *

Since reaching an all-time high (ATH) on March 1, SPX has traded sideways in a 3% range. The ATH came on the day of the new president's State of the Union address and also corresponded with bullish sentiment extremes in, for example, the equity-only put/call ratio and the Investors Intelligence survey. Our recent posts have emphasized that these extremes, together with the subsequent loss in price momentum, are most often associated with a mild correction of 3-5%. A return to the 2300 area for SPX appeared to be odds-on. Read more on these points here and here.


Friday, April 14, 2017

Weekly Market Summary

Summary: US indices closed lower this week, but not by much. SPX lost just 1% and is just 3% from its all-time high. A number of notable short-term extremes in sentiment, breadth and volatility were reached on Thursday that suggest equities are at or near a point of reversal higher. The best approach is to continue to monitor the market and adjust with new data. That said, it's a good guess that SPX still has further downside in the days/weeks ahead.

* * *

Our last several posts have emphasized several points:
Strong uptrends (like this one) weaken before they reverse, meaning the current sell off is unlikely to lead directly into a major correction. 
Even years with powerful returns (like 2013) experience multiple drawdowns of 3-8% along the way, meaning the current sell off was due and is perfectly normal. 
There are a number of compelling studies suggesting that 2017 will continue to be a good year for US equities, meaning equities will likely end the year higher. 
Read more on these points here and here.

SPX ended the week at 2328, 3% off it's all-time high (ATH) made on March 1. That is a very mild drawdown. Our post last week argued that a sell off to at least the 2300 area (4% off the ATH) was likely. From that respect, a lower low is likely to still lie ahead. That post is here.

There were a number of notable short-term extremes in sentiment, breadth and volatility reached on Thursday that suggest a rebound in equities is ahead. Let's review these.

First, the equity-only put/call ratio reached a rare extreme on Thursday, with nearly as many puts as calls being traded on the day. That has happened only about a dozen times in the past 8 years. All of these have been at or near a short-term low in SPX (green lines). A rebound is likely ahead. That rebound might not last long, however: note that in several instances, the low was retested or exceeded in the days/weeks ahead (red arrows). Enlarge any chart by clicking on it.


Saturday, April 8, 2017

Weekly Market Summary

Summary: US indices made their all-time high in early March; aside from the Nasdaq, which made new highs this week, these indices have since moved sideways. SPX has alternated up and down 5 weeks in a row, producing little net gain. Seasonality is particularly strong in April, so a fuller retest of the March highs might still be ahead this month. And indications that 2017 will be a good year for equities continue to add up. But there is a notable set up in place for the first correction since November to trigger. This week is likely to be pivotal.

* * *

Our last weekly summary post two weeks ago emphasized two points. First, that strong uptrends weaken before they strongly reverse. Second, that even years with powerful returns (think 2013's 30% gain) experience multiple drawdowns of 3-8% along the way, meaning the smooth uptrend that had been in place from November to March has likely ended. That post is here.

In the event, SPX reversed and gained 2% at its highest point in the following week. That high was less than 1% from the index's all-time high (ATH). The broader NYSE was similar. Both NDX and COMPQ made new ATHs this week.

Still, it's accurate to say the reversal in equities has been weak so far. Uptrends (green arrows) are partially defined by their ability to become and then stay overbought (top panel). Since the State of the Union on March 1, SPX has failed in this regard. Short term moving averages are either declining or flat. Until this changes, SPX is likely to chop sideways or, more likely, test lower levels (yellow shading). Enlarge any chart by clicking on it.


Friday, April 7, 2017

April Macro Update: Employment Growth Continues to Decelerate

SummaryThe macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

One concern in recent months had been housing, but revised data shows housing starts breaking above the flattening level that has existed over the past two years. A resumption in growth appears to be starting.

That leaves employment growth as the main watch out: employment growth is decelerating, from over 2% last year to 1.5% now. It's not alarming but it is noteworthy that expansions weaken before they end, and slowing employment growth is a sign of some weakening that bears monitoring.

A second watch out is demand growth. Real retail sales excluding gas is in a decelerating trend. In February, growth was just 1.8%. Personal consumption accounts for about 70% of GDP so weakening retail sales bears watching closely.

Overall, the main positives from the recent data are in employment, consumption growth and housing:
  • Monthly employment gains have averaged 178,000 during the past year, with annual growth of 1.5% yoy.  Full-time employment is leading.
  • Recent compensation growth is among the highest in the past 8 years: 2.7% yoy in March. 
  • Most measures of demand show 2-3% real growth. Real personal consumption growth in February was 2.6%.  Real retail sales (including gas) grew 2.8% yoy in February.
  • Housing sales grew 13% yoy in February. Starts grew 6% over the past year.
  • The core inflation rate is ticking higher but remains near the Fed's 2% target.
The main negatives are concentrated in the manufacturing sector (which accounts for less than 10% of employment):
  • Core durable goods growth rose 3.4% yoy in February. It was weak during the winter of 2015-16 and is slowly rebounding in recent months. 
  • Industrial production has also been weak; it's flat yoy due to weakness in mining (oil and coal). The manufacturing component grew 1.4% yoy in February.
Prior macro posts are here.

* * *

Our key message over the past 4 years has been that (a) growth is positive but slow, in the range of ~2-3% (real), 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.

Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes (enlarge any image by clicking on it).



A valuable post on using macro data to improve trend following investment strategies can be found here.

Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.


Employment and Wages

The March non-farm payroll was 98,000 new employees minus 38,000 in revisions.  In the past 12 months, the average monthly gain in employment was 178,000. Employment growth is decelerating.

Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low print of 98,000 this month, 84,000 in March 2015 and 24,000 in May 2016 fit the historical pattern. This is normal, not unusual or unexpected.


Monday, April 3, 2017

Interview With Financial Sense on Identifying an Equity Market Top

We were interviewed by Cris Sheridan of Financial Sense on March 28. During the interview, we discuss current market technicals, the macro-economic environment, the investor sentiment backdrop and the prospect for future equity returns. The theme of our discussion is what to look for at an equity market top.

Our thanks to Cris for the opportunity to speak with him and to his editor for making these disparate thoughts seem cogent.

Listen here.



If you find this post to be valuable, consider visiting a few of our sponsors who have offers that might be relevant to you.

Friday, March 24, 2017

Weekly Market Summary

Summary: US indices have fallen nearly every day since the FOMC raised the federal funds rate on March 15th. This week, the SPX also experienced its first 1% daily loss in 109 days, bringing one of the longest such streaks in history to an end. There are a number of reasons to expect equities to be at or near a point of reversal higher. A retest of the recent high is likely.

That said, it's a good guess that the market's period of smooth, persistent strength over the past 4-5 months has come to an end. Higher volatility and more days with 1% losses (and 1% gains) lie ahead.

* * *

After a strong start to the year, the US indices have turned weak. Since the FOMC raised the federal funds rate on March 15, SPX has closed lower 6 days and higher only once. The 13-ema is now declining, indicating that the intermediate trend is down. There has been no reversal in price, yet, but there are several reasons to believe that a reversal may be near.

On Tuesday, after 109 days, the S&P finally fell more than 1% during one trading day. This was the third longest streak without a 1% loss in the past 36 years.

The charts below look at the 5 prior times since 1980 that SPX went more than 95 days without a 1% fall. It's a small sample but there is a consistent pattern: the index rallies at least 2-5% in the ensuing weeks. Within 2 weeks, SPX was back at its prior high 4 times. The one exception was 1993, which was also the only time that SPX was below its 50-dma; even then, it returned to its high within 2 months. In the other 4 instances, SPX was above its 50-dma, like now. Enlarge any chart by clicking on it.


Wednesday, March 22, 2017

Fund Managers' Current Asset Allocation - March

Summary: A tailwind for the rally over the past year has been the bearish positioning of investors, with fund managers persistently shunning equities in exchange for holding cash.

Sentiment has turned bullish.  Optimism towards the economy has surged to a 2-year high and profit expectations are near a 7-year high.  As a result, global allocations to equities rose to a 2-year high in March and "risk appetite" is also at a 2-year high. All of this suggests the big tailwind for equities has now dissipated. The one remaining positive is the high cash balance at funds.

Europe and Japan are now the most overweighted equity markets on a relative basis. Allocations to the US have dropped as the region has underperformed so far in 2017; this is where US equities typically start to outperform again. The weighting towards emerging markets has jumped in the past two months; this is now back to where the last two rallies in that region have started to fade.

Findings in the bond market are still of greatest interest. Inflation expectations are at 13-year highs, a level at which yields have reversed lower in the past.  Fund managers' allocations to global bonds fell to a more than 3-year low in March, a level which has often marked a point of capitulation.

For the fourth month in a row, the dollar is considered the most overvalued in the past 11 years. Under similar conditions, the dollar has fallen in value in the month(s) ahead.

* * *

Among the various ways of measuring investor sentiment, the BAML survey of global fund managers is one of the better 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. We did a recap of this pattern in December 2014 (post).

Let's review the highlights from the past month.

Cash: Fund managers' cash levels dropped from 5.8% in October 2016 to 4.8% in March. Recall that 5.8% was the highest cash level since November 2001. Cash remained above 5% for almost all of 2016, the longest stretch of elevated cash in the survey's history. Some of the tailwind behind the rally is now gone but cash is still supportive of further gains in equities. A significant further drop in cash in the month ahead, however, would be bearish. Enlarge any image by clicking on it.


Monday, March 20, 2017

Households' Equity Ownership Reaches 30%. It's Statistical Noise

Summary: Households have 30% of their financial assets in equities, the same proportion as they held at bull market peaks in the 1960s and in 2007. Does this mean another bear market is imminent? No. Two of the last three times the purportedly significant 30% level has been reached, stocks gained another 40-60%. The level is statistical noise.

Households' equity ownership proportion mostly reflects the appreciation in the stock market: their equity proportion fell almost in half in the last bear market yet during this time, investors actually added new money to equity funds. The level of households' assets in equities seems to closely predict high and lows in the stock market because they both measure the exact same thing: the level of the stock market.

There are better ways to measure investor sentiment and valuations, both of which, like the equity proportion, rise during bull markets and fall during bear markets.

* * *

Chances are you have seen a chart like the one below. It shows US households' equity ownership as a proportion of total household financial assets (blue line) versus the stock market (red line).  The message is usually this: US households now own more equity than at the stock market peak in 2007. It's a sign that another bear market is imminent. Enlarge any chart by clicking on it.


Sunday, March 12, 2017

The Set Up As The FOMC Get Ready For A Third Rate Hike

Summary: The FOMC is likely to enact a third hike in the federal funds rate this week. With economic data continuing to be good, the risk to equities of a rate hike is small. Higher rates indicate continued economic growth, so equities, commodities, the dollar and yields generally respond positively. However, the recent picture is more mixed: in particular, the dollar and yields have sold off after rates have been hiked. This was not the consensus' expectation, nor is it this time. Is another surprise likely now?

* * *

On Wednesday March 15, the FOMC is likely to raise the federal funds rate (FFR) for the third time during the current economic expansion. We wrote about what to expect ahead of the first rate hike here and the second rate hike here.

The Fed chair and its governors have very clearly signaled their intentions in advance of this meeting. The market places the probability of rate hike at over 90%. In just over a week, 10 year treasury yields have jumped 30 basis points (bp) to their highest level since December 15.

Why has the Fed telegraphed their intentions to the market so clearly? Doesn't this tie the FOMC's hands should interim data make a FFR hike unnecessary?

The FOMC has learned that surprising the market with a FFR hike is a very bad idea. With the SPX rising 15% since the election, a surprise would likely catalyze a big drop. Here are two examples of how this has happened in the past.

The 1966 bear market is one of only two bear markets since the 1940s that occurred outside of a recession. The approximate cause: the FFR was rapidly and unexpectedly raised from 4% to 6% (read more here).

More recently, the FOMC surprised the market with just a 25 bp FFR hike in February 1994. Going into the meeting, the market put only a 20% probability of a hike. What happened next? The SPX fell 10% in the next two months. So keeping the market constantly prepared for a possible change in the FFR has been the FOMC's modus operandi for a long time.


Friday, March 10, 2017

March Macro Update: Housing Sales and Starts Rebound

SummaryThe macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

One concern in recent months has been housing, but revised data shows housing starts breaking above the flattening level that has existed over the past two years. A resumption in growth may be beginning.

That leaves employment growth has the main watch out: employment growth is decelerating, from over 2% last year to 1.6% now. It's not alarming but it is noteworthy that expansions weaken before they end, and slowing employment growth is a sign of some weakening that bears monitoring.

Overall, the main positives from the recent data are in employment, consumption growth and housing:
  • Monthly employment gains have averaged 196,000 during the past year, with annual growth of 1.6% yoy.  Full-time employment is leading.
  • Recent compensation growth is the highest in nearly 8 years: 2.8% yoy in February. 
  • Most measures of demand show 3-4% nominal growth. Real personal consumption growth in January was 2.8%.  Real retail sales grew 2.9% yoy in January.
  • Housing sales grew 6% yoy in January. Starts grew 10% over the past year.
  • The core inflation rate is ticking higher but remains near the Fed's 2% target.
The main negatives are concentrated in the manufacturing sector (which accounts for less than 10% of employment):
  • Core durable goods growth rose 2.2% yoy in January. It was weak during the winter of 2015 and is slowly rebounding in recent months. 
  • Industrial production has also been weak; it's flat yoy due to weakness in mining (oil and coal). The manufacturing component grew 0.5% yoy in January.
Prior macro posts are here.

* * *

Our key message over the past 4 years has been that (a) growth is positive but slow, 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.

Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes (enlarge any image by clicking on it).



A valuable post on using macro data to improve trend following investment strategies can be found here.

Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.


Employment and Wages

The February non-farm payroll was 235,000 new employees plus 9,000 in revisions.  In the past 12 months, the average monthly gain in employment was 196,000. Employment remains solid.

Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low prints of 84,000 in March 2015 and 24,000 in May 2016 fit the historical pattern. This is normal, not unusual or unexpected.


Wednesday, March 8, 2017

Nominated: Best Financial Blog of 2016

We are truly honored to have been nominated as one of the best financial blogs of 2016. The award will be given out in New York City on March 30th as part of Stocktoberfest East. The ceremony will be hosted by Josh Brown and Howard Lindzon. More information can be found here.


Sunday, March 5, 2017

The Similarities (and Key Differences) Between 2017 and 2013 So Far

Summary: 2017 is off to a remarkably similar start to 2013. No two years are ever exactly the same, so there's no reason to suggest that 2017 will repeat the 30% gains achieved in 2013. But many of the technical and fundamental similarities between these years suggest that 2017 may continue to be a good year.

There are two watch outs, however, that make 2017 much higher risk than 2013. It's also worth recalling that equities fell 3-8% at six different points in 2013. Expecting 2017 to continue to ride smoothly higher will probably prove to be a mistake.

* * *

2017 is off to a remarkably similar start to 2013. Is it set to be a repeat of that year? It's an important question as stocks gained about 30% in 2013.

Consider some of the following:

2017, like 2013, is the first year in a new Presidential term.

Both years got off to a fast start. By March, SPX had gained 8% in both 2013 and 2017.

Both years started by making a string of new all-time highs (ATHs). By the end of February, the Dow Industrials had closed at a new ATH 12 days in a row. A similarly rare streak of 10 days took place by March 2013.

SPX is often weak in February. But the index gained in both January and February in 2013 and 2017. In the other instances that this has happened since 1945, SPX closed up for the full year every time by an average of 24% (more on this here).

Both 2013 and 2017 came on the heels of long, volatile periods. SPX dropped 20% in 2011 and started 2013 only  2% higher than 18 months earlier. Similarly, SPX dropped 16% in 2016 and started 2017 only 5% higher than 18 months earlier. In both years, a dip at the election in November caused the market to be oversold; in both years, the market was significantly overbought by March (top panel).