Friday, October 6, 2017

October Macro Update: Hurricanes End 83-Month Employment Expansion

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.

The bond market agrees with the macro data. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (arrows). The lag between inversion and the start of the next recession has been long: at least a year and in several instances as long as 2-3 years. On this basis, the current expansion will last well into 2018 at a minimum. Enlarge any image by clicking on it.


Saturday, September 30, 2017

Weekly Market Summary

Summary:  The major US indices traded at new all-time highs (ATH) again this week, led by surging small cap stocks. SPX is now higher 6 months in a row and 10 of the past 11 months; that level of momentum has never marked a bull market high.

Short-term optimism has reached an extreme that has resulted in a lower weekly close within the next 6 weeks every time over the past 5 years.

The fundamental narrative for the current rally is that the Trump administration's tax plan will boost earnings by an estimated 6%. If investors expect the tax plan to also cause economic growth to accelerate, then they are very likely to be disappointed.

* * *

SPX, COMPQ, RUT and NYSE made new all-time highs (ATH) again this week.  SPX has been up 5 of the last 6 weeks. The dominant trend remains higher. Enlarge any image by clicking on it.


Sunday, September 24, 2017

Weekly Market Summary

Summary:  The major US indices all traded at new all-time highs (ATH) this week. Even the lagging small caps index closed at a new ATH on Friday, and transports are very near a new ATH. Persistent strength like that seen throughout 2017 has almost always continued into year-end. However, like last week, a few studies suggest short-term upside will likely be limited. The third quarter ends on Friday.

* * *

US equities are now in the second longest and second strongest bull market of the post-war era. Enlarge any image by clicking on it.


Friday, September 15, 2017

Weekly Market Summary

Summary:  The major US indices all recorded new all-time highs (ATH) this week. The very broad NYSE, covering 2800 stocks, also made a new ATH, suggesting the rally is supported by adequate breadth. Longer-term studies and the fundamental macro data continue to indicate that further upside into year-end is odds-on. Remarkably, a new survey shows that fund managers are the most underweight US equities in 10 years, despite the SPX rising 9 of the last 10 months by an impressive 17%.

On a short-term basis, there are several reasons to be on alert for weakness over the next week or two.    An important FOMC meeting is on deck for Wednesday.

* * *

US equities remain in a long term uptrend. SPX, DJIA, NYSE, COMPQ and NDX all made new all-time highs (ATH) this week.

Long-term uptrends typically weaken before they reverse strongly. Note the bottom panel: the 20-wma will flatten in advance of a significant correction to price (yellow shading). This process has not started yet. That doesn't mean that an intermediate-term fall of 5-8% is unlikely; in fact, a correction by that amount is common in most years. But any such fall is likely to followed by a rebound to the prior highs before a more siginificant correction ensues.


Tuesday, September 12, 2017

Fund Managers' Current Asset Allocation - September

Summary: Global equities have risen 12% in the past 6 months and 17% in the past year, yet fund managers continue to hold significant amounts of cash, suggesting lingering risk aversion. They have become more bullish towards equities, but not excessively so with their hedging activity near a 10 month high.

Allocations to US equities dropped to their lowest level in 10 years (since November 2007) in September: this is when US equities usually outperform. In contrast, weightings towards Europe and emerging markets have jumped to levels that suggest these regions are likely to underperform on a relative basis. These weightings also suggest that Europe and/or emerging markets are likely to be the source for any global "risk off' event. Notably, the S&P has outperformed Europe's STOXX600 by 10% the past four months.

Fund managers are modestly underweight global bonds.

The US dollar has gone from overvalued a few months ago to the most undervalued in nearly 3 years. Fund managers had viewed the dollar as overvalued starting in November 2016; since then, the dollar has lost about 8%. Contrarians should be alert to a change in direction for the dollar.

* * *

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, fund managers are very overweight cash and underweight bonds. Their equity allocation is modestly overweight. 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. 


Saturday, September 2, 2017

September Macro Update: Employment Growth Slows Further

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.

The bond market agrees with the macro data. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (arrows). The lag between inversion and the start of the next recession has been long: at least a year and in several instances as long as 2-3 years. On this basis, the current expansion will last well into 2018 at a minimum. Enlarge any image by clicking on it.


Tuesday, August 29, 2017

Interview With Financial Sense on Identifying the Next Bear Market

We were interviewed by Cris Sheridan of Financial Sense on August 24th. During the interview we discuss current market technicals, the macro-economic environment, the investor sentiment backdrop and the prospect for future equity returns. One theme of our discussion is what to look for ahead of a bear market in US equities. Another theme is how the current period of low volatility will likely resolve.

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.

Sunday, August 6, 2017

Profit Margins Expand to New Highs to Boost 2Q17 Results

Summary: The headline numbers for 2Q17 financial reports are good: S&P profits are up 19% yoy; sales are 6% higher; profit margins are at new highs. This is in stark contrast to early 2016, when profits had declined by 15% and most investors expected a recession and a new bear market to be underway.

These strong results are not due to better oil prices. Sales for the sectors with the highest weighting in the S&P have grown an average of 9% in the past year. Moreover, margins outside of energy have expanded to 10.8%, a new high.

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) and margins already at new highs, it will likely take excessive bullishness among investors to propel S&P price appreciation at a significantly faster rate.

* * *

84% of the companies in the S&P 500 have released their 2Q17 financial reports. The headline numbers are good. Overall sales are 6% higher than a year ago, the second best growth rate in more than 5 years. Earnings (GAAP-basis) are 19% higher than a year ago. Profit margins are at new highs of 10.3%, exceeding the prior highs from 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.


Saturday, August 5, 2017

August Macro Update: Slowing Growth in Employment and Consumption

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.

The bond market agrees with the macro data. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (arrows). The lag between inversion and the start of the next recession has been long: at least a year and in several instances as long as 2-3 years. On this basis, the current expansion will last well into 2018 at a minimum. Enlarge any image by clicking on it.


Monday, July 24, 2017

Fund Managers' Current Asset Allocation - July

Summary: Global equities have risen 7% in the past 3 months and 16% 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 nearly their lowest level since November 2008 in July: this is when US equities usually outperform. In contrast, weightings towards Europe in particular have jumped to levels that suggest this region is likely to underperform. These weightings also suggest that Europe is likely to be the source for any global "risk off' event. Notably, the S&P has outperformed the Europe's STOXX600 by 7% the past two months.

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 eight months, fund managers are neutral towards the dollar after having considered it overvalued since November.  During this time, the dollar has fallen 7%. 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, fund managers are very overweight cash and very underweight bonds. Their equity allocation is modestly overweight. 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. 


Sunday, July 9, 2017

Weekly Market Summary

Summary:  US equities reached a new one-month low late last week before rebounding on Friday. In particular, NDX found support right on its mid-May low. This is now an important line in the sand, with implications for SPY as well; so long as the Thursday low holds, look for higher prices.

Despite general weakness in equites over the past several weeks, there have been no notable extremes in breadth, the volatility term structure or put/call ratios that often mark durable lows. On balance, this suggests any short-term gains are unlikely to be sustained longer-term. Moreover, in the past 2 weeks, equities have posted strong gains overnight that have been entirely given up during cash hours, a pattern that has the whiff of distribution.

Earnings reports for 2Q begin this week.

* * *

US equities remain in a long term uptrend. The 20-weekly ma (blue line) is often an approximate level of support during uptrends. Enlarge any image by clicking on it.


Saturday, July 8, 2017

Business Insider: The Most Important Finance People to Follow

Many thanks to the people at Business Insider for including us in their annual list of the Most Important Finance People to Follow for a fourth year. The full list is here.


Friday, July 7, 2017

July Macro Update: Recession Risk Remains Low

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.

The bond market agrees with the macro data. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (arrows). The lag between inversion and the start of the next recession has been long: at least a year and in several instances as long as 2-3 years. On this basis, the current expansion will last well into 2018 at a minimum. Enlarge any image by clicking on it.


Saturday, July 1, 2017

Weekly Market Summary

Summary:  SPX has gained every month in the first half of the year, and it is up 8 months in a row for just the fifth time in 26 years. Long streaks like these have consistently led to further gains in the following months. Likewise, strong gains to start the year - SPX gained 8% in the first half and NDX gained 16% - have most often led to further gains in the second half of the year. The bullish trend in equities is supported by continued advances in the macro economic data.

The crack that opened in NDX two weeks ago has widened further. The index has now fallen 5% and has broken below its 50-dma. The consistent historical pattern is for SPX to follow, lower. That hypothesis is further supported by bullish sentiment - at a 3-1/2 year high by at least one measure - and the exceedingly tight trading range in SPX over the past month which most often precedes an expansion in volatility.

* * *

For the week, large cap stocks lost 0.5% while the Nasdaq-100 (NDX) lost nearly 3%. The volatility index, VIX, gained 11%.

Equities have finished a very strong first half of the year. US large caps gained +8% while NDX gained twice that (+16%). Both of these outperformed the consensus long, Europe (+5%). But the best performing region to start the year was emerging markets, which gained an astounding +18%. Enlarge any chart by clicking on it.


Saturday, June 24, 2017

This Is What A Bubble Looks Like: Japan 1989 Edition

Summary: Take the US tech bubble of the 1990s, add the subsequent real estate bubble of the 2000s, multiply by two, and you have a good approximation of the events leading to Japan's stock market crash in 1990.

The Nikkei stock index rose more than 900% in the 15 years before it finally topped. It was a frenzy powered by a belief that Japan Inc. was on its way to taking over nearly every major industry worldwide. The stock market bubble was further fueled by a massive real estate bubble at least twice the size of the one the US experienced in the 2000s. Tokyo alone became more valuable than all the land in the US.  In short, it was the product of a tsunami of monumental and concurrent events that are unlike anything present in the US today.

* * *

Long advances in the stock market bring out fears that the rise will end in a crash. A current meme is how the US market today is just like the one leading up to the 1987 crash. That same argument was made in 2013, 2014 and 2016, and failed each time. More on that in a recent post here.

Today's stock market is sometimes compared to Japan's main stock index, the Nikkei, in the years leading up to its brutal crash in 1990.

Some might recall the Nikkei's spectacular advance. The index rose 30% in 1989 alone, but this came after a long bull market. Over the last 5 years of that bull market, the Nikkei rose 3.4 times; over the last 15 years, it rose more than 10 times. The rise was relentless.


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.