Sunday, September 17, 2017

Market Is In An Uptrend And Trends Tend To Persist

One strategist I read regularly and who prepares weekly technical commentary, Charles Kirk at The Kirk Report, had a reference in this week's report relative to the strength of the current market. Kirk highlighted the below quote from James DePorre,

"If you simply focus on what the pricing action is saying, then your job of profitably navigating the market becomes a lot less complex. The simple fact is that we are in a very long-term uptrend, and trends tend to persist. The media might have all sorts of headlines to create their narrative, but all we really need to know is that the odds favor the bulls in an uptrend and vice versa. At some point, that pattern (and trend) will change, but trying to predict it ahead of time is a hard way to make a living."
The quote is certainly applicable in the equity market environment investors are currently experiencing as corrections and pullbacks seem to be nearly few and far between. I noted this lack of volatility in a post late last week, The Risk Of De-Risking The Equity Portfolio. And as it relates to trends, over the long term, the market trend is one that moves higher as can be seen in the below chart. An important observation from the below chart is the fact the line mapping the current market advance falls between long term support (green line) and resistance (red line.) So one might say the market is neither oversold or overbought from a technical perspective when only evaluating the below chart.

Evaluating the long term is relevant and appropriate, but as famed economist John Maynard Keynes once noted, "In the long run we are all dead." So evaluating the shorter term market picture is important too.

Charles Kirk included the below chart with the quote he shared from James DePorre. The weekly two and a half year chart represents the New York Stock Exchange Composite Index. The index closed Friday at 12,080 and the technical chart pattern indicates a target price of 12,869. This target price represents a 6.5% advance from Friday's close. Obvious from the chart's pattern, if this return is realized, a move higher is highly unlikely to occur in a straight line. Kirk's commentary included with this chart noted,
"It rarely pays to bet against markets that have bullish plays in motion with a consistent series of higher swing highs and higher swing lows in the follow through. After acquiring its first reversal target this year, a secondary play remains in motion here in an apparent fifth-wave type advance. This chart suggests there is still plenty of upside potential left in the U.S. markets..."

Some additional market charts are included below. The charts note recent breakouts to the upside for the indexes: the NYSE Composite Index, the S&P 500 Index, iShares Europe ETF (IEV) and the iShare MSCI Emerging Markets Index (EEM). In short, beyond the U.S., markets around the world seem to be breaking out to the upside as well.

The first two charts in the above chart cluster also show the index moves to the upside are occurring on higher volume as well. The below chart displays the 'common stock only' advance-decline line volume for the NYSE Index.  This line also shows a break to the upside above resistance.

And finally, the last few weeks of September have a tendency to be weaker than the first two. On Wednesday, the market will hear from the Fed following a two day FOMC meeting and important insight might be gleaned from the Fed's statement about the pace of unwinding the Fed's balance sheet. Additionally, the S&P 500 Index closed at 2,500.23 on Friday and these round number levels have a history of resulting in market pauses. The below chart from MKM Partners, and provided by Rachel Shasha, shows the round number level pauses going back to early 2015.

In summary, market valuations do seem elevated, but in a low interest rate environment, these valuations levels do not seem out of line. And as I have noted in earlier posts, valuations alone do not cause corrections. Investments outside of equities are difficult for investors due to the low yields they generate. Certainly, cash and high quality bonds can serve as an important foundation in an equity market pullback, but upside returns in cash and bonds appear to be muted if equities continue to advance higher. The absence of any significant pullback over the last two years is a bit of a concern; however, the market technicals are indicating equities want to move higher. As many have noted, the market is in a very long-term uptrend, and trends tend to persist.

Saturday, September 16, 2017

Stocks Need Some Healthy Competition

It seems a day does not go by where various strategists lament the market's valuation and lack of any significant pullback in over a year and a half. Not only are the valuations of a number of equity indices above their long term average, some might say the valuations are indicative of the speculative froth in the market. One data point highlighted is the margin debt level. Certainly margin debt has increased as can be seen in the first chart below. However, the second chart shows that margin debt as a percentage of total equity market capitalization has remained fairly stable since 2010. A good article on evaluating margin debt can be found in a MarketWatch article from a few years back, Cash vs. margin debt is the real problem for this market.

I have discussed in a number of prior posts that equities can trade at higher valuations in a low interest rate environment like we are experiencing at this point in time. Therein lies the issue with stocks. Interest rates around the world are at low levels and negative yields on many debt issues. Investors that desire a decent income return on their investments are hard pressed to find that in the bond market. The below chart compares yields on selected investments in the U.S. and around the globe. Excluding the yield on high yield investments, 5.5%, all the other yields in the below chart are 2.2% or lower.

So income yields on many bond investments are at rock bottom levels, and then compare these yields to total returns and investors can see stocks have far outpaced bonds. This disparity in returns has led some bond investors to position assets in what they would call bond-like stocks, that is, higher yielding equities such as utility stocks. These bond-like stocks are not bonds and are highly correlated to the broader equity market.

Historically, an investor might hold bonds in a portfolio to serve as a shock absorber in an equity market pullback. This shock absorber benefit remains an important reason to own bonds today even though yields are low. The other reason investors, and specifically retirees, would hold bonds, is they felt they were receiving adequate income from the bonds to support their spending needs. However, today, receiving a 4%-5% yield on a U.S Treasury seems like a far fetched idea at the moment.

Next week the Federal Reserve has a two day FOMC meeting culminating with an interest rate announcement on Wednesday afternoon. The market is not expecting a rate increase coming out of this meeting; however, we believe rates need to continue their trend higher and believe the Federal Reserve is behind the curve on increasing rates in this cycle. This low level of interest rates has led many investors to conclude this is a T.I.N.A. market, i.e, There Is No Alternative to stocks.

As the final chart below shows, the Fed has been able to get the Fed Funds rate back to a level last seen in 2003/2004. Much work is yet to be done to get rates back to a more normalized level of say 2%-3% though. By allowing longer term Fed assets to roll off the balance sheet, a reasonable possibility exists that longer term rates could move higher as well. Higher rates could provide some healthy and need competition for stocks.

Friday, September 15, 2017

The Risk Of De-risking The Equity Portfolio

The unique aspect of the current U.S equity market has been the market's desire to move higher without any significant pullback. As the below chart shows, the last correction (double digit decline) occurred in early 2016 and culminated with a 13.3% decline ending February 11, 2016. Since the February correction, two other pullbacks of around 5% occurred around June 2016 and November 2016.

Thursday, September 14, 2017

Spike Higher In Bullish Sentiment

In today's Sentiment Survey release by the American Association of Individual Investors, bullish sentiment jump twelve percentage points to 41.3%. All of the increase in bullish investor sentiment come from a 13.8 percentage point drop in bearish sentiment as can be seen in the second chart below.

The bull/bear spread of 19.3 is the second highest of the year following early January's 20.97 bull/bear spread.

Sunday, September 10, 2017

S&P And MSCI May Change The Composition Of The Telecommunications Sector

In July of this year S&P Dow Jones Indices and MSCI announced they were considering making changes to the current GICS Telecommunications Sector. Any changes would be announced in November and go into effect in 2018. Currently, the telecommunications sector represents about 2% of the S&P 500 Index. S&P's and MSCI's intent is to broaden the composition of the sector and rename it Communications Services with the sector weight increasing to approximately 10% of the S&P 500 Index. As noted in the release,
"The main proposal set out in the consultation paper is the creation of a Communication Services Sector, comprised of the current Telecommunication Services Sector, Media Industry Group, and specific companies from the Software & Services Industry Group."
Sector weights in other indexes would be impacted as well with a couple of those noted below. As an example, Communications Services would increase to 13.7% from 1% in the Russell 1000 Growth Index. In the S&P 500 Index, the Information Technology sector would decline to 18.4% from the current 23.3% weighting.

Sunday, September 03, 2017

Growth Outperforming Value And The Economic Cycle

One style of the market that has outperformed, except in 2016, has been growth type equities. In 2016 value outperformed growth with a value outperformance burst subsequent to the election. Value's outperformance essentially ended at the beginning of this year though.

Friday, September 01, 2017

Equity Market Nears Record High And Investors Become Less Bullish

As the equity market nears a record high, both institutional and individual investors continue to indicate they are less bullish. The NAAIM Exposure Index continues to decline with long equity exposure down to 77%.

Yesterday's AAII Sentiment Survey report showed bullish sentiment fell another 3.1 percentage points to 25% and now is below the minus one standard deviation level for bullish sentiment. 

The market rarely rewards investors for being properly positioned for a market pullback. Sentiment measures are contrarian ones and by these measures only, this widespread skepticism would suggest the market might continue to move higher.

Saturday, August 26, 2017

DowDupont Will Be Included In Dow Jones Industrial Average Index

As many readers know, effective September 1, Dow Chemical (DOW) and DuPont (DD) will merge into one company, DowDupont (DWDP). Effective that same day, S&P Dow Jones Indices will replace DuPont, a component of the Dow Jones Industrial Average Index, with DowDuPont. S&P notes,
"Replacing du Pont with the new DowDuPont allows the Dow Jones Industrial Average to maintain its exposure to the Materials sector....The change won’t cause any disruption in the level of the index. The divisor used to calculate the index from the component’s prices on their respective home exchanges will be changed prior to the opening on September 1. This procedure prevents any distortion in the index’s reflection of the portion of the U.S. stock market it is designed to measure."

Friday, August 25, 2017

Large Decline In Bullish Investor Sentiment

This week's AAII Sentiment Survey reported a 6.1% decline in bullish investor sentiment to 28.1%. The bullish sentiment level is now near one standard deviation below the long term average. Nearly all of the decline in the bullish sentiment showed up in the bearish number which increased 5.5%. The bull/bear spread is now -10.4 percentage points.

Sunday, August 20, 2017

Dr. KOSPI's Protocol For Global Growth Diagnosis

It has been about two weeks and market sentiment seems to have quickly turned decidedly bearish and the S&P 500 Index is down only 2.2% from its high. I will not list all the bearish commentary over the last few days, but we even pushed out some thoughts this weekend on our Twitter account (@HORANCapitalAdv) that leaned a little bearish. A couple of reasons for the increased bearishness might be the fact the market has gone over a year without a pullback of more than 5% and stock valuations do appear elevated on an absolute basis. Lastly, with the increase in technical and computerized trading, readers should know the S&P 500 Index acquired a significant target price that was triggered over four years ago and was formed out of a 16 year trading range for the market. Once significant levels like this are reached, it is not uncommon for the market to at least consolidate gains.