Thursday, November 15, 2018

Institutional And Individual Investors More Bearish On Equities

At the end of October the American Association of Individual Investors reported individual investor bullish sentiment was 28.0%, one standard deviation below the bullishness average. Sentiment measures are contrarian ones and are most actionable at their extremes. October's reading was certainly not an extreme level; however, the reading was at a low level of bullishness for the individual investor sentiment measure. Since the January market high, the bullishness reading has vacillated between +26% to +45%, with a level in the mid teens being an extreme.  Today's reading of 35.1% bullishness falls within this range, as does the 36.2% 8-period moving average.

Interestingly, the NAAIM Exposure Index was reported at 35.1% this week. This is a level last reached in early 2016, i.e., near the market's 2016 low. The median response was 45% and was the lowest median reading of the year. For readers, 0% means active managers are 100% cash or hedged to market neutral and 100% means managers are fully invested.

Urban Carmel who writes The Fat Pitch blog, provides a review of the BAML November Fund Managers' Survey. Noted in his review,
"In one respect, they [fund managers] are still bullish: global equity allocations are still 31% overweight. Into the major lows in 2011, 2012 and 2016, fund managers were underweight. Allocations could easily fall much further before global equities reach a bottom. But in most other respects, fund managers are already very bearish:..."
From a contrarian perspective, bearishness seems increasingly a more pervasive thought. Sentiment is not at an extreme bearishness level yet. Other measure like the put/call ratio are elevated but not at an extreme, however, sentiment continues to move in a more bearish direction.

Wednesday, November 14, 2018

Small Business Continues To Be Highly Optimistic

Today's NFIB Small Business Optimism Index was reported at a strong 107.4, down only 1.4 points from the Index's 45-year August high. According to the NFIB report for October,
"Small business optimism continued its two-year streak of record highs. Overall, small businesses continue to support the 3%+ growth of the economy and add significant numbers of new workers to the employment pool. Owners believe the current period is a good time to expand substantially, are planning to invest in more inventory, and are reporting high sales figures. Seasonally adjusted, 30 percent of owners think the current period is a good time to expand substantially, citing the economy (72%) and strong sales (14%)."

Sunday, November 11, 2018

Dollar Defies The 7-Year Cycle

Historically the U.S. Dollar has had a tendency to exhibit strength over a 7-year cycle. In July of this year the Dollar strength cycle crossed into its eighth year though, as seen in the below chart.

One factor impacting the Dollar's rise is the increasing interest rate environment in the U.S. relative to rate moves outside the U.S. The U.S. Dollar has a high positive correlation (+.71) to the direction of interest rates.

The Fed Funds rate of 2.25% in the U.S. compares to the ECB's target rate of zero. This rate differential is seen across other bond maturities and makes the U.S a potentially more attractive investment relative to some of the lower rates in the developed foreign markets. As an example, the yield on the 10-year German Bund is currently .40%, down from .80% earlier in the year. The US 10-Year Treasury currently yields 3.18% and is up from 2.50% at the beginning of this year.

With higher interest rates likely into next year in the U.S., the Dollar may strengthen further. The stronger Dollar is one factor that is leading to lower U.S. oil prices. The price of oil has a minus .76 correlation to the Dollar, that is as the Dollar rises, the price of oil declines, all else being equal.

At the end of last month I noted the negative impact on emerging market returns due to the Dollar as well. This Dollar headwind is applicable to international investments broadly as seen in the chart below. The chart compares the rolling 1-year return for the All Country World Index ex U.S. versus the S&P 500 Index. Of course other factors influence foreign equity returns, and one negative one at the moment is the tariff/trade issue. 

I believe we are nearer the end than the beginning of this Dollar strength cycle, but it likely continues into 2019. What seemed like a 7-Year cycle for Dollar strength in the past, may be influenced more by interest rates. As the rising interest rate cycle comes to an end in the U.S., so should the move higher in the Dollar, albeit with a lag of about 12-months.

Tuesday, October 30, 2018

Emerging Markets: An Opportunity?

For a period of time this year, the U.S. equity market avoided the weakness that was occurring in many other equity markets around the world. October has certainly changed this though. As can be seen below, the S&P 500 Index is in correction territory now, i.e., down greater than 10% from its high at the end of September.

Monday, October 29, 2018

Much To Like About The Economy

Recent equity market volatility has raised the question about the health of the current economic expansion. I must confess it is difficult to find too much in the way of negative news. What is important about this is the fact that a recession does not seem to be around the corner in our view. William Delwiche, CMT, CFA of R.W. Baird noted in a recent commentary, "Bear markets are almost always associated with a recession. Given the latest economic data and the leading indicators that point to further growth, the odds of recession are low." We would agree.

Following are just some of the favorable data points and charts.

Tuesday, October 23, 2018

VIX Curve Moving Back Towards Contango A Positive For Stocks

The level of the VIX is one measure to gauge fear in the equity markets. When the near term VIX index is trading at a higher level than the VIX further in the future, for example, the 3 month VIX (or ticker VXV), then the VIX curve is said to be in backwardation. This is not the normal structure for the VIX curve as the VIX curve is usually in contango, meaning prices in the distant future are higher than those nearer term. For equity market volatility, i.e. the VIX, this makes sense as volatility inducing events are less predictable in the distant future versus today thus, the future VIX should be at a higher level than the near term VIX. As the below chart shows, in instances where the near term VIX is higher or significantly greater than one, this tends to occur near equity market bottoms.

As the near term VIX begins to decline or fall below the future VIX or VXV, the equity market tends to move higher. This process can take place over a several week period, but nonetheless, the equity market does tend to bottom 'near' spikes in backwardation. The recent spread between the VIX and VXV of 3.4 may have marked a near term peak in backwardation. If this is the case, the equity market may be setting the stage for a rally into year end.

Monday, October 22, 2018

Many Individual Stock Returns Are In Correction Territory

On a price only basis the S&P 500 Index remains up 3.08% year to date and up 4.66% on a total return basis. As the following chart does show, the S&P is off its late September high by 6.54%.

Friday, October 19, 2018

Fall 2018 Investor Letter: A Midterm Election Year

There are many indicators pointing to continued strength in the U.S. economy including increased manufacturing activity, robust readings from the service sector and low unemployment levels last seen 49 years ago. Employee wages are rising, and the labor market is benefiting from the current growth in the economy. We view the low levels of unemployment and continued wage growth as a positive signal for the economy.

As we discuss in the Fall 2018 Investor Letter, history shows the fourth quarter of a midterm election year combined with the first quarter of the following year are the two strongest returning quarters for the market over the four-year presidential cycle. The start of the fourth quarter may lead investors to believe something other than the historical data though. Days into the quarter, markets have turned lower and volatility has increased to a more normal level. Although this is unsettling, the underlying economic and market fundamentals are still supportive of favorable equity returns looking ahead. As the above chart shows, the performance of the S&P 500 occurs late in a mid term year.

For additional insight into our views for the market and economy as the year nears and end, see our Investor Letter accessible at the below link.

Wednesday, October 17, 2018

Hiring Pace Continues To Lag Job Openings Growth

If job openings are an indication of the economy's strength, yesterday's Job Openings and Labor Turnover (JOLTs) report is confirmation of economic strength. Job openings reached another record high of 7.136 million. Compared to last August's openings of 6.044 million, openings are up 18.1% on a year over year basis.

The timing of the unemployment data is one month ahead of the JOLTs data, however, the number of unemployed looking for work is 1.172 million lower than job openings. This is hard evidence that labor is a scare resource at the moment. This is not the type of data output that occurs in a recessionary environment. 

Friday, October 12, 2018

Pullbacks, Fear And Opportunity

From early 2016 to early 2018 the S&P 500 Index moved higher with very little downside volatility. As the below chart shows, that stretch of time was an abnormally long one in terms of very little downside market move. One consequence of this low volatility period is many investors' began to believe the equity market does not go down. In reality, a low volatility market is not normal though. Having the market pullback between 5-10% once or twice a year should be expected by equity investors. The current decline from peak to current level is only 6.9%.