Most Read Articles From Our Blog In 2017

Below is a list of the most read blog articles in each month during 2017. One interesting commonality for some of the top posts is the fact the ones focusing on investor sentiment tend to gain higher levels of readership. Sentiment is one important market factor we monitor on a fairly regular basis. Secondly, some prior articles seem to remain applicable as 2018 is set to begin. For example, articles like Market Pullbacks Should Be Expected and The S&P 500 Index Is Expensive and Has Been So Since The Early 1990's are certainly timely even today.

Our firm's bullish equity stance in 2016 and 2017 has certainly rewarded our clients. We are in the midst of finalizing our Winter Investor Letter which will contain some of our firm's thoughts on the coming year.

To our clients and readers, we wish all of you a Healthy and Prosperous New Year.

Second Longest S&P 500 Rally Since 1932 - January 25, 2017

Recent Outperformance Of Low Volatility A Sign Of Risk Off Ahead? - February 12, 2017

Time To Reduce One's Equity Exposure? - March 1, 2017

Widespread Bearishness Indicating Market Nearing A Turning Point? - April 14, 2017

The Unfortunate Rise Of The Misleading 'Scary Chart' Comparisons Again - May 29, 2017

Market Pullbacks Should Be Expected - June 26, 2017

Strong Earnings Growth And Favorable Valuations Lead To Weak Stock Returns - July 22, 2017

The S&P 500 Index Is Expensive And Has Mostly Been So Since The Early 1990's - August 5, 2017

Stocks Need Some Healthy Competition - September 16, 2017

Citgroup Economic Surprise Indices Have Little Bearing On Equity Market Performance - October 15, 2017

Individual And Investment Manager Sentiment Is Diverging - November 2, 2017

If Cash Is King - December 19, 2017

Continued Improvement In Bullish Investor Sentiment

In the few weeks after the 2016 presidential election, individual investor bullish sentiment spiked to near 50%. Over the course of the next five months though, bullish sentiment trended lower to a year low of 23.85%. From March through April the market had some volatile periods that may have influenced investor sentiment; however, true to form this year, the market never experienced a prolonged or significant contraction.

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Dogs Of The Dow Make Up Ground In Second Half Of This Year

Four trading days left until the calendar turns to 2018 and one will be able to determine the list of stocks that will comprise the Dow Dogs of 2018. The Dow Dogs were laggards in the first half of the year, but have made up significant ground in the second half of 2017. To date the Dow Dogs of 2017 have outperformed the S&P 500 Index on a total return basis due to the Dogs higher dividend yield. However, the Dogs of the Dow have underperformed the Dow Jones Industrial Average Index on both a price only and total return basis. The best performing Dow stock that is not included in the Dow Dogs this year is Apple (AAPL) and the stock is up 51.1%.

The Dogs of the Dow strategy is one where investors select the ten stocks that have the highest dividend yield from the stocks in the Dow Jones Industrial Index (DJIA) after the close of business on the last trading day of the year. Once the ten stocks are determined, an investor invests an equal dollar amount in each of the ten stocks and holds them for the entire next year. The popularity of the strategy is its singular focus on dividend yield.

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As of Friday's close both Boeing (BA) and Caterpiullar (CAT) will drop out of the Dogs for 2018. The two holdings in the running for inclusion in next year's portfolio are Procter & Gamble (PG) and General Electric (GE) with dividend yields of 2.99% and 2.74%. respectively.

Small Business Optimism And Equity Market Return One Year Later

When the NFIB Small Business Optimism reading for December 2016 was announced in January, the December reading jumped 7.4 points to 105.8. At that time the optimism reading was the fifth highest reading recorded by NFIB. Prior instances of strong optimism readings were followed by positive stock market returns in the subsequent twelve months. NFIB's Small Business Optimism report last week closed out the subsequent twelve month period from the December 2016 reading and the stock market did not disappoint. As the below chart shows, the S&P 500 Index was up over 18% from December 15, 2016. The market's return was the best performing one out of the other four top NFIB readings. 

As noted in an earlier post, last week's NFIB Small Business Optimism report has the index at its second highest level in its 44-year history.

I will begin tracking the market's performance over the next twelve months and will evaluate the return. If history rhymes at all, 2018 stock market returns would be positive.

Is Optimism Too High?

One of my more regular topics that I write about on the blog from time to time is an update on sentiment measures, both individual and business. Sentiment might be viewed as the third leg of a stool, with the other two being the economy and business financial health or earnings growth. Without positive sentiment from businesses and investors, the economy is more likely to see lackluster growth. What got me to thinking about whether optimism is too high or not was a recent post by Josh Brown whose blog is titled The Reformed Broker.

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If Cash Is King

Much has been written about the stock market's advance since the end of the financial crisis in 2009. Without getting into the valuation issues, as I have written about that for maybe too many times, the recent return, nearly past two years, has been pretty remarkable and has occurred with a very low level of volatility.

Business and consumer optimism is high, institutional investor optimism is high and individual investor optimism is rising. Almost seems as good as it can get from a sentiment perspective. We know corporations are sitting on a lot of cash with large amounts trapped overseas. The tax bill working its way through Congress is addressing this issue via a change on the taxation of cash held outside the U.S. This increase in corporate cash seems to be an issue that has developed over many years as can be seen in the two charts below. The first chart notes the absolute dollar amount of the cash while the second chart shows corporate cash as a percentage of GDP.

With the passage of a tax reform package, undoubtedly, corporate cash will likely be used in a number of different ways. Recently, Factset reviewed how companies responded to the tax holiday in 2004. Factset's analysis notes:

"In 2003, a combined $30.3 billion in special dividends was paid to shareholders of S&P 500 constituents  this figure jumped to $179.4 billion in 2004, an increase of 492%. In 2005, aggregate special dividends fell to $49.2 billion. Of this $179.4 billion, a collective $149.8 billion (84%) came solely from companies in the GICS Information Technology sector. Notable companies such as Microsoft (MSFT-US) and Motorola (MSI-US) contributed the most to this total. Financials and Healthcare were also top contributors."

And finally, at the end of the day, there will likely be demand for stocks outside of just corporate buybacks. As the below chart shows, both in absolute terms and as a percentage of GDP, household deposits are far above pre-financial crisis levels. As a percentage, deposits are nearly 60% of GDP. If cash is king, individual investors are sitting on potential fuel for the next move higher in equities.

Disclosure: Long MSFT

Companies Begin Highlighting Earnings Benefit From Tax Reform

It seems a day does not go by where the market's valuation is a front and center topic of discussion. Suffice it to say that I believe, and have written as such recently, that the market does not correct simply because it may be trading at an elevated valuation. Although market declines or pullbacks have been few and far between, when the next pullback occurs, a factor in the the magnitude of the decline will likely center on the market's valuation.

The below chart shows the current market P/E where the earnings are based on the 12-month forward earnings estimate supplied by I/B/E/S. Certainly the P/E is elevated at near a +1 standard deviation level, still the current P/E is quite a bit lower than the technology bubble valuation peak of near 25 times earnings.

Overall earnings growth will be important for the equity market to generate respectable returns in 2018. With passage of a tax reform package nearing realization, companies will benefit from the decline in the maximum corporate tax rate. As an example, tonight FedEx (FDX) reported earnings and noted in the conference call that a lower tax rate will add $.85 to $1.00 to per share earnings. This represents an earnings boost of 8% based on currently expected May 2018 earnings of $12.45 per share. What the tax bill does for many companies is provide an earnings benefit that will result in a reset of the market's valuation to a lower level. The result is the market's valuation is closer to its long run average of 16 to 17 times earnings.

Disclosure: Long FDX

A Spike Higher In Bullish Investor Sentiment

Today the American Association of Individual Investors reported results of their Sentiment Survey for the week ending 12/13/2017. The report shows individual investor bullish sentiment jumped 8.1 percentage points to 45.0%. 

Most of the jump in bullish sentiment was a result of a 6.1 percentage point decline in bearish sentiment. This has resulted in the bull/bear spread widening to 16.9%, the third widest spread in 2017.

As I have noted in prior sentiment updates, the survey results can be volatile and the 8 period moving average removes the weekly volatility. Additionally, the sentiment measures are contrarian ones and are most useful when they are at their extremes. The current report is not at an extreme level; however, it is elevated and worth paying attention to as the market continues to move higher and exhibit a low level of volatility.

A Continued Surge In Small Business And Consumer Optimism

Sentiment for both consumers and small businesses continues to soar. Today the NFIB Small Business Optimism Index was reported at 107.5. I highlighted the surge in consumer sentiment at the end of November.

NFIB notes in its report,

"Not since the roaring Reagan economy has small business optimism been as high as it was in November, according to the National Federation of Independent Business (NFIB) Index of Small Business Optimism, released today." 

“We haven’t seen this kind of optimism in 34 years, and we’ve seen it only once in the 44 years that NFIB has been conducting this research,” said NFIB President and CEO Juanita Duggan. “Small business owners are exuberant about the economy, and they are ready to lead the U.S. economy in a period of robust growth.”

The report also indicates the current reading for November is the second highest reading in the 44-year history of the Index. Some highlights in the report:

• Job Creation plans increased six points last month, providing more evidence of a strong labor market.
• The number of owners who said it’s a Good Time to Expand rose four points.
• Inventory Plans increased by three points.
• Inventory Satisfaction increased by three points and,
• Actual Earnings Trend moved up two points.

The significant improvement in sentiment, especially in business sentiment, has been a common theme for the last year. NFIB's report on December 2016 small business optimism saw one of the Index's largest increases. Below is a chart tracking the market's performance since NFIB's last five highest readings from December of last year. This year's market return has been the strongest.

Sentiment is an important part of investing psychology. With both consumer and small business expressing high levels of optimism, it is not surprising equity returns have been as strong as they have been this year.

Earnings, Not Multiple Expansion, The Key To Favorable 2018 Equity Returns

It seems like an eternity since the S&P 500 Index experienced a pullback of more than 5%. In fact, the last greater than 5% pullback occurred over a year ago during the period of June 8, 2016 to June 27, 2016. This lack of downside volatility has taken place during a nearly uninterrupted increase in the market that began in February last year. Additionally, the market advance since the end of the financial crisis looks remarkable as well. Little or no downside volatility might be understandable if the equity markets were trading sideways this entire time; however, that has not been the case as can be seen below.

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Strong Corporate Profit Picture A Key Component In Today's GDP Report

Included with today's second estimate GDP report by the Bureau of Economic Analysis is the preliminary estimate for third quarter corporate profits. The corporate profit measure is reported in several different formats, i.e. with and without inventory valuation and capital consumption adjustments. As I noted in a June post, more information on the adjustments can be found can be found in this BEA Briefing Paper (PDF).

The profit growth before tax and with the inventory valuation and capital consumption adjustments equaled 5.4% on a year over year basis. Without the adjustments, year over year profit growth equaled 10%. Importantly, NIPA profits have a nearly 1.0 correlation to IBES S&P 500 forward earnings and historically peak four quarters, or a year before the IBES forward earnings estimate. This preliminary corporate profit report is not signalling a peak in IBES S&P 500 forward earnings.

Also, with the preliminary corporate profit growth figure one can evaluate the NIPA P/E. The growth in NIPA corporate profits has resulted in a slight decline in the NIPA P/E as can be seen in the below chart. As I noted in the June post referenced above, what is useful with the NIPA profit measure is the fact it covers a larger earnings base for the U.S and covers more industries as it is not limited to public companies. Additionally, the NIPA figure makes an effort to adjust for the differing accounting measures being utilized by companies.

By reviewing some of my posts written over the past few months, the lack of any meaningful market pullback has been one recurring theme. However, with the continued strength exhibited in corporate profit growth, the market's path is certainly warranted as stock prices follow earnings. Also, the strong profit picture is beginning to result in a downtrend in the market's NIPA valuation, without a significant correction taking place. That does not mean high valuation equities will not correct more significantly, like what occurred in some technology stocks today. All in all, today's revision higher in Q3 GDP and the prelimnary profit report are both tailwinds for the economy and equity markets, all else being equal.

Soaring Consumer Confidence

Consumer confidence soared to a 17-year high in The Conference Board's report today. High levels of consumer confidence tend to translate to an improved retail sales environment as can be seen in the below chart. With consumers accounting for approximately 70% of economic (GDP) activity, today's confidence report portends a positive retail sales environment during the holiday shopping season.

On the other side of the coin though, The Conference Board's third quarter CEO Confidence measure was reported with a slight decline in early October as represented by the green line in the below chart. About two weeks ago we reported on the NFIB Small Business Optimism measure and it declined as well in its recent report; however, small business optimism remains at a high level.

Overall, confidence levels for business and consumers are at relatively high levels and this should be a tailwind for economic activity near term.

The Sentiment Cycle Phase: "Buy The Dip"

Aside from fundamental market data, the equity market tends to follow a sentiment cycle as described by Justin Mamis, a famed market technician and author, who wrote several books on technical analysis. One of his books, The Nature of Risk, contains a discussion on the equity market's sentiment cycle. Below is The Sentiment Cycle chart included in The Nature of Risk.

In The Nature of Risk Mamis notes the market sentiment cycle begins with stocks climbing the proverbial "wall of worry." In a post I wrote in July 2009, Where Are We In The Market Cycle?, I noted the market seemed to be coming out of the financial crisis and had moved into this "wall of worry" phase of the sentiment cycle. Then in June of 2014 I noted in a blog post, VIX Is Low But Investors In Denial Stage Of Market Sentiment Cycle, I surmised the market was likely in the "denial" phase of the sentiment cycle. Today, I believe we are in or near the "buy the dip" phase of the market sentiment cycle.

One missing aspect with the market today is the lack of slowly increasing trading volume like occurred in the run up to the market top in 2008 and seen in the above monthly market chart. However, the lack of any significant market pullback since mid year 2016 is certainly representative of investors being content with "buying on the dips."

The sentiment cycle length seems to be an extended one in this bull market cycle and we can list any number of reasons for the extension. However, from a sentiment and technical perspective, this cycle, although long in duration, likely has further upside as buying "enthusiasm" seems absent. A confirming enthusiasm data point would be increasing volume into a so called blow off top.

Lastly, in Justin Mamis' last newsletter, he highlighted The Sentiment Cycle chart and had the following to say about it:

A cycle begins with stocks climbing “a wall of worry,” and ends when there is no worry anymore. Even after the rise tops out, investors continue to believe that they should buy the dips...Unwillingness to believe in that change marks the first phase down: “It’s just another buying opportunity.” The second, realistic, phase down is the passage from bullish to bearish sentiment...Selling begins to make sense. It culminates with the third phase: investors, in disgust,...dump right near the eventual low in the conviction that the bad news is never going to stop…

I think investors would have a hard time arguing against the fact that "buy the dip" is prevalent in recent stock market action. 

Answering Market Questions Over Thanksgiving

In addition to receiving a few questions about Bitcoin from a few relatives over Thanksgiving, the other common question/comment was "can you believe this stock market, how long can it last." I confess I do not believe in market timing nor do I have a crystal ball; however, that does not mean one should put their head in the sand and ignore important market signals. Aside from the importance of monitoring weekly economic data reports, investors can review a couple of high level data points to gain perspective on the health of the economy and companies broadly. Just as earnings growth is important to evaluate at the company level, market level earnings are important as a rising tide may be lifting all boats. There is truth to the fact that stock prices have a tendency to follow earnings and that is clearly evident in the below chart.

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NFIB Small Business Optimism Index Highlights Tight Labor Market

Last week NFIB's October report on Small Business Optimism fell short of expectations, but remained at a high level at 103.8 versus 103 in the prior report. A few highlights from the report:

• "The tight labor market got tighter for small business owners last month, continuing a year-long trend. Fifty-nine percent of owners said they tried to hire in October, with 88 percent of them reporting no or few qualified applicants."

• "Consumer sentiment surged based on optimism about jobs and incomes, an encouraging development as consumers account for 70 percent of GDP," said NFIB Chief Economist Bill Dunkelberg.

And continuing to track the market's performance from December of last year (January's report) when NFIB reported one of the highest NFIB readings, the current S&P 500 Index return is outpacing prior market returns associated with high NFIB readings as seen in the below chart.

With a surge in consumer sentiment and a small business environment that is showing continued strength in hiring, these two factors alone should serve as a tailwind for the economy and market in the months ahead.

Are Bearish Investor Sentiment Responses Translating Into Actual Action?

The S&P 500 Index is only down .60% from its November 8, 2017 high yet individual investor and institutional equity sentiment has turned significantly less positive. This negative sentiment has not translated into broadly lower equity prices though, but knowing sentiment measures are contrary indicators, they are approaching levels that would be suggestive of higher equity prices ahead.

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Equity Corrections Will Occur Again, Maybe Sooner Than One Expects

If there is one factor that perplexes me about the current market environment it is the lack of volatility since the election. The last time the market experienced a greater than 5% correction was in June of 2016 and the last double digit pullback was in February 2016. Going back to 1980 the average intra-year market decline for the S&P 500 Index is 14.1%. I have written a number of recent posts on the positive global economic environment, at the risk of sounding like a broken record, that may be serving as a tailwind for equity market returns around the world.

On the surface, if one knew mutual funds were holding elevated cash positions, they might conclude that this is a bullish data point since the cash can be deployed in additional equity investments. On the other hand, elevated liquidity in equity funds may be a sign of investors rapidly allocating more funds to equities and this might actually be a negative sentiment measure. In fact, as the below chart shows, there is a high correlation to elevated liquidity in equity funds and market tops.

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If History Repeating; Another Five Years For Equity Bull Market

Shortly after the 2016 election in a post titled, Equity Market Beginning To Resemble Bull Market Of The 1950's And 1980's, I discussed how the equity market continued to trace a similar path as the market in the those two earlier decades. A part of my conclusion indicated the anticipated policies under a Trump administration would resemble policies implemented in the 1950's and 1980's, like tax reform and infrastructure spending. Reality is setting in and not much seems to be getting done in Washington on those two fronts; however, the current market continues to follow a similar path as in the 50's and 80's. Better sentiment and regulatory reform, even though by executive order, seems to be having a positive influence on companies. If the past is any guide then, the bull market might have at least another five years to run as can be seen in the below chart.

Biases Influence Investment Decisions

Every investor makes investment decisions that are influenced by ones biases that form over time. These biases may come in many forms but they tend to fall into a couple of categories, emotional or cognitive. I mention this because it is not that uncommon that I sit down to write a blog post on a certain topic thinking the post's conclusion will go in one direction, but end up with a different conclusion after evaluating some of the research. Some of these blog topics are developed by flipping through a lot of charts, which I do frequently. One such chart is below and shows the relative performance of the S&P 500 Dividend Aristocrats to the S&P 500 Index.

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Investment Opportunities Outside The U.S.

In a post yesterday I somewhat rhetorically titled the post wondering if the equity market was at a top. In short, I do not know, but offered suggestions for investors about reviewing their asset allocation vis-à-vis their spending needs.

Not all markets have traveled the same path as the S&P 500 Index though. A number of markets outside the U.S have lagged the U.S. since the end of the financial crisis. The below chart compares the cumulative performance of the S&P 500 Index (SPY) versus the MSCI ACWI ex U.S Index (ACWX). The chart goes back to the beginning of 1992 and clearly the S&P 500 has a performance advantage with a widening gap beginning to develop around 2011.

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Is This The Market Top?

I read an individual's commentary this weekend that was titled Is This As Good As It Gets, and I will have more comments on this later in this post, but it coincides with some clients/investors inquiring whether they should raise cash now. The 'raise cash now' question is certainly understandable when one looks at the strength of the market since the February low last year, up nearly 40% on a price only basis in less than two years.

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Individual And Investment Manager Sentiment Is Diverging

At the end of August bullish investor sentiment reached a year low of 25% and since that time individual investor sentiment has risen to 45.1% as reported by the American Association of Individual Investors (AAII) today. During this time period the S&P 500 Index has increased nearly 5%, providing some support to the contrarian nature of the individual sentiment report.

Conversely, the National Association of Active Investment Managers reported a decline in their Exposure Index to 60.2% from 71.7% in the week earlier. As noted by NAAIM, the Exposure Index,

"is not predictive in nature and is of little value in attempting to determine what the stock market will do in the future. The primary goal of most active managers is to manage the risk/reward relationship of the stock market and to stay in tune with what the market is doing at any given time. As the name indicates, the NAAIM Exposure Index provides insight into the actual adjustments active risk managers have made to client accounts over the past two weeks."

Nonetheless, investment managers are positioned for a less constructive bullish market while the individual investor seems more optimistic from a sentiment perspective. One should keep in mind these sentiment measures are most predictive at extremes and it can be argued neither the AAII sentiment reading nor  the NAAIM Exposure Index is at an extreme level. However, sentiment expectations for institutions and  individuals are moving in opposite directions and both will not be right.

The Time Period Matters For Outperformance: High Beta Versus Low Volatility

I have read commentary over the last few days noting the outperformance of the PowerShares High Beta Index (SPHB) versus its counterpart, the PowerShares Low Volatility Index (SPLV) over the past 1-year time frame. However, much of this outperformance was generated in the couple of months following the November election.

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Sizable Declines In A Few Individual Stocks; Time To Review Allocations

Much is going right as it relates to the equity markets around the globe; however, this past week saw the market punish companies that reported earnings that did not match market expectations. The below 2-week chart only lists a few of those companies, but companies like Celgene (CELG) down 28.1% and Expedia (EXPE) down 17.5% suffered much of their losses on one or just a few trading days.

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An Increasing Dividend Payout Ratio Is A Positive Indicator For The Market

Admittedly, in an equity market run investors are currently experiencing, i.e., the second longest run without a 20% pullback, a common theme that continues to seep into ones thinking, including mine, is when is the market going to experience a bear market correction of 20% or more. Even a double digit pullback is a scarcity as the below chart of the S&P 500 Index shows. The last double digit pullback occurred in February of 2016.

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Citgroup Economic Surprise Indices Have Little Bearing On Equity Market Performance

One set of indices that seems to cycle from positive to negative over a relatively short period of time are the Citigroup Economic Surprise Indices (CESI). This aspect of these indices means they gain prominence from a commentary standpoint when they reach high and low points. What is important for investors to know is the CESI is a mean reverting index, that by design, cycles between highs and lows over relatively short periods of time. In June of this year, the Citigroup U.S. Economic Surprise Index (CESI-US) was a minus 78 after falling from plus 57 in March. At the June low some commentary began noting the U.S. economy might be headed for a recession. However, the correlation of the S&P 500 Index to the CESI-US is a small negative .04, so actually a slight negative correlation between the two variables.

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Synchronized Global Growth

Much of the sentiment and global market data continues to come in on the positive side of the ledger. Friday's University of Michigan Consumer Sentiment jumped six points to 101.1 for October and is the highest reading in thirteen years. As reported by Econoday, "The expectations component is up nearly 7 points to 91.3 with the component for current conditions posting a nearly 5 point gain to 116.4."

In reviewing the Global PMI's for Manufacturing, as of the end of September, the below table shows all of the PMIs are in excess of 50 which suggests improvement versus deterioration in the manufacturing sector. PMI's are leading indicators with health in the manufacturing sector providing insight into sales, employment, etc. The common surveyed questions center on new orders, manufacturing output, employment, suppliers' delivery times and inventory.

Source: JP Morgan Asset Management

The positive sentiment and economic data has translated into positive equity market returns around the world. All of the 45 country Exchange Traded Funds (ETFs) at the following link are showing positive returns year to date through October 13, 2017.

The economy is not the market and vice versa; however, the positive sentiment and positive economic data currently being reported is translating into higher equity market prices. The lack of market volatility is certainly something that will not persist forever. Maybe the Fed's desire to reduce its balance sheet will result in higher equity market volatility. A correction or pullback near term would be healthy, noting the average intra-year pullback is just over 14%.

A Decline In Small Business Optimism

Today, NFIB reported the September Small Business Optimism Index results and they showed the Index fell 2.3 points to 103, which was below the lowest consensus forecast. In spite of the decline, the index remains at a high level as can be seen in the below chart.

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Fall 2017 Investor Letter: The Hated Rally Continues

Our Fall 2017 Investor Letter has a music lyrics theme to it and since we have an age-diverse team as it relates to the employees of HORAN Capital Advisors so goes the taste in music for our colleagues as readers of the newsletter will find out.  As Chuck Prince, former chairman and CEO of Citigroup, said almost a decade ago,  "As long as the music is playing, you got to dance." This seems to be one of those markets where the music just doesn't seem to stop and just maybe has resulted in one of the most hated equity market rallies in some time.

The Fall 2017 Investor Letter touches on a number of topics, including the unwinding of the Fed's balance sheet, low interest rates and the negative impact on income generation for investors and the benefit achieved by investors that have pursued diversification outside of the U.S. equity market.

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

• Fall 2017 Investor Letter

Shifting Investor Sentiment

It seems the market's consistent bid to move higher this year might be confusing the individual investor. That is, the fact the market has escaped any material pullback this year may be weighing on consumers in that they are prepared for or expect a pullback. As the below chart shows, the market has avoided such a pullback of more than 3% so far this year.

This lack of volatility has not translated into a bullish individual investors though if the American Association of Individual Investors Sentiment Survey is a guide. This week's sentiment report shows bullish sentiment declined almost seven percentage points to 33.3%. Most of this decline showed up in an increase in the neutral reading with a 5.3 percentage point increase to 37.9%.

With the strength of this year's market return that actually began in February of last year, one would expect the individual investor to be bullish on equities. Remembering the sentiment reading is a contrarian one, high bullishness readings can be a negative for future equity prices. Excessive individual investor bullish is certainly not the case at the moment if the survey readings are to be believed.

A Recession And Equity Market Bubble Five Years Ago Did Not Materialize, Now What

I was communicating with a client today who reminded me of a conversation we had five years ago almost to the day about whether or not the U.S. equity market was in a bubble. The discussion was prompted by the USA Today article, Consumer Sentiment Stat Hints that Bull Market May be Stalling Out, that highlighted a data point from the recent University of Michigan Sentiment Survey. In the survey it was noted that 65% of individuals surveyed believe stock prices rise over the next twelve months. This is a high level for the survey and a contrarian data point for stocks. The conclusion from that 2012 conversation was equities were attractive and our firm wrote as much in our third quarter 2012 newsletter. Additionally, I shared a Fidelity white paper, U.S. Equities: Light At The End Of The Tunnel. An interesting read in retrospect.

Much was occurring in 2012 with the 10-year Treasury yield below 2% and the Federal Reserve providing massive monetary support (QE) to the economy, i.e., buying $40 billion of mortgage bonds each month. This was occurring on the back of an equity market that was up 100% from the March 2009 low to June 2012. Both print and television financial commentary at the time was intimating concern for the markets.

A CNN Money article from September 2012 was titled, Stocks End Week At Multi Year Highs. In the article a link was provide to, Are Investors Getting Too Greedy which referenced CNN Money's Fear & Greed Index that was flashing an extreme Greed level of 93. Several weeks later and into the first week of October 2012, Sam Zell, Chairman of Equity Group Investments, stated in an interview on CNBC, "We're heading for a recession and that's exactly what you're looking at now."

Five years after 2012 to today and following all the consternation about bubbles, corrections and recessions, the U.S. equity market (S&P 500 Index) is up an additional 87% and the economy has avoided a recession. Certainly the period from 2015 through the third quarter of 2016 was a choppy one with the S&P 500 Index trading mostly sideways for almost two years. But so far in 2017, U.S. stocks seem to know only one direction and that is up, with the S&P 500 Index returning just under 13% on a price only basis with very little downside volatility

Raising the bubble question now is even more appropriate today then it was five years ago given how far the equity markets have risen over the last five years. Also, market data is decidedly different and is summarized below. Some of the data was taken from the earlier cited Fidelity white paper. If any variable in the below table jumps out at readers, it should be the higher valuation of the S&P 500 Index based on the price earnings ratio or P/E, 56.5% higher, while earnings are higher by only 17.5% during the same time period. In other words, the market advance over the last five years has largely been supported by multiple or P/E expansion. Sentiment data is also more bullish at the moment, but not at a level that has historically been associated with a bear market type downturn.

Certainly given current market valuation levels, earnings growth will be important for strong S&P 500 Index returns as we look ahead. Twelve month trailing earnings as of June 2017 does capture the energy weakness in 2012; however, when evaluating the year over year June 2017 to June 2018 estimated operating earnings growth rate for the S&P 500 Index, earnings growth is expected to equal about 18% and in line with the forward P/E. On a calendar year basis, comparing 2018 to 2017, earnings growth is expected at a respectable low double digit growth rate.

In a couple of recent posts I have noted the Fed's desire to actually begin withdrawing liquidity from the market and they announced as much in last week's Fed statement with a start date beginning next month. An old adage that gets repeated around Fed accommodation changes is, 'don't fight the Fed'. Just as the Fed has been supply liquidity since the onset of the financial crisis, and this has likely had some positive impact on asset prices, withdrawing liquidity can be disrupting on the way out. We will be on guard for potential asset price volatility, but will note, historically, stocks have been positively correlated to the rate moves when they occur below 5%.

In summary, we were strongly bullish in 2012 given equity valuations and a high equity risk premium. We do not expect a recession near term, but believe today that more pressure falls on companies to generate earnings growth, which we do think is likely, but probably not a market where a rising tide raises all boats.

In client accounts we have reduced some equity investments where we believe earnings growth is more challenged  and taken profits in some stocks that have moved higher and gotten ahead of valuations. At the same time, we have allocated equity investments to developed and emerging international markets over the last 18-months or so. This allocation adjustment has been a positive for clients and we continue to find valuations outside the U.S attractive.

Higher Bond Yields A Headwind For Technology Stocks

In a recent note from the John Murphy of the stockcharts.com website ($$) he notes technology stocks tend to have an inverse relationship to bond yields. In his commentary he noted,

• "One of the lesser known intermarket principles is the inverse link between bond yields and technology stocks' relative performance...Growth stocks like technology...do better in a slower economy which is usually associated with low interest rates."

• "Value stocks (like banks) do better in a stronger economy with rising bond yields...Rising global bond yields could make the going tougher for technology stocks."

The below chart was included with his comment and shows the inverse relationship between the 10-Year Treasury yield (red line) to a ratio of the Technology SPDR (XLK) divided by the S&P 500 Index. Jon Murphy notes, "Rising rates this past month may again be contributing to tech selling, especially with a more hawkish sounding Fed. The inflationary impact of rising energy prices may also give the Fed more cover for a December rate hike."

Weakness is beginning to show in some of the large cap technology stocks. Below is a chart of the average return of Apple, Alphabet and Amazon for month to date in September. This time period is a short three weeks, but the performance of large cap technology stocks is something investors will want to follow as the last three months of the year unfold.

Disclosure: Firm/family long AAPL, GOOGL

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.

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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.

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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.

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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.