Thursday, November 28, 2019

Business Cycle Data And Investor Sentiment Supportive Of Higher Equity Prices

One factor impacting investor sentiment at the moment may be the fact the equity market has generated strong returns to date in 2019. The impact on individual investor sentiment has been one of caution. On a price only basis the return on large cap to small cap stocks is in excess of 20% this year, with emerging market returns low double digits as seen below. The second chart shows returns for these same indexes since the beginning of 2018, nearly two year returns. Returns over this time period are less than the returns this year, so clearly 2019 returns are simply a bounce back from the weak returns generated in 2018.

With the strong equity market returns in 2019, investors seem to be shying away from additional stock purchases. Some support for this point of view is based on the fact dollar flows into both equity mutual funds and equity ETF's continue to be strongly negative. The first chart below shows the weekly flows while the second chart shows the cumulative flows since the beginning of 2019. 

One part of the equity market that is gaining some interest is the international markets. Flows into this space have been positive for the last three weeks as seen in the above charts. Jeremy Schwartz, CFA, Global Head of Research at WisdomTree, noted in a recent article that hedged equity returns in Europe are hitting new highs as well.

Also confirming investors' reduced interest in equities is the increasing level of assets in money market mutual funds. Assets in money market assets are approaching $3.6 trillion.

I have seen a couple of reports over the last few days noting this action by investors may be appropriate in that the market may be running out of steam. Some of the commentary notes this is likely due to the economy being in the late stages of its expansion. This might certainly be the case, but what does a late stage look like?

Fidelity released a report earlier this year highlighting factors associated with the stages of the business cycle. A few of the late stage factors highlighted in the article are tight capacity utilization and a slowing economic growth rate. Just the opposite is occurring with these two factors. As reported earlier this week, GDP was revised higher and is now over 2%. And, in a post yesterday, I noted a proxy for potential GDP, i.e., productivity growth and labor force growth, indicated GDP may continue to improve. With respect to capacity utilization, the current level is in the mid 70% range. This is not a tight capacity level.

In the mid cycle phase inventory levels begin to increase in response to accommodating consumer demand. Business inventory to sales are rising and retail inventories to sales appear to be stabilizing. Not seen below are the actual reported numbers on inventories and both business and retail inventories are increasing.

And finally, circling back to investor sentiment, today's AAII sentiment survey release shows a slight decline in bullish sentiment to 33.6%. This is far from expressing extreme bullishness.

The current business cycle continues to establish a record in terms of length and the equity market continues to show resilience and achieve new highs in what seems like a daily basis. The equity market is not going to move higher in a straight line and the trade and tariff issues with China create headlines that are headwinds for the market. However, investors seem to be exhibiting a level of caution not typically seen at market highs. The economy is likely somewhere near early late cycle or late mid cycle and given the level of cash on the sidelines, market pullbacks may be viewed as 'buy on the dip' opportunities by investors. Just possibly the market grinds higher into year-end.

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