YTD Equity Market Declines In 83% Of All Up Years Since 1945

CFRA Research, in conjunction with S&P Global, recently published a report on the probabilities of a market pullback. A number of interesting data points are outlined in the report, but a few interesting ones are as follows:

• "during bull markets since 1945, the S&P 500 experienced a pullback (a decline of 5.0%-9.9%) once a year, on average,"

• "a correction (a 10% to 19.9% decline) every 2.8 years, and,"

• "a bear market (-20%+) every 4.7 years."

• "the S&P 500 suffered a YTD price decline in more than 80% of all years in which the S&P 500 recorded a positive annual performance since WWII."

As further proof that the market does not move higher in a straight line, the CFRA report notes the S&P 500 Index incurred a year-to-date price decline in 83% of all up years since 1945.

Also interesting in the report is the fact that 70% of all year-to-date declines occurred in the first quarter of the year and approximately a third of all the year-to-date declines occurring in January.

The entire report is a worthwhile read as it contains data on the market's performance after surpassing millennial points.

Source:

Pullback Probabilities
CFRA research
By: Sam Stovall, Chief Investment Strategist
January 17, 2017
https://goo.gl/teukJW

Market Breaks Out Of Sideways Trading Range To The Upside

Over the course of the last three trading days this week, the S&P 500 Index and Nasdaq broke out of the trading range in place since mid December. We highlighted this range in a recent post that noted sizable corrections are unlikely when earnings are improving.

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Buybacks vs. Capex

The below chart shows that through the end of 2015, S&P 500 companies were contributing a similar percentage of revenue to capex as they were back in 1995 (6.495% in 2015 vs. 6.5% in 1995). This same percentage capex contribution, however, is now only covering 113.4% of depreciation, when it covered 132.73% at the end of 1995.

[Note: going back to 1980 or 1990 shows that companies are clearly investing significantly less in capex since then, but for the purposes of this post it was sufficient to show that it is relatively unchanged in the past twenty years.] 

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Individual Investors Cautious On Equity Market

If the contrarian individual investor sentiment measure reported by the American Association of Individual Investors indicates anything, individual investors seem to be questioning the sustainability of this market rally. Because the Sentiment Survey is a contrarian measure, just maybe the market advance has further upside. In AAII's report this morning, bullish sentiment fell 5.4 percentage points to 31.6% which is nearing an extreme for the reading. Most of the decline in bullish responses showed up in the neutral reading as it increased 4.6 percentage points to 34.9%. This is the highest neutral rating since it was reported at 42% in early November of last year.

Second Longest S&P 500 Rally Since 1932

Chart of the Day's report this morning notes the S&P 500 Index return since the October 2011 low is now the second longest since the Great Depression. Specifically, their commentary notes,

"With the S&P 500 once again in record high territory, today's chart provides some perspective on the current rally by plotting all major S&P 500 rallies of the last 86 years. With the S&P 500 up 107% since its October 2011 lows (the 2011 correction resulted in a significant 19.4% decline), the current rally is above average in magnitude and the second longest rally since the Great Depression."

Source: Chart of the Day

Notes:
- A major stock market rally has been defined as a S&P 500 gain of 30% or more (following a correction of at least 15%).
- The S&P 500 was not adjusted for inflation or dividends.
- Selected rallies were labeled with the year in which they began.
- There are 252 trading days in a year (100 trading days equal about 4.8 calendar months).

Sizable Equity Pullback Less Likely During Periods Of Strong Earnings Growth

The return for many of the the equity indexes subsequent to the U.S. election has been stronger than many expected. However, most of the post election return was generated in the six weeks following the November 8 election with the equity market trading sideways since mid December. The post election spike higher has some investors waiting for a pullback in the market in order to invest cash that may be on the sidelines. Below are a couple of index charts that show this sideways trading range.

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CEO Confidence Surges Higher

Early this month The Conference Board reported the fourth quarter 2016 Measure of CEO Confidence. The fourth quarter reading was reported at 65 and is the highest reading since the first quarter of 2011. Readings above 50 indicate more positive than negative responses.

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A Chart Supporting Market Bears

For investors and analyst it is important to read and evaluate perspectives that run counter to ones own in order to increase the likelihood they are not missing something in their analysis or thinking. For example, the equity market has essentially moved higher, uninterrupted, since the end of the financial crisis low in 2009 and the bull market seems to want to continue; however, is there something suggesting the bull market may be nearing an end? Many of the technical aspects of the market support an additional move higher though and just one bullish chart is noted below.

Source: The Kirk Report

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Trying To Market Time Is Fraught With Risk

The U.S equity market has certainly had a nice recovery since the financial crisis low in 2009. The magnitude and length of the recovery may have some investors contemplating selling their equities in favor of sitting on the sidelines until the next pullback.

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Buy The Rumor, Sell The News

The old investing adage “Buy the rumor, sell the news” comes to mind following the “Trump Rally” to end 2016. As we all know, President-Elect Trump has not yet been sworn into office and yet, the year-end climb in US markets has been mostly attributed to his policy proposals. This makes sense as the market is always forward-looking, but it is important to keep in mind that it often overshoots in the near term. As a prime example, the chart below shows the relative performance of the Utilities sector against the S&P 500 in the three months before (left) and after (right) the two most recent Fed rate hikes. The line moving higher indicates Utilities outperforming the S&P 500 and lower indicates Utilities underperforming.  As any market participant would tell you, this conservative/high income sector should suffer from an increase in interest rates. And it did, but all of the underperformance came before the actual event (Fed rate hike) and subsequently, Utilities dramatically outperformed (short-term).

The surprise victory of Donald Trump in the Presidential election brought about a dramatic market rotation that benefited cyclical sectors like Financials and Industrials. Cyclical sectors outperformed due to the widespread belief that Trump’s pro-business policies could boost domestic economic growth. 

This rotation may prove to be wise and Trump’s policies may boost the U.S. economy, but in the near term, we would not be surprised to see some of this rotation temporarily undone. The market has been driven higher by policy speculation; actual legislation may prove the wisdom of “Buy the rumor, sell the news.”

Buybacks Decline In Q3 2016, But Cash At Record Level

At the end of December S&P Dow Jones Indices reported information on S&P 500 buybacks and dividends for Q3 2016. The preliminary report noted quarter over quarter buybacks decline 12% and year over year buybacks fell 25.5%. The continued decline in buybacks may be a result of companies retaining cash due to the uncertainty surrounding the November election. Dividends were up fractionally QOQ and up 3.5% on a YOY basis. However, in spite of the decline in buybacks, Howard Silverblatt of S&P Global noted,

"cash reserves also set a new record for the third consecutive quarter, as S&P 500 Industrial (Old), which consists of the S&P 500 less Financials, Transportations and Utilities, available cash and equivalent now stands at $1.49 trillion, up 8.2% from the prior record of $1.37 trillion. The current cash level is nearly double [that] of expected 2017 operating income, giving corporations leeway in their expenditures."

Other key highlights from S&P Dow Jones Indices' report,

• Information Technology continued its buybacks dominance, even as its overall percentage of S&P 500 buybacks decreased to 23.2% ($26.0 billion) in Q3 2016, from 23.6% ($30.1 billion) in Q2 2016.

• Apple (AAPL) spent the most on buybacks in Q3 2016, at $6.0 billion, down from $10.2 billion in Q2 2016 and $13.3 billion spent in Q3 2015.

• Microsoft (MSFT) was second, with $4.4 billion, up from $3.7 billion in Q2 2016.

• Energy saw its contribution increase but overall expenditures decline, to 1.20% ($1.34 billion) in Q3 2016, compared to 1.09% ($1.39 billion) in Q2 2016 and 6.07% ($8.8 billion) in Q3 2014.

• Industrials decreased its expenditures by 39.4% ($13.3 billion) from $21.9 billion in Q2 2016.

• Consumer Staples which decreased its expenditures by 28.4% ($8.4 billion) after $11.7 billion in Q2 2016.

Winter 2016 Investor Letter: Rising Confidence And The Populist Movement

In our Fall 2016 Investor Letter we discussed how emotions tend to run high around certain periods like the recent U.S. election. We noted in that newsletter that emotional investment decisions can drive investors to reduce their stock market exposure and harm long term returns. Certainly, the equity market performance following the the November election was one that strongly rewarded investors that stuck with their investment discipline.

Our recently published Winter 2016 Investor Letter discusses the broad improvement in confidence that is showing up in a number of economic variables. The improvement in consumer confidence is important as the consumer accounts for nearly 70% of economic activity. Also included in the newsletter is commentary around the rise of the "Populist Movement' from the BREXIT vote in June to the Italian Referendum in December. While we take no stance on the merits of such movements, it is undeniable that recent elections have dramatically altered the state of western politics and the policies that may be pursued will have an impact on ones investment portfolio as we review the year ahead.

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

• Winter 2016 Investor Letter

Equity Market Technicals Still Leaning Bullish

Yesterday I wrote that investor sentiment is broadly more bullish at the start of 2017 versus the beginning of 2016. Elevated bullish sentiment tends to be a contrarian indicator and can coincide with near term market tops. Now having noted the heightened sentiment measures, but shifting to a technical view of the market, some market excess has been worked off in the last few weeks of December with the S&P 500 Index down 1.4% since December 13th.

As the above chart shows, the late December weakness has created a bull flag formation during this two week period with the market trending lower. Additionally, the Money Flow Index (MFI) has retraced to a more neutral level while the stochastic indicator is near an oversold level.

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Investor Sentiment More Bullish Than A Year Ago

In 2015 investors had to contend with a very volatile equity market during the summer months. On August 24, 2015 the Dow fell 1,000 points intraday before closing down 588 points. This volatility extended into October with the end result, the S&P 500 Index was up only 1.4% for all of 2015. This level of volatility and flat returns left investors anything but bullish going into 2016. As fate would have it, investors faced another market decline to begin 2016 as the S&P 500 Index fell 11.4% before bottoming on February 11, 2016. Fast forward to the end of 2016, and after an equity market that returned 12.0% for this past year (S&P 500 Index), broad measures of investor sentiment are much less fearful as 2017 begins as can be seen in the below chart and raises the question whether much of near term returns are already priced into the market.

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The Final 2016 Dogs Of The Dow Performance And the New 2017 Dow Dog Changes

The 20.5% return for the 2016 Dogs of the Dow exceeded the performance of both the Dow Jones Industrial Average and the S&P 500 Index in 2016. The Dow Dogs returned 20.5% versus 16.4% for the Dow Index and 12.0% for the S&P 500 Index. The best performer of the Dogs was Caterpillar (CAT) up 42.2% with the weakest performer being Pfizer up only 4.5%.

File (xls)

For the coming year, 2017, two of the existing Dow Dogs, Procter & Gamble (PG) and Wal Mart (WMT) will be replaced by Boeing (BA) and Coca-Cola (KO). Boeing has a dividend yield of 3.65% and Coke has a dividend yield of 3.38%.

Most Read Articles From Our Blog In 2016

Below is a list of the most read articles on our firm's blog in 2016. Our generally bullish view on the equity market for 2016 proved rewarding for our clients. We stuck to our bullish call in January when the market was down 8% as noted in the second article link below. When the market began to sell off again into late May, we highlighted our view that equity market headwinds were positioned to subside as noted in the first article link below. Our year-end Investor Letter will be released on Tuesday and will contain additional thoughts on 2016, but more importantly, our outlook for 2017.

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

Equity Market Headwinds Positioned To Subside - May 20, 2016

Maximum Fear May Be Near - January 15, 2016

Oil And Equity Price Trend Conundrum - August 2, 2016

Is The Value Style Outperformance Sustainable? - March 12, 2016

History Suggests Record Equity Market Highs Do Not Mean Investors Should Sell Stocks - August 11, 2016

Tobin's Q Below 1.0 In Q3 2015 - January 2, 2016

Jobs Were The Missing Link? - August 5, 2016

Value Stock Outperformance May Indicate Stronger Economy Ahead - July 17, 2016

Another Month Of Equity Outflows - September 2, 2016

Bullish Investor Sentiment Lower Than Level Reached In 2009 - May 26, 2016

The FANG Basket Of Stocks Gets Derailed - February 28, 2016

Recent Returns Remain Far Below the Longer Term Average

It wasn't until 2013 that the S&P 500 Index broke out 17 year time frame the annualized return (price only) for the S&P 500 Index is approximately 2.59%.

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Has Broadly Improved Sentiment Pushed The Equity Market To An Extreme?

The market's advance since the presidential election has certainly been remarkable. Much of the gain is being attributed to anticipated policies being proposed by a new Trump administration. Obviously none of the proposed policies have been put in place as of yet, but the market is already weighing in with positive expectations. A common thought is whether or not the market has gotten ahead of itself. Given the rapid rise in such a short time period, the market certainly seems to be ahead of itself. However, from a return standpoint, it may not be as can but seen in the below chart. Over the last two years the market's return totals just over 8% and all of the return has come since the election. This makes the average return over the last two years only about 4%.

h/t: Santiago Capital

Much of the positive market sentiment has been driven by a strong improvement in various consumer and business sentiment indicators. Below are a couple of charts showing the spike in a number of sentiment indicators.

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François Trahan Bearish On Stocks In 2017

Whether one is bullish or bearish on equities at any particular time, it is important to read and evaluate opinions that are contrary to ones own. In a recent WealthTrack interview Trahan, voted the #1 portfolio strategist in 10 out of the last 11 years by Institutional Investor Magazine, conducted with Consuelo Mack, François Trahan provides his reasoning for his fairly bearish view on stocks in 2017.

He states the BREXIT inspired pullback was a gift for equity investors. He believes the recent market run up has been predicated on the positive economic data reported throughout the summer months. He does agree the move higher after the election is partly based on anticipated Trump policies. However, he believes much of what a Trump administration is proposing will not work its way into the economy right away, i.e., tax cuts, infrastructure spending, etc. I would say we agree on this as well.

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Investors May Want to Look At Sectors That Worked In The 1980's

Subsequent to the election last month I published a post suggesting the equity market going forward was beginning to resemble the bull market of the 1950's and 1980's, A decade is a long time and market leadership will rotate in and out of sectors based on the business cycle. In that earlier post I noted the potential commonality to the current market compared to those prior decades related to policy decisions coming out of Washington, D.C. In the 1950's the Gross National Product in the U.S. more than double from 1945 to 1960. Government spending in the 1950's was targeted at construction of the interstate highway system, building of schools and an increase in military spending. In the 1980's President Reagan's policies focused on reducing the tax burden on Americans, lowering government regulation and shrinking government itself. President Elect Donald Trump also projects to implement similar policies, i.e., reduce regulation, shrink the government, increase spending on infrastructure and lower taxes. For investors the question to answer is what market segments worked then and might these same sectors outperform early in a Trump administration.

The chart below shows the sector return for the period following the early 1980's recession through 1989. For the entire time period, staples, health care and utilities outperformed with technology being the laggard. I include the Fed Funds target rate for reference since the current Fed is likley of the mind to continue its monetary tightening.

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