Watch For A Peak In Consumer Sentiment

Utilizing sentiment measures in one's analysis is not an exact science. On the other hand, at their extremes, these sentiment measures do provide signals of a potential near term change in market and economic direction.  A number of 'investor sentiment' measures are available to evaluate, but I am highlighting only two below, the NAAIM Exposure Index and the American Association of Individual Investors (AAII) Sentiment Survey.

As the below chart shows, the NAAIM Exposure Index reading of 98.3% is approaching overly bullish sentiment on the part of institutional active managers. Reflecting the individual investor sentiment is the green line on the chart showing AAII's percent bullish reading and it is trending higher at 43.5%, but not at an extreme. High readings for this measure are generally at levels near 50% bullish or higher.

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Respect The Predictive Power Of An Inverted Yield Curve

There are a few events in investing that have a high likelihood of being good predictors of the equity market's future direction, like, stock prices follow earnings, market breadth leads price, or an inverted yield curve leads economic weakness. One factor I believe the bears have missed in the recent market advance seems to be their discounting of the increasing strength of corporate earnings growth. The improved earnings growth picture has not only improved the market's valuation, but as the below chart shows, the faster earnings growth seems to be pulling stocks higher as well.

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Yet To Break The Bull Market Record

I have been a bit lax in writing blog posts as client and investment responsibilities have taken precedence. On a day like today though, I feel compelled to type out a blog post recognizing today's record breaking bull market, or is it?

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Near Record Small Business Optimism

As I review and highlight business and consumer optimism, I feel as though my thoughts are a bit like a broken record that plays the same song over and over again. With that, another business optimism survey is highly positive. The National Federation of Independent Business (NFIB) reported that small business optimism rose to the second highest level in the indexes history. The optimism index level of 107.9 was only .1 points lower than the record high reading reached in July 1983.

Having difficulty filling open job positions seems to be a common theme in these optimism and confidence surveys and today's NFIB report is no different as it is noted,

"The July 2018 report also set new records in terms of owners reporting job creation plans and those with job openings. A seasonally-adjusted net 23 percent are planning to create new jobs, up three points from June. Thirty-seven percent of all owners reported job openings they could not fill in the current period, a one-point increase from June (emphasis added.)"

Another category contributing to business optimism is the fact top line revenue growth remains robust. The report shows that "July is the eighth consecutive strong month of reported sales gains after years of low or negative numbers. A net 35% of owners expect better business conditions, ticking up two points from June."

All in all this is another strong confidence report. Historically, recessionary periods do not occur until several years subsequent to peaks in the NFIB index and other economic data suggests further economic growth ahead. 

Is Korea Equity Market Weakness A Precursor To Weakness In U.S. Markets?

About a year ago I provided an update on the Korea Stock Exchange Index (KOSPI) and the fact it can serve as a leading indicator to U.S. equity market performance. As noted in that earlier post, I referenced noted economist, Ed Hyman of Evercore ISI, who believes the KOSPI index is a leading indicator of the global economy as South Korea's exports account for over 40% of the country's gross domestic product. In other words, the KOSPI Index performance is a reflection of the health of the global economy. Also worth noting is the largest sector weighting in the KOSPI index is the technology sector, accounting for over 40% of the index weight. The below chart compares the KOSPI index, in US Dollars, to the S&P 500 Index. Since early June the performance of the KOSPI Index has diverged to the downside versus the S&P 500 Index. Even with the KOSPI priced in Won a similar divergence is seen.

Some of the weakness may be attributable to investors reducing emerging market positions in ETFs like the iShare MSCI Emerging Market Index (EEM) as Korea remains classified as an emerging market country and makes up about 14% of the index. China is the largest weighting at 32%. The EEM ETF has experienced outflows of nearly $5 billion since June 1. Last week though, EEM had inflows of about $178 million.

Some of the weakness in the Korean market might be related to tariff issues. The Trump administrations comments about increasing tariffs on more Chinese exports is being felt in other Asian countries. However, economically, the Korean economy is continuing to expand, but higher tariffs could have a negative spillover impact on their economy.

Another Highly Optimistic Business Owners' Survey

Many of the consumer and business sentiment surveys continue to be reported at or near record levels. I highlighted a few of these high level optimism surveys last month in a post titled, Sentiment Is Widely Positive. Earlier this week Gallup released the results of the quarterly Wells Fargo/Gallup Small Business Index and Gallup noted, "small business owners are more optimistic than at any point in the 15-year history of the Index." The index level high of 118 surpasses the prior high of 114 reached in 2006.

The interviews for the survey were conducted in mid July so it does account for any issues surrounding trade and tariffs. If record high optimism is any indication, business sentiment around the trade issues seems much less worrisome at the moment than the headlines from news commentary may be suggesting.

As I have recently noted in earlier articles, the job market is tight so it is not surprising business owners mention finding qualified workers as their biggest challenge. The survey notes,

"The Wells Fargo/Gallup Small Business Index includes an open-ended question asking small-business owners to name the most important challenge facing their businesses. In the current update, owners remain more likely to say that hiring poses a greater challenge than any other single issue, with 18% citing this as their top concern. Hiring is the only issue cited by at least 10% of owners."

Sentiment Measures Not At Extremes

Keeping in mind sentiment data is contrarian in nature and most predictive at its extremes, today's American Association of Individual Investors Sentiment Survey report shows bullish sentiment increased over seven percentage points to 36.36%. The plus and minus one standard deviation levels for the bullishness reading are 48% and 28%, respectively. Although the bullishness reading jumped higher in this week's report, the reading remains below the average reading of 38%. In order to minimize the weekly volatility often the 8-period moving average is evaluated as well. This week the 8-period moving average continued moving lower to 33.3% and is represented by the red line on the below chart.

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A Tight Labor Market Evidenced By Declining Jobless Claims

Further evidence of a tight labor market is seen in today's decline in weekly jobless claims to 213,000. This was the first decline in the last three weeks and the 4-week moving average of initial claims continues its trend lower. This report coincides with Tuesday's JOLT report that shows job openings continue to exceed job hires as well. Jobs are plentiful at the moment.

Job Openings Continue To Exceed Job Hires

Today's June Job Openings and Labor Turnover report once again shows job openings exceed the number of hires for the month by 1.0 million. This continued trend higher in openings versus hires is a sign employers continue to have difficulty filling open positions.

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A Strategy Based On Stock Buybacks Continues To Underperform

It seems one key focus of recent commentary has been the buyback activity by companies due to the cash flow benefit resulting from the tax cuts passed late last year.

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François Trahan: Cycle Peak Leading To Change In Leadership

François Trahan, Co-Head of Portfolio Strategy at Cornerstone Macro, and named #1 in portfolio strategy in 8 out of the last 10 years by Institutional Investors Magazine, recently sat down for an interview with Consuelo Mack on WealthTrack. Whether one agrees or disagrees with his perspective, it is important insight to include in one's evaluation of the market. Much of François' investment thesis centers around his belief that the economic cycle has peaked.

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Is The Value Style Really In Favor Now?

It seems as though I have written a dozen or more articles on the value versus growth style during the current economic cycle. The extent to which growth has dominated has certainly been a little surprising. For most of the the equity market's upward move since the bottom of the financial crisis, the growth style of investment has dominated as seen in the below chart.

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Small Caps Beginning To Exhibit Weakness

Just returned from a week vacation on the Outer Banks of North Carolina and attempting to catch up on market events from last week as I stayed relatively disconnected from technology. The family drove from Ohio to the Outer Banks and if the traffic on the way there, as well as activity on OBX has any economic significance, the economy is strong.

Confirming this strength were a few economic reports last week, durable goods and GDP. Although the headline durable goods orders of 1.0% missed expectations of 3.2%, strength was seen in core capital goods and unfilled orders. Core capital goods rose .6% and exceeded the .5% consensus expectation. Overall this is a strong report. Then on Friday the advance estimate of second quarter GDP was reported at an annual rate of 4.1%. The last 4%+ GDP print was Q3 2014 when the rate was 4.9%. According to the Commerce Department on the Q2 2018 GDP report, "The acceleration in real GDP growth in the second quarter reflected accelerations in PCE and in exports, a smaller decrease in residential fixed investment, and accelerations in federal government spending and in state and local spending. These movements were partly offset by a downturn in private inventory investment and a deceleration in nonresidential fixed investment. Imports decelerated." The weak economic report for the week was a miss in the existing home sales report which have now been soft for three consecutive months. This is something to keep an eye on.

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Hard To Find Much Bad News

One could certainly say the current economic expansion is long in the tooth, i.e., second longest on record. As we also wrote in our summer Investor Letter, the headlines on news reports seem a lot worse than reality. Personally, I stopped tuning into the daily television business shows not too long ago as news headlines seem disconnected from actual economic and business results. Simply looking at some of the economic and business reports today:

• Initial jobless claims are at their lowest level in nearly half a century, being reported at 207,000.

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Consumers Are Buying

If there is one takeaway from today's advanced retail sales report it is the consumer continues to buy. On a year over year basis total retail sales increased 6.6% as of the end of June. For the month, the actual increase was .5% and met consensus expectations. A large positive in the report was the .5% revision higher in May's .8% increase to a 1.3% increase. In Econoday's release covering the report they note,

"What's striking is that autos were very strong in both June and May, up 0.9% and 0.8% respectively, with restaurants really showing unusual acceleration, up 1.5% and 2.6% in the two months. Gains here point to new confidence among consumers and are consistent with the strength underway in the labor market."

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Individual Investors Like The FANG's ex Alphabet

From time to time I review the top 10 stocks that are attracting the interest of members of Better Investing (BI). BI reports the information based on a review of transactions from the company's club accounting website as well as separate member transaction reports. The list has become a little less technology dominated since my last report in March this year. The FANG's ex Alphabet (GOOGL) continue to draw investor interest though. The only top 10 stock seeing net selling activity is Gilead Sciences (GILD)

Full File (xls)

Sentiment Is Widely Positive

Today's Sentiment Survey report from The American Association of Individual Investors (AAII) is further confirmation that sentiment results are widely positive. The AAII report shows bullish individual investor sentiment jumped 15.2 percentage points to 43.1% this week. Ten percentage points came from a decline in bearishness of 10.1 percentage points and a decline of 5.1 percentage points in the neutral category.

This improvement in sentiment coincides with other sentiment measures showing high levels of optimism as well. Yesterday we noted the near record high in the NFIB Small Business Optimim Index. The consumer is optimistic as well with the University of Michigan Sentiment Index at a level that exceeds pre-financial crisis readings.

Sentiment measures tend to be contrarian ones, especially the AAII Sentiment Survey. From a positive standpoint bullish sentiment is not at an extreme high, that is, at a level in excess of 50. In and of themselves, these positive sentiment readings can serve as a tailwind for further positive activity both economically and and for the equity markets.

Looking Under The Headline NFIB Small Business Optimism Index Level

One area that could show an early sign of weakness resulting from the trade/tariff headlines is in sentiment levels, specifically, sentiment of consumers and business. Just yesterday the NFIB Small Business Optimism Index report showed small businesses remain highly optimistic. The report noted,

• "The Small Business Optimism Index posted its sixth highest reading in survey history for the month of June, at 107.2, down 0.6 from May."

• "Since December 2016, the Index has averaged an unprecedented 105.4, well above the 45-year average of 98 and rivaling the all-time high of 108.0 in July 1983."

Juanita Duggan, NFIB President and CEO stated, "Small business owners continue to report astounding optimism as they celebrate strong sales, the creation of jobs, and more profits. The first six months of the year have been very good to small business thanks to tax cuts, regulatory reform, and policies that help them grow."

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Summer 2018 Investor Letter: A Recession In 2020?

The economy is not the stock market and vice versa, but positive economic data tends to be supportive of a positive equity market environment. The current environment seems a bit like a Goldilocks one and that might be a cause of concern for some. If one is a writer for business publications it is difficult to find a great deal of negative news. To that end recent articles are focused on predicting a recession and end to the bull market in 2020. Predicting the end of the equity bull market a few years into the future is something of a stretch when economists and strategists are unable to accurately predict economic growth (GDP) for the next one or two quarters as highlighted in our Summer 2018 Investor Letter. Our current Letter comments on the hunt for bad news in spite of what seems like a strong underlying economy. We discuss issues that could derail the expansion, but the economic and market environment looks sound at this point in time.

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

• Spring 2018 Investor Letter

The Economy Is More Than Just Jobs But...

Today's employment report was strong as nonfarm payrolls increased 213,000 and beat expectations of 190,000. The prior month's report of 223,000 jobs was revised higher to 244,000. In short, a strong jobs report. A positive in the report was the increase in the participation rate to 62.9% versus the prior month's participation rate of 62.7%. The number of unemployed actively looking for jobs jumped 499,000 to 6.564 million. Because the change in payrolls was smaller than the change in the number actively looking for a job, the unemployment rate increased to 4.0% from the prior month's rate of 3.8%.

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