Individual Investors Far From Overly Bullish

If readers glean one item from today's release of the American Association of Individual Investors'  Sentiment Survey release, investors are far from bullish. With sentiment measures being contrarian ones, all else being equal, this is a positive for the equity market. This week's survey saw the bullishness reading declined a little over four percentage points to 29.4% with most of this difference moving to the bearish reading, i.e., up over five percentage points.

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The Unknowns Can Derail Past Conclusions

An important factor associated with writing blog content is it serves as a written record of one's thinking at certain points in time. It is often beneficial to go back and review one's thoughts and conclusions at these various points in time. If the conclusions that are drawn from one's writings turn out to be different than what was expected, understanding why is important going forward.

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Data Around Jobs Suggests Continued Economic Growth

The NFIB Small Business Optimism Index released this morning was largely a positive report in my view with the Index reported at 103.1, but down 1.6 points. The Index level remains in the top 15% of readings for the Optimism Index. Where the report shows weakness it is mostly in the expectations areas. For example, the survey notes, "optimism slipped because fewer owners said they expect [emphasis added] better business conditions and real sales volumes in the coming months." Related to expectations was NFIB President and CEO, Juanita Duggan expressing in the report,

"In spite of the success we continue to see on Main Street, the manic predictions of recession are having a psychological effect and creating uncertainty for small business owners throughout the country. Small business owners continue to invest, grow, and hire at historically high levels, and we see no indication of a coming recession."

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Recession Talk Again

It seems much of the discussion and commentary recently is focused on an imminent recession partly precipitated by the consequence of an inverted yield curve. The recent recession chatter reminded me of an article I wrote a little over two years about a recession forecast and market bubble that was headline news in 2012. Yes, recession talk was headline news in 2012. The article included a table similar to the one below.

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Diverging Confidence Reports, But Favorable Employment Environment

Two reports on consumer confidence were reported last week with The Conference Board's report early in the week. Continued strength was evident in the Conference Board's report with the reading coming in at a near record high for this expansion of 135.1. The reading exceeded the high end of the expectations range of 133. Then at the end of the week, the University of Michigan report on consumer sentiment was reported at 89.8 and came in lower than the low end of the expectation range of 92.0. This data is an another mixed data point on the economy that I touched on late last month.

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The Mixed Economic Data Presents A Challenge For Investors

Thursday's release of the Conference Board's Leading Economic Indicators Index (LEI) shows an increase in the LEI for July of .5%. This reverses the declines in May and June. Importantly, and as the Conference Board release highlights, "While the LEI suggests the US economy will continue to expand in the second half of 2019, it is likely to do so at a moderate pace." Although a moderate expansion is expected, it is expansion nonetheless. The chart below shows the one year change in the LEI of 1.63%. Prior to previous recessions, the YoY change turned negative and this is not the case at this point in time.

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Compensation Growth Supporting Strong Retail Sales Environment

The market lost ground for the third consecutive week last week, down 2.93%. In spite of the recent weakness, equities continue to show respectable returns this year with the S&P 500 Index up 15.23%. Foreign stocks have not held up nearly as well and the emerging market index (green line) is only up 2% year to date so far in 2019.

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The Yield Curve Dominates The Narrative

On Wednesday the financial media would have one believe the world and market's would fall apart as a result of the 2-year/10-year U.S. Treasury yield curve inverting, i.e., the 2-year yield moved to a higher level than the 10-year yield. The S&P 500 Index fell 2.93% on the day. The importance of the inversion is the fact the yield curve has some predictive power in recession forecasting. From a technical perspective though, the yield curve inverted on an intra-day basis but not on a closing basis. At the close Wednesday, the curve was positive, even if only by 1 basis point and has since steepened to 7 basis points.

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Improvement In Forward Earnings Expectations Versus Trailing Actual

Just as the market encountered an earnings recession in 2015/2016 due in part to the after effects of higher oil prices and a stronger US Dollar, current earnings reports show S&P 500 earnings growing at a low single digit pace. A large part of today's earnings slowdown is attributable to the tougher prior period comparisons resulting from the earnings improvement from the tax cut in late 2017. I wrote a post earlier this year on this topic and will not repeat it here, but those interested can read it at this link, The Tax Cut And Jobs Act Is Distorting 2019 Estimated Earnings Growth.

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Investor Sentiment Has Reached An Extreme And Not A Bullish Extreme

AAII is reporting individual investor bullish sentiment declined a sizable 16.8 percentage points to 21.7% in the week ending 8/7/2019. This is the lowest level since bullish sentiment reached 20.9% on December 13, 2018, a market bottom in the fourth quarter 2018 pullback. The low level of of bullish sentiment certainly classifies this as an extreme level.

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High Consumer Confidence But Not Too Bullish Of An Investor

Earlier this week I wrote that on balance economic and company data seemed to be more positive than negative. Also noted in that post was the fact the services segment of the economy has become a significantly larger component than the manufacturing segment. Certainly there are headwinds that seem mostly associated with the trade and tariff issues and this was top of mind in the just completed week. On the day President Trump announced that more tariffs are likely to be imposed on September 1, the market swung 600 points. On a percentage basis though, the market was up 1% that day and fell to down 1%. Much of the financial commentary from the media seemed focused on the point swings in the Dow Jones Index itself. On a percentage basis not a significant change. As the below chart shows, the S&P 500 Index remains up 16.96% this year on a price only basis and is only down 3.74% from its high. For the week the market was down just 3.1%.

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Economic And Company Data More Positive, But Headwinds Exist

One area of the economy in both the U.S. and abroad that has garnered heightened attention of late is the manufacturing sector. Based on business surveys it is clear trade and tariff issues are having a more significant impact on the manufacturing sector. As the below chart shows the Purchasing Managers Index for manufacturing has dipped below 50 in the Eurozone yet remains above 50 in the U.S. A reading below 50 indicates the manufacturing sector is contracting, but not necessarily a recessionary level reading. Recessionary readings generally are in the low 40's area. Although the U.S. manufacturing PMI is above 50, the sector has slowed since its mid 2018 level.

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Low Bullish Investor Sentiment And Equity Fund/ETF Outflows

In the most recent report on investor sentiment by the American Association of Individual Investors, individual investors continue to express a low level of bullish sentiment. As the sentiment indicators are contrarian ones, a low bullish sentiment reading is viewed as one positive for higher equity prices. No one indicator works in a vacuum, but it does seem the individual investor remains cautious on the current equity market. The sentiment readings tend to be volatile from week to week, as a result evaluating the 8-period moving average smooths this volatility. For the week, the 8-period moving average did tick slightly higher to 30.5% from the prior week but remains at a lower level.

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Buybacks Down In First Quarter 2019, But Remain Near A High

Late last month S&P Dow Jones Indices reported preliminary dividend and buyback results for the S&P 500 Index for first quarter of 2019. On a quarter over quarter basis dividends declined by $2.48 billion. This sequential decline in the first quarter versus the fourth quarter is not an uncommon occurrence. On a YoY basis dividends were up 7.46% and this was down from the fourth quarter YoY growth rate of 9.46%. Buybacks declined by $17.17 billion on a QoQ basis. As reported operating earnings were up significantly on a QoQ basis, +$48.32 billion or 19.9%, but only up 3.54% on a YoY basis.

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Summer 2019 Investor Letter: A Rate Cut Seems Near

The headwind created by the trade and tariff issues formed a heightened level of uncertainty facing the economy and the market; however, the stock market, yet again, scaled the proverbial “wall of worry” over the first six months of this year. The June total return for the Dow Jones Industrial Average of 7.3% was the best June monthly return since 1938. Further, for the first half of 2019, the S&P 500 Index recorded its best six-month total return in twenty-two years increasing 18.5%. As of July 2019, the U.S. economic expansion that followed the Great Recession becomes the longest on record at 121 months. The second longest expansion was from 1991 to 2001 with a length of 120 months. In our Summer 2019 Investor Letter we discuss how some of today’s policy decisions are beginning to rhyme with the 1991 to 2001 period. One of those policy decisions centers around a likely Fed Funds interest rate reduction by the Fed at the end of July. What may seem unusual is the fact an interest rate reduction seems likely at a time where the stock market is near an all-time high and the economy continues to expand. This is discussed in more detail in the Investor Letter.

Economic data is suggesting a slowing global environment, but a recession seems further out than near. Furthermore, it appears the Federal Reserve will reduce rates by 25 basis points at its July meeting, if for no other reason than to provide an “insurance cut” to push out a potential recession. More insight on our views for the balance of the year are covered in the Investor Letter accessible at the below link.

• Summer 2019 Investor Letter

Dividend Payers Return Lags The Return Of The Non Dividend Payers

S&P Dow Jones Indices recently reported the return for the dividend payers and non-dividend payers in the S&P 500 Index for the period ending June 28, 2019. Given the underperformance of the value style over the past several years then it is not surprising the dividend payers are underperforming the non-payers on an average return basis year to date and over the trailing twelve months. The dividend paying stocks tend to be more defensive and have a value tilt. 

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Earnings Growth Expected To Increase From Here

Second quarter earning season kicks into gear in the coming week and a lower bar seems set by a number of firms. Downward estimate revisions are occurring in twice the number as upward estimate revisions. As it stand now, second quarter earnings are estimated to be lower than the same quarter last year by 1.9%, yet I expect earnings growth in the quarter to be positive when the reporting season comes to a close.

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Investors Are Selling Equities: Not A Typical Behavior At Market Tops

After a brief summer vacation and now catching up on some market research, recent fund flow data caught my eye. In this week's ICI fund and ETF flow/issuance report, equity out flows totaled a sizable $28.8 billion. Of this amount $25.2 billion represents outflows from U.S. domestic funds and ETFs. This is the second week in a row that equity flows have been negative. On the receiving end, bond funds and ETFs had inflows of $10.4 billion for the six day period ending July 2 and inflows of $10.5 billion in the prior week. ICI data is reported with a weekly lag. More current Lipper flow data is showing equity outflows continuing for the week ending July 10. This flow data makes it difficult for me to believe the equity market has reached a top. That does not mean one will not see equity market pullbacks, but investors seem far from 'all-in' as they say.

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Dogs Of The Dow Update: As Of June 21, 2019

With the first half of 2019 nearing an end, the Dogs of the Dow strategy is keeping pace with the Dow Jones Industrial Average Index. However, the Dow Dogs for 2019 trail the return of the broader S&P 500 Index. 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 Average 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 that portfolio for the entire next year. The popularity of the strategy is its singular focus on dividend yield.

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Understanding The Purchasing Managers Index

No one variable provides the key to the future direction of the economy or market. However, one economic data point that tends to get a lot of attention is the Purchasing Mangers Index for both manufacturing and non-manufacturing parts of the economy. In fact in an article I wrote earlier this week I highlighted the optimism being expressed by manufacturers and small businesses. Many of my articles get republished on Seeking Alpha as did this one. One reader comment to the article stated I must not be "paying much attention to the manufacturing PMIs, which are showing a severe turn to pessimism." PMIs are important variables we do review; however, we believe many misinterpret the meaning behind the PMI's.

A key misinterpretation revolves around contracting manufacturing versus a recession level PMI reading. PMI readings below 50 do indicate manufacturing is generally contracting but it does not mean with certainty that the economy is headed for a recession. According to the Institute for Supply Management that reports PMI data, they note,

• "A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting."

As it relates to economic expansions though, ISM states,

• "PMI^® above 42.9 percent, over a period of time, generally indicates an expansion of the overall economy [emphasis added]. Therefore, the May PMI^® indicates growth for the 121st consecutive month in the overall economy and the 33rd straight month of growth in the manufacturing sector. 'The past relationship between the PMI^® and the overall economy indicates that the PMI^® for May (52.1 percent) corresponds to a 2.7-percent increase in real gross domestic product (GDP) on an annualized basis,' says Timothy R. Fiore, CPSM, C.P.M., Chair of the Institute for Supply Management^® (ISM^®) Manufacturing Business Survey Committe."

As the below chart of the PMI data shows, PMI readings below 50 occur frequently and a recession does not always follow. 

Last week several additional manufacturing reports exhibit weakness. The Empire State Manufacturing Survey's General Business Conditions Survey Index was reported at -8.6, below  the consensus expectations of 10.0. The drop from the prior month reading was 26.4 points, the largest drop in the index's history which dates back to 2001.

Thursday's Philadelphia Fed business Outlook Survey missed expectations at .3 versus consensus of 11.0. Econoday noted though,

"Yet outside of the headline which is not a composite but a general sentiment reading based on a single question, details in today's report are less alarming. New orders did slow but not very much and remain respectable and solid at 8.3. And unfilled orders are building nicely so far this month, at 10.2 for a more than 8 point gain which is very strong for this reading. Shipments continue to move out the door at 16.6 and hiring remains solid at 9.4."

In  conclusion, the manufacturing data is indicating a slowdown, but it is not at recessionary levels. Globally, PMI's have improved with the Eurozone PMI trending higher for most of this year. Also, the emerging market and China PMIs have improved to above 50 after dipping below 50 earlier this year. So PMIs in the low 40's would be more of a concern versus brief periods falling below 50.