Elevated Asset Level In Money Market Funds

I have noted in recent blog articles the fact investment flows into ETFs and equity mutual funds has been strongly negative, i.e., outflows. Some of the equity outflows have found their way into fixed income ETFs and mutual funds. Another large beneficiary though has been money market funds. The below chart shows assets in money market mutual funds as reported by ICI as of mid week last week. Money market assets began to trend higher during the volatile market environment in 2018 and the money market inflow has picked up the pace in 2019 with assets now totaling $3.49 trillion.

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Investor Pessimism Is Generally Bullish For Stocks

As recent weeks pass it seems the investor sentiment measures are increasingly indicating an investor that is becoming more bearish even as the market continues to trend higher this year. The current investment environment seems like one where the market is climbing the proverbial "wall of worry." A case in point is the spike on Friday in the CBOE Equity Put/Call ratio to .99. This is the highest level since the Equity Put/Call ratio reached 1.13 on December 21, 2018, Historically, readings above 1.0 have been associated with levels where the market is near a point where it turns higher. This potential set up to a move higher is on top of the 21% gain achieved year to date.

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A China Trade Deal: Reset Higher In Market And Economic Expectations

The equity market ended this past week on an upbeat note, reacting positively to a China/U.S. trade deal. In looking at the Dow Jones Industrial Average Index, it gapped higher by 197 points at the open on Friday and was up as much as 517 points until late in the day. The below chart shows the S&P 500 Index and a similar gap higher open occurred Friday.

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Fall 2019 Investor Letter: Soft Versus Hard Economic Data

In the third quarter many factors contributed to heightened market volatility that tested the patience of investors. If one simply read the headlines this year, they might have adopted a pessimistic market outlook and completely missed the 20% gain in U.S. stocks through the first nine months of the year. A few factors contributing to the volatility are listed below.

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Bullish Investor Sentiment Nearing Washout Level

Individual investors continue to express a lack of bullishness on stocks. According to the recent release of AAII's Sentiment Survey, bullish investor sentiment fell to 20.31%. This is the lowest level since reaching near the same level in May 2016, at a time the S&P 500 Index was trading at 2,064. Since that time the S&P 500 Index is up nearly 900 points.

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Stocks Responding To Improved Earnings Expectations

Earnings growth expectations for S&P 500 companies continue to improve with the 12-month forward earnings growth estimate equaling 9.18%. This improving trend has been in place since February and is one tailwind supporting higher stock prices so far this year.

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Small Business Optimism Remains Elevated But Down From Earlier Highs

The NFIB Small Business Optimism Index fell 1.3 points to 101.8 for the month of September. Although this is the second decline in as many months, the Index remains at a high level. The NFIB report notes, "The survey shows no sign of a recession and indicated continued job creation, capital spending, and inventory investment, all consistent with solid, but slower growth."

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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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