Data suggests more upside

Coming off a weekend of political disappointment, it’s easy to get caught up in the emotions of it all. As I pointed out, the market was due for a pullback, and it got a reason to. We can “beat a dead horse” and dissect all of the “what-if” scenarios and implications of the failure. But none of this will be fruitful for your investment decisions. We know that pullbacks and corrections are an inevitable part of investing. And once in awhile we get a major decline, usually due to a recession. The key question is does the data suggest a business cycle peak?

The short answer is no.

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Consumer confidence numbers just came out at a high not seen since November 2000.

Small business optimism

Scott Grannis points out that Small Business Optimism has soared post election and is near all time highs.

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Earnings growth is finally back and is projected to be around 9-11% for 2017. This would be the largest annual increase in earnings since 2011. And this doesn’t even factor in the potential for tax reform and repatriation.

And interest rates are still very low. The earnings yield on the S&P 500 is currently 5.59%, while the 10 year treasury bond yield sits at 2.38%. Even the Fed’s overly optimistic projection suggests the real Federal Funds rate won’t even turn positive until another two years or so. So, even though valuations are on the high side and interest rates have risen quite a bit post elections, stocks still present an attractive risk premium.

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An interesting chart to follow going forward is the ten year yield. Post election the 10 year yield has risen on the assumption of pro-growth policies of the new administration. Since then a trading range between 2.3% and 2.62% has been formed. An upside breakout suggests all is clear, while a breakdown suggests that more of the President’s agenda may be in jeopardy.

Time will tell. But for now, things are looking pretty good to me. But I parse this by saying we’re probably closer to the end of the bull market, than we are to the beginning. The stock market and the economy don’t always correlate. We’ve had great performance in stocks over the last 8 years, while the economy largely under-performed. I wouldn’t be surprised if, going forward, we experience a situation where the economy starts to outperform, while stock performance slows down to an eventual crawl.

The great thing about diversification and asset allocation is that we don’t have to be prophetic. We stick to our strategy and re-balance when necessary. It’s that simple, but certainly not easy.

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Financial Markets Week in Review: September 21-25

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This week was an overall risk-off environment, as US stocks lost 1.8% and foreign stocks down 2.7%.  Meanwhile Gold, Treasuries and the US Dollar found some demand. September has historically been the worst month for stocks, and Ryan Detrick astutely points out that this last week has historically been one of the worst weeks of the year.

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The weakness was broad based across most sectors. Only Utilities closed positive for the week. Health Care, mainly Bio-tech, has been a drag ever since the May highs. It’s concerning to see one of the leading sectors in a bull market suddenly turn into a laggard. But markets are cyclical in nature. They go against our natural tendencies to want to go with what is working. It’s possible that this under-performance continues into the late cycle stage. But that doesn’t mean there won’t be bargains in individual companies inside the sector.

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As all four major averages are below their 50 and 200 day moving averages, it’s prudent to be cautious in the near term. The St. Louis Fed Financial Stress Index has elevated due to the recent volatility, but is still below normal and well below the levels seen in 2008 and even 2011.

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Even the yield curve has flattened over the last 12 months or so. As short term yields start to pick up steam in response to the nearing Fed Funds rate hike. Though yields remain far from an inversion which has done a good job at predicting impending recessions.

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Most of the weeks economic data came from overseas. However on Friday, final quarter over quarter US GDP came in at 3.9%. Which was slightly better than the 3.7% estimates.

Fed Chair Yellen spoke on Thursday and again reiterated the likelihood of an initial rate increase before year end. She states that the Fed wants to get ahead of the curve before inflation picks, because if they wait too long they may have to tighten more quickly in response and that could disrupt financial markets. The Fed has consistently stated that they will maintain a very gradual pace of rate increases. And this is more important (and beneficial to equities) than the actual timing of the first.

It’s also possible that the market has already priced in the first increase for them. USD has increased over 20% in the last year, credit spreads have widened and the S+P 500 has fell some 12% already.

For next week…

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More important data on tap for next week: Consumer Confidence on Tuesday, China Manufacturing on Wednesday night and US NFP employment report on Friday.

It’s difficult but investors should try to avoid headlines and focus on data. Low recession odds and accommodating monetary policy has generally been beneficial for stocks. 3rd quarter earnings will begin soon and the bar has been set quite low. If earnings can get back on track that may help provide the necessary catalyst for equity markets.

Want to learn how to trade and analyze the markets? Whether your a day/swing trader or investor wanting to learn how to analyze trends in the financial markets, there is something in The Trading Playbook for everyone. 

What isn’t happening?…

The answer to the question posed in the title is, broad market participation. Last week we talked about some of the positive aspects of the markets for 2015 (Financials, Small caps and Nasdaq 100 outperformance), now we will look at some of the bearish divergences we are also seeing this year. It’s important to note that this is mostly a short term market observation. There are always two sides to every financial market transaction, so it can be of benefit to understand each side’s point of view.

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We have seen some deterioration in the advance – decline line during this last pullback in the markets off the May 20 highs. The chart above plots the advance – decline line of the common stock that is traded on the NYSE. It remains in a bullish configuration overall, but the trend has taken a cautionary turn this month.

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This chart shows the advance – decline percentage of the S+P 500 index on a cumulative basis, with the S+P 500 chart on the bottom. Basically the same bearish divergence as the A/D line took out its March and April lows this month, even though the S+P 500 average is still trading above. On a near term basis this means that a smaller amount of stocks are participating on the upside. Of course, this trend could reverse tomorrow for all we know. But for now, all we can do is go by the information that is currently available.

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Now if we take a look at sector performance, we can see that 25% of the S+P 500 is outperforming (by outperforming I mean closer to it’s year to date high than the S+P 500 is) while the remaining 75% is further below their year to date highs. Now in fairness, only the Energy and Utilities sector (11% of the S+P 500 index) is significantly underperforming. But it’s worth noting nonetheless.