Challenging Times for Investors

January 30, 2017

Last week the S&P500 made another modest jump higher. With most of the advance occurring on one day, the S&P closed up 1% by the end of the trading week. Volume was light, and volatility—as measured by the VIX index—dipped down to levels not seen since 2014. This is an amazing situation:  as investors push stock prices in the US reach to all-time highs, these same investors are buying very little insurance against potential losses from these all-time highs. Most investors are throwing caution to the wind and believe that stock prices simply can not fall, at least not by much.

So in terms of technical analysis, prices are even more stretched than they were last week…..on both the daily and the weekly chart resolutions. And in terms of broad, long-term valuation measures (measures that are more stable that the simple P/E ratios because E, or earnings, is so volatile), prices are near multi-decade highs.  The price-to-sales ratio, the price-to-GDP ratio, and the more stable Shiller PE ratio are all clearly screaming that the bull market that started in 2009 has pushed valuations to levels that have been attained only a tiny percentage of the time (in terms of weekly closes) in the last hundred years. And every time this has happened in the past, future (or prospective) returns from those stretched valuations have not only been dismally low, but they’ve usually translated into losses over the shorter (one to five year) horizons.

One of the unfortunate consequences of this run-up in prices, is that anyone—professional or not—who’s been the least bit concerned about normal pull-backs in equity prices (or even more serious drops such as an emergence of another bear market) has been brutally punished in terms of performance results. Historically, it almost always paid off, in terms of investment performance, to protect against downside movements in equity prices, typically with hedges in the same asset class (equities) or by owning assets that are negatively correlated with equities (such as US Treasuries).  But in this latest bull market move, the most successful strategy has been to be 100% long US stocks, with no hedging. Even better–you could beat the stock market if you levered up by borrowing money to buy even more stocks; very risky, but this has worked for the relatively small percentage of money managers who’ve done it.

What has this meant for those who have not done this—simple: poor performance. For example, in the world of US hedge funds, where some of the smartest and most experienced money managers do their work, about 90% of them have under-performed the S&P500 since 2009. Yet another example is Harvard University, which boasts of having the largest university endowment in the country—Harvard’s endowment recently reported a 2% loss for the fiscal year 2016. What’s worse, the size of Harvard’s endowment at the end of fiscal 2016 ($37.7 billion) was essentially unchanged from where it stood at the end of fiscal 2007 ($37.4 billion). That’s nine years of no net growth, despite employing an army of the best and the brightest money managers in the world!

Of course, this situation will change at some point, but until it does, the challenging times for investors may continue for a bit longer.

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As Stock Market Prices Cling to All-Time Highs, Internals Deteriorate

January 23, 2017

The S&P500 dipped a very insignificant 0.15% last week, ending the week essentially unchanged from the prior week. S&P volatility inched up a bit higher, but the VIX index still closed near the very low end of its long-term range. And equity trading volumes were light—but a big part of that had to do with the MLK holiday which reduced the number of trading days last week.

In macro news, the reporting was light and mixed in terms of results. On the positive side, industrial production beat expectations. Initial jobless claims dropped to a multi-decade low. And the Philly Fed survey beat consensus estimates. On the negative side, the Empire State Manufacturing Survey missed. The housing market index also missed. And consumer prices—both headline and core—came in just as expected.

The technical picture for the S&P500 has not changed much. After reaching the present price levels early in December—on the heels of the Trump presidential election—the S&P500 has not moved much. And since the upward price movement has stalled, momentum indicators have turned bearish. The loss of upward momentum doesn’t suggest that any big fall is imminent; it does suggest that a minor pullback would be normal to see.

On the other hand, several longer-term breadth indicators are sending bigger warning signals, signals that do suggest that a larger drop should be unsurprising. While prices hover near all-time highs, the number of issues advancing minus the number declining is now negative…..not something you normally see in a healthy, rising stock market.  Also, the McClellan Oscillator has now turned negative….something that usually precedes larger drops in stock prices. Finally, the percent of stocks above the 50 and 150 day moving averages has turned down; also not good for the near-term prices.

Finally, the Fed had now openly communicated that it’s near-term policy will be to raise rates. This is therefore a tightening policy, a policy that stock markets rarely celebrate (as interest rates go up, corporate profits get reduced by higher financing costs, and consumer purchasing power also gets reduced by higher financing costs).

So while stock market prices cling to super high levels, market internals are deteriorating and interest rates are rising. This has never—-in the past—-boded well for future stock market prices.


Buy the Election….Sell the Inauguration?

January 17, 2017

The S&P500 went pretty much nowhere last week. To be precise, it slipped a minuscule 0.1%. Volume rose but this happened mainly because, by comparison, the prior week’s volume was shaved down by a holiday. S&P volatility remained super low—the VIX index hovered near the extreme lows last reached in the summer (of 2016) months.

As has been the case for the last several weeks, the S&P500 remains extremely overbought. On both the weekly and the daily charts, the S&P continues to hug the upper Bollinger band and is well above the 50 day moving average. From these levels, even a small pullback to this 50 day average would seem very reasonable over the next week or so.

Last week’s macro reports came in mostly on the weak side. While initial jobless claims were better (lower) than estimated, both wholesale trade and business inventories beat consensus estimates, everything else missed expectations. The labor market conditions index fell. Retail sales—both headline and core—missed consensus estimates. Consumer sentiment was lower than expected and core producer prices were hotter.

So as usual, there are no conclusive signs that the US economy is about enjoy any strong growth spurt. Instead, it continues to stumble along, the same way is has since it first came out of the Great Recession.

Finally, there’s been a lot of post-election analysis of the US stock markets—analysis that’s focused on the massive bounce that occurred after Trump got elected President. Most experts missed this trade; in fact, most of these same experts predicted the opposite—if Trump were to get elected, they claimed, then markets would tank. So over the these past 60+ days, many of these same experts have been jumping—even if a bit late—-onto this stock buying spree. Meanwhile, US Treasuries have been sold off hard; the US 10 year note yield has risen, just since the election, by almost 100 basis points.

But over the last couple of weeks, the US 10 year note yield has started backing off those highs. And as of Friday, this yield has now fallen by about 30 basis points. The reason this is important is because the yields in the US Treasury market are somewhat correlated to the US stock market prices: when stocks rise, US Treasury prices tend to fall….and vice versa.

So this recent decline in yields is important because it suggests that as more money flows into the safety of the Treasury market, that there’s a chance the buyers of Treasuries will be sellers of US stocks.

And given that there’s been such a huge run-up in stock prices since the election, even a modest selloff—after the inauguration—would make sense.


US Stock Markets Continue to Levitate

January 9, 2017

After dipping the prior week, the S&P500 resumed its recent bounce and rose a strong 1.7% last week. Volume was very light, but once again this was due more than anything else to the holiday season and reduced number of trading days At the same time, stock market volatility dropped even further, this time roughly matching the lows reached in the normally super complacent summer months.

In US macro news, the results were mixed to weak. While PMI manufacturing rose a bit from last month, and ISM manufacturing beat expectations, most other reports were disappointing. Mortgage applications—for both refinancings and purchases—dropped again.  The ADP employment report missed, fairly badly. PMI services also fell. International trade was worse than expected. Factory orders missed. And the big report of the week—payrolls—was disappointing.  Fewer jobs were created than economists had predicted. While average hourly earnings rose, the average workweek fell. Also disappointing was the labor force participation rate which showed no signs of improvement; instead, it’s still hovering near multi-decade lows.

Technical analysis continues to show an extremely over-stretched stock market.  Prices are literally moving up an off the charts…..on both the daily and weekly resolutions.

But that would be OK if valuations were not so obscenely….when viewed by historical comparisons….high.  For example, in the S&P500 the enterprise value of all businesses divided by their total earnings before interest and taxes (EV/EBIT) is now as high—or higher—than it was during the tech bubble!

Yet investors continue to buy, buy, buy….clearly with the implied expectation that regardless of today’s obscenely high values future valuations will climb even higher. In short, most stock market investors have now succumbed to the greater fool theory—-primarily based on the fact that this theory has seemed to work over the last couple of years and also because everyone can point to the still very accommodating monetary policies of the Federal Reserve.

Clearly, these investors have forgotten the fact that the greater fool theory never works forever. Also, these investors are ignoring the fact that not only has the Fed already raised rates twice in this cycle, but it has signaled that it will be raising them three more times later this year.

Surely, most of these investors know fully well what they’re doing—they’re picking up free nickels in front of a deadly steamroller. And they’ll all be able to get out of the stock markets just before any serious selling begins…if it ever even begins.

Surely.


US Stocks End the Year with a Whimper

January 3, 2017

The Santa Claus Rally somehow failed to arrive in the last week of 2016. Instead of rising slightly—like they do more often than not during this holiday season—the S&P500 slipped 1.1%.  Volume of course was light, again due to the holiday period. And volatility jumped, more that the slight drop in prices would have predicted. The VIX index rose from roughly 11 almost 15, or about 30%…..not an insignificant increase.

Things were quiet in US macro news. The Case Shiller home price index showed another very modest rise in prices. What’s more notable is that now—fully five years after the US housing market bottomed in late 2011 and early 2012, the US housing market has fully regained all those losses and returned to all-time high prices across most major metropolitan markets. Consumer confidence beat expectations, most likely on the back of near record high prices in the US stock markets. Pending home prices however, missed expectations, most likely due to the two-month run up in mortgage rates. International trade also disappointed. Initial jobless claims increased more than estimated and finally, the Chicago PMI missed, quite substantially.

An interesting divergence has now developed in the US equity charts. While the weekly resolution still shows that an uptrend in prices is still fully in effect, the daily charts show a completely different story. They point to a recent breakdown in momentum, and with last week’s losses in the books, they suggest that the uptrend in prices has begun to break down. So this upcoming week will be enough to resolve this divergence. It should only take about five days to determine if the longer-term weekly charts will be correct (and the uptrend will resume) or if the shorter-term daily charts will be correct and continue to push US stocks lower.