The Few Asset Classes that are On Sale

July 23, 2018

The S&P 500 finished the week essentially unchanged. Volume was light, but some of this was due to the fact that many traders take vacations during this time of year. Volatility remained stuck near the lows of the 2018 trading year…..levels that are still notably higher than those enjoyed for most of 2017.

In US macro news, the results were mixed. Retail sales, industrial production, business inventories, and the housing market index all met their respective expectations. Initial jobless claims and leading indicators both beat their consensus estimates. And housing starts missed.

For two weeks in a row now, the Fed has made almost no changes to the size of its balance sheet. This means that a fairly severe reduction during the last two weeks of the month must happen for the monthly total target to be achieved.

In terms of technical analysis, the weekly charts are still bullish. While most of the technical damage from the big pullback earlier this year has been repaired, all the damage will not be repaired until….or unless….the S&P makes new all-time highs. This has not happened. On the daily charts, while the overall signal is bullish, there are some signs that upward momentum is waning and that some sort of pullback could arise soon.

So while the US economy is hanging in there, and while US equity (and credit) markets are still enjoying near record highs, there are some other asset classes that have fallen off in price…..and for investors who are looking for value, these asset classes should be considered.

In the US, the entire MLP asset class is still far off the highs reached in 2014; in fact, as a group, this asset class is over 50% below those record highs.

Precious metals—gold, silver and platinum—have been in a cyclical bear market for several years now, and all are cheap at least relative to their old cyclical high prices, prices reached many years ago.

Overseas, emerging market corporate and sovereign debt has, as a group, fallen back in price quite a bit. Part of the reason is the tightening process being led by the Federal Reserve, which is making dollar funding more expensive for EM corporations and governments. And to the extent the Fed continues to hike, this asset class could suffer even more price declines.

As most investors complain that all prices are high today, so there is no alternative to US stocks, the truth is that there are several major asset classes that are on sale. Sure they could fall even further in price, but buying assets 50%+ (MLP’s) off peak is a usually a much better decision than buying assets only 1-2% off peak (US stocks).

Stay Long US Stocks….For Now

July 16, 2018

The S&P500 closed higher last week; it rose 1.5% which added to the gains from the prior week. As we noted in last week’s note, this gain was completely expected–it was a continuation of the bounce that began several weeks ago, and it was building on the positive technical signals that grew even stronger on both the daily and weekly charts.

On the downside, volume was extremely light, so by no means were investors rushing into the stock market with new money to buy more shares. In fact, all the evidence from analysis of funds flow suggests that the largest marginal buyer of US stocks over the last couple of years has been the corporate sector itself. Cheap money (cheap in large part due to the Fed’s stimulative monetary policies) acquired by corporations that sell bonds has been used by these same corporations to buy back their own shares. In the process, corporate debt to GDP ratios have reached all-time highs, highs that in the past have always been associated with the onset of credit crunches as the massive volumes of newly issued debt crash in price, leaving corporations to face much higher costs to re-finance this debt. This causes cash flows to suffer, and this in turn leads to corporate lay-offs and big reductions in capital spending.

But to be fair, this hasn’t happened yet.

In terms of US macro reports, last week’s news was neutral to negative. Headline inflation figures, both CPI and PPI, came in higher than expected. For wage earners, the higher CPI figure means that their real earnings are dropping, because their nominal wages are not keeping up with inflation. Job openings, in the JOLTS survey, also missed. On the positive side of the ledger, initial jobless claims were better than expected.

Now that the S&P500 has rallied for several weeks in a row, it’s time to look at the bigger technical picture. As noted last week, the weekly charts have now returned to being bullish, especially with the most important momentum indicators. That said, the S&P500 has still not returned to its highs of the year, highs reached in late January. Finally, our Simply Rule is still delivering a bullish signal, the same signal that it’s delivered all year—and in retrospect, properly so.  This means that investors should remain long the basket of the entire S&P500; in other words, investors should continue to own S&P500 ETF’s such as the SPY.

At least for now.

S&P500 Bounces

July 9, 2018

After a fitful start to the week, the S&P500 closed on Friday to register an impressive 1.5% gain on the week. Volume was light, but this was pushed down in part due to the July 4th holiday on Wednesday. Supporting the bounce, the VIX index moved back down to the mid-12 levels. So volatility is now approaching the lows of the year; that said, the VIX is still almost 30% higher than the lows reached for much of the 2017 calendar year.

In US macro news, the ISM manufacturing index. factory orders, and ISM services all beat their respective consensus estimates. Construction spending, initial jobless claims, and ADP employment all missed. The big report of the week, June payrolls, was a mixed bag. The headline number of jobs created and the labor force participation rate beat their estimates; but the headline unemployment rate and average hourly earnings both missed. It’s important to remember that six months into 2018, that annualized hourly earnings at 2.7% are exceeded by annualized consumer price inflation at 2.8%. This means that in the first half of this year–fully nine years after the so-called recovery began in 2009–that real wage growth is actually negative. Unlike Wall Street investors, that is people with excess capital, capital that can be invested in stocks and bonds, most people on Main Street who do not have such capital are not only not benefiting from Wall Street’s gains, but they’re falling behind in incomes, because their inflation is eclipsing their wage gains.

Also, the Fed’s balance sheet just registered one of its largest weekly reductions since it initiated quantitative tightening—the balance sheet dropped by almost $16 billion, bringing the total shrinkage since October 2017 up close to $170 billion.

But the S&P500, so far seems to be ignoring the reduction in base money, which is not unusual because US equity investors back when the US stock markets first started eroding in late 2007 did not immediately respond to Fed easing either. They spent more than a full year falling, in the face of Fed easing.

With respect to technical analysis, this most recent bounce is impressive because it took place without even challenging the 200 day moving average. In other words, the big support that would normally be found at the 200dma was not needed to turn the most recent sell-off around. So now both the daily and the weekly charts are signalling that there may be some more upside ahead for the S&P500.

DM and EM Bear Markets?

July 2, 2018

Just as we outlined here last week, the S&P500 did in fact retreat in the short-term, specifically over the last week, when it gave back 1.33%. But since volume was light, it can’t be claimed that investors were rushing for the exits. On the other hand, investors did express their greater caution by taking out more insurance against further losses—the VIX index rose to the mid-teens for the first time since late May.

US macro reports were mixed as usual, with no signs that US economic growth is accelerating. In fact, the latest revision to Q1 growth missed expectations—it came in at 2.0% (annualized) instead of the 2.2% that was expected. While 2% growth is better than no growth, this rate of growth is well below levels that were reached in prior recoveries, when they were typically above 3% per year.

In terms of technical analysis, the charts are still bearish on the dailies. That said, the S&P500 did manage to hold near the 50 day moving average, and if this level can be held next week, then a short-term rally may ensue.

The weekly charts are still bullish, but only barely, after last week’s losses.

More importantly, our Simply Rule for the S&P500 is still bullish, so investors can stay long the entire index (in other words, this analysis does not apply to any particular company in the S&P500, but it does apply to the index as a whole).

Finally, this same Simple Rule, when applied to the developed market (DM) equities and to emerging market (EM) equities generates an entirely different conclusion. For both DM and EM equities, a new bear market cycle has begun. So that means if we owed DM or EM ETF’s such as EFA or EEM, we’d have exited these positions by now, and would have allocated those funds to other investments. As the situation in DM and EM equities evolves, we’ll look to our Simply Rule to give us a signal that we should re-enter these asset classes. But this buy signal is not around the corner—it will most likely take several months to register.