The macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.
The strong, uninterrupted start to the year for equities is very likely to lead to further gains in the second half of the year. But the crack that opened in NDX two weeks ago has widened further and the consistent historical pattern is for SPX to follow, lower.
Take the US tech bubble of the 1990s, add the subsequent real estate bubble of the 2000s, multiply by two, and you have a good approximation of the events leading to Japan's stock market crash in 1990. The Nikkei stock index rose more than 900% in the 15 years before it finally topped. It was a frenzy powered by a belief that Japan Inc. was on its way to taking over nearly every major industry worldwide. The stock market bubble was further fueled by a massive real estate bubble at least twice the size of the one the US experienced in the 2000s. Tokyo alone became more valuable than all the land in the US. In short, it was the product of a tsunami of monumental and concurrent events that are unlike anything present in the US today.
NDX has opened a noteworthy crack in US equities. NDX has fallen 4.5% in the past week. In the past 7 years, falls of more than 4% in NDX have preceded falls in SPY of at least 3%. That doesn't sound like much, but it would be the largest drop so far in 2017. A key watch out now is whether NDX weakens further and breaks both its 50-d as well as its mid-May low; if so, then SPY is likely to follow with its first 5% correction since the US election.
Global equities have risen 5% in the past 3 months and nearly 20% in the past year, yet fund managers continue to hold significant amounts of cash, suggesting lingering doubts and fears.
Higher environmental standards and reduced carbon emissions have not harmed the US economy. They have arguably contributed to technological innovation and the advent of new industries and better jobs.
In 1987, the US stock market crashed. Today is not like 1987.
All of the main US indices made new all-time highs this week. The indices appear to be supported by strong breadth, with 7 of the 10 SPX sectors also making new highs. This post reviews several studies that suggest price momentum is likely to carry the indices higher over the next several months and through year-end. That does not preclude an interim drawdown of at least 5% - we regard that as very likely, sooner rather than later - but any weakness has a strong probability of being only temporary.
The macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely. That said, housing starts grew only 1% in the past year. Permits are up only 2%. Moreover, employment growth has been decelerating, from over 2% last year to 1.6% now. It's not alarming but it is noteworthy that expansions weaken before they end, and slowing employment growth is a sign of some weakening. Finally, real retail sales excluding gas is in a decelerating trend. In April, growth was just 1.6% after having grown at more than 4% in 2015. Personal consumption accounts for about 70% of GDP so weakening retail sales bears watching closely.
US equity markets made new all-time highs again this week. By Friday, SPX had risen 7 days in a row; that type of trend persistence has a strong tendency to carry the markets higher over the next week(s). That said, the month of June is seasonally weak and there are a number of reasons to suspect it will be again this year, not the least of which is the FOMC meeting mid-month during which markets anticipate the federal funds rate will be hiked for a 4th time. The prior three rate hikes have coincided with notable drawdowns in equities (as well as a fall in treasury yields).
Investors are clearly shifting away from actively managed funds to those based on index strategies. Only time will tell, but this has the look of a durable, secular change in investment management. But much of the perceived threat to market stability of indexing is overblown.
Fund managers have become more bullish, but not excessively so. Cash balances at funds remains high, suggesting lingering doubts and fears. Of note is that allocations to US equities are near their lowest level in 9 years: this is when US equities typically start to outperform.
US equities rose for a third week in a row, to new all-time highs. Trend persistence like this normally leads to higher highs in the weeks ahead. It's true that volatility has dropped to significant lows and that volatility risk is to the upside.
S&P profits are up 22% yoy. Sales are 7.2% higher. By some measures, profit margins are at new highs. Bearish pundits continue to repeat claims that are more than 20 years old: that "operating earnings" are deviating more than usual from GAAP measurements, and that share reductions (buybacks) are behind most EPS growth.
US equities ended the month of April above or near new all-time highs. There are no significant extremes that suggest the trend higher will suddenly end. But the upcoming "summer months" are normally marked by lower price appreciation and larger drawdowns.
Fund managers have become more bullish, but not excessively so. Cash balances at funds remains high, suggesting lingering doubts and fears. Allocations to US equities dropped to their lowest level in 9 years in April: this is when US equities typically start to outperform.
A week ago, a number of notable short-term extremes in sentiment, breadth and volatility had been reached, suggesting a rebound in equities was ahead. In the event, US equities gained 1% and both NDX and COMPQ made new ATHs. But new uptrends are marked by indices impulsing higher as investors quickly reposition and chase price. Momentum quickly becomes overbought. Neither of these has happened, at least not yet.
US indices closed lower this week, but not by much. SPX lost just 1% and is just 3% from its all-time high. A number of notable short-term extremes in sentiment, breadth and volatility were reached on Thursday that suggest equities are at or near a point of reversal higher. The best approach is to continue to monitor the market and adjust with new data. That said, it's a good guess that SPX still has further downside in the days/weeks ahead.
US indices made their all-time high in early March; aside from the Nasdaq, which made new highs this week, these indices have since moved sideways. SPX has alternated up and down 5 weeks in a row, producing little net gain. Seasonality is particularly strong in April, so a fuller retest of the March highs might still be ahead this month. And indications that 2017 will be a good year for equities continue to add up. But there is a notable set up in place for the first correction since November to trigger. This week is likely to be pivotal.
US indices have fallen nearly every day since the FOMC raised the federal funds rate on March 15th. There are a number of reasons to expect equities to be at or near a point of reversal higher. A retest of the recent high is likely. That said, it's a good guess that the market's period of smooth, persistent strength over the past 4-5 months has come to an end. Higher volatility and more days with 1% losses (and 1% gains) lie ahead.
A tailwind for the rally over the past year has been the bearish positioning of investors, with fund managers persistently shunning equities in exchange for holding cash.
Households have 30% of their financial assets in equities, the same proportion as they held at bull market peaks in the 1960s and in 2007. Does this mean another bear market is imminent? No.
The FOMC is likely to enact a third hike in the federal funds rate this week. With economic data continuing to be good, the risk to equities of a rate hike is small. Higher rates indicate continued economic growth, so equities, commodities, the dollar and yields generally respond positively. However, the recent picture is more mixed: in particular, the dollar and yields have sold off after rates have been hiked. This was not the consensus' expectation, nor is it this time. Is another surprise likely now?
2017 is off to a remarkably similar start to 2013. No two years are ever exactly the same, so there's no reason to suggest that 2017 will repeat the 30% gains achieved in 2013. But many of the technical and fundamental similarities between these years suggest that 2017 may continue to be a good year. There are two watch outs, however, that make 2017 much higher risk than 2013. It's also worth recalling that equities fell 3-8% at six different points in 2013. Expecting 2017 to continue to ride smoothly higher will probably prove to be a mistake.
All of the US equity indices made new all-time highs again this week. Treasuries were the biggest winner. A drawdown of at least 5-8% in SPX is odds-on before year year end, but there are a number of compelling studies suggesting that 2017 will probably continue to be a good year for US equities.
US equities continue to make new all-time highs each week, supported by strong equity fund inflows and macro data that has exceeded expectations. Surprisingly, equities outside the US are actually outperforming the S&P. The current trend is very extended and there are four notable headwinds that may impact equities in the weeks ahead. There is, conversely, a favorable set up in the bond market.
Optimism towards the economy has surged to a 2-year high. Cash remains in favor (a positive) but global equity allocations are back above neutral for the first time since late 2015. Another push higher and excessive bullish sentiment will become a headwind.
In the past year, S&P profits have grown 46% yoy. Sales are 4.5% higher. By some measures, profit margins are back at their prior highs. This is a remarkable turnaround from a year ago, when profits had declined by 15% and most investors interpreted this as a sure sign that a recession and a new bear market were underway.
Investing always involves some risk. Right now, US macro is not one of them.
Global equities are nearly 25% higher than in February 2016. A tailwind for this rally has been the bearish positioning of investors, with fund managers persistently shunning equities in exchange for holding cash. That's no longer the case. Optimism towards the economy has surged to a 2-year high.
US equities are starting the year at new all-time highs. The rally is supported by healthy breadth and a relatively solid economic foundation. The biggest watchout is volatility, which has fallen to an extreme. A mean reversion in volatility is odds-on and that is normally unfavorable, short term, for equities.
Bond yields usually rise as the FOMC raises rates. This is one of the mostly strongly held consensus views in the market right now. A year ago, investors also thought yields were set to rise; instead they fell over the next half year. Might investors be wrong now once again?
Global equities are more than 20% higher than in February. A tailwind for this rally has been the bearish positioning of investors, with fund managers persistently shunning equities in exchange for holding cash.
Employment growth is decelerating, from over 2% last year to 1.6% now. Housing starts and permits have flattened over the past year. There is nothing alarming in any of this but it is noteworthy that expansions weaken before they end, and these are signs of some weakening that bear monitoring closely.
A year ago, profits for companies in the S&P had declined 15% year over year (yoy). The consensus believed this signaled the start of a recession in the US. How has that dire prognosis worked out? In a word: terrible.
Manufacturing output is at an all-time high. Manufacturing employment is at a post-industrialization low. Deregulation, dollar devaluation and protectionist/isolationist policies will not resurrect manufacturing employment.
The US economy will soon be in its 8th year of expansion. The US will also have a new president next year. So, is a recession a certainty in 2017? No. Economic expansions don't die at a predetermined definition of old age, and changes in the presidency have not been a useful predictor of a coming recession. The danger in forecasting based on these things is that it makes an imminent downturn appear to be a fait accompli. It's not, and believing that it is closes your mind to other possibilities. Maintaining a mind open to changes in the data and the opportunities they present is the essence of successful investing.
Fund managers' inflation expectations have jumped to the highest level in 12-1/2 years.
In July, fund managers' had their highest exposure to bonds in 3-1/2 years. In other words, they expected yields to keep falling.
Demographics is a key driver of economic growth. Most people focus on the aging of the Boomer generation. But the working-age population in the US has been growing almost as fast as the retirement of Boomers.
The macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely. That said, there are some signs of weakness creeping into the data. Retail sales are at a new all-time high, but overall growth is decelerating and less than 2% real. Employment growth is also decelerating, from over 2% last year to 1.7% now. Housing starts and permits have flattened over the past year. There is nothing alarming in any of this but it is noteworthy that expansions weaken before they end, and these are signs of some weakening that bear monitoring closely.
Investors have become very concerned about excessive debt in the US. The worry is that current leverage has risen so rapidly and become so extreme that the economy is at imminent risk of a crisis. Is this concern valid?
Global equities are more than 15% higher than in February. A tailwind for this rally has been the bearish positioning of investors, with fund managers' cash in October rising to the highest level since 2001. Similarly, their equity allocations are now like those in February, mid-2010 and mid-2012, periods which were notable lows for equity prices during this bull market. Overall, fund managers' defensive positioning supports higher equity prices in the month(s) ahead.
