Technicals: The technicals for US equities are a concern. Price has been trendless since December. Moreover, each marginal new high has included fewer companies and each drop lower has stopped before what has, in the past, been a 'washout' low, i.e., a point where so many companies have been heavily sold off that a new uptrend begins. Ultimately, this pattern usually resolves to the downside. Read further here.
Macro: The US economy is not a source of concern. Employment growth over the past year has been the best since the 1990s and compensation growth is decent, at about 2.5%. Together, this should be a tailwind for future growth. To wit, the most recent GDP and personal consumption growth were among the best of the past 5 years. And if consumption, which is 70% of the economy, continues to grow, companies will start to invest: right now capacity utilization is still under 80%, hence CapX has been low. To be clear, growth is not explosive like during the 1980s or 1990s, but it is positive. Read further here and here.
Financials: Corporate results are also not a big concern. Margins in 1Q expanded to a new high. The biggest drag has been from the energy sector and when their 60% decline is excluded, EPS for the S&P is growing at trend (about 8%). Sales growth is less, about 2-3%. Better US macro and ex-US macro will likely be tailwind for sales growth in the future. Read further here.
Valuations: That said, valuations are quite rich, especially on a price/sales basis. To our knowledge, they have almost never been higher. Valuation is a terrible timing mechanism but a good guess is that part of the reason the advance in equity prices has slowed this year is due to these high valuations. This will be a headwind for more rapid appreciation in equities, as it has been in the past. Read further here.
Sentiment: Sentiment is heady and a prime concern. A large majority of fund managers, investment advisors, active traders and retail investors are bullish and/or not bearish. This should not be a surprise as the last correction was 3 years ago. Together with valuation, this is probably the main reason equities are struggling to appreciate this year. Read further here and here.
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Understanding where headwinds to the equity market lie is not academic. If macro or financials were the main headwinds, we would expect this bull market to be near an end. That it has more to do with sentiment and valuation implies that a reset in equity prices (lower) will set up the next leg higher in 2015 and 2016. That would be the best set up. Of course, a long sideways pattern is always a frustrating possibility.
Our weekly summary table follows.
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