Weekly Market Summary

Summary: After gaining 16% from the February low, SPX has been trading in a 2% range during May. A minor 20% of the rally has been retraced, a sign of resilience and consolidation. Despite the recent rally, investors are positioned for weakness, not further gains.  There might still be a capitulation low ahead but the set up is for higher prices in the next month(s). End of May and start of June seasonality is a possible short-term tailwind for equities.

The main watch out is NDX: a key support level has been tested twice, including on Thursday of this past week: if it is breached, the index has the potential to fall 5-10% lower into the 'hot mess' from summer 2015 and winter 2016.

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In our last market summary three weeks ago, the near term trend had turned weak and the set up was for SPY to move to its 50-dma and lower Bollinger Band. There was little reason to expect more significant weakness as breadth, sentiment, macro, commodities and seasonality were generally supportive. That post is here.

In the event, SPY visited its 50-dma the following week and then revisited that same level again this week. During this time, SPY has lost about 1% and remained within a tight 2% range for the past 3 weeks.

To put that in perspective, SPY rallied 16% from its February low to its late April high, and then retraced just 20% of that rally. This is, overall, very minor and a sign of resilience after recording strong gains.

The weakest index in the US has recently been the NDX. It might be the best barometer for what happens next. NDX formed an important low on May 6 (4300 level) and then retested that low this week. Should that low be breached, NDX will be back into the hot mess from August/September 2015 and January/February 2016, with the potential to "waterfall" 5-10% lower once again.

Fund Managers' Current Asset Allocation - May

Summary: At the panic low in equities in February, fund managers' cash was at the highest level since 2001, higher than at any time during the 2008-09 bear market. Since 2009, allocations had only been lower in mid-2011 and mid-2012, periods which were notable lows for equity prices during this bull market.

Since then, equities around the world have risen an average of 16%. Despite this, both cash and equity allocations are basically unchanged since February. This supports higher equity prices in the month(s) ahead.

Allocations to US equities fell to back to their 8-year low in May, a level from which the US should continue to outperform, as it has during the past year. Europe remains overweight. Emerging market allocations have jumped significantly in the past four months and are now overweight for the first time since September 2014, a high from which emerging market indices fell over the next half year.

The dollar is no longer considered overvalued. In the past three months, the dollar index has fallen 6%.

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Among the various ways of measuring investor sentiment, the BAML survey of global fund managers is one of the better as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $600b in assets.

The data should be viewed mostly from a contrarian perspective; that is, when equities fall in price, allocations to cash go higher and allocations to equities go lower as investors become bearish, setting up a buy signal. When prices rise, the opposite occurs, setting up a sell signal. We did a recap of this pattern in December 2014 (post).

Let's review the highlights from the past month.

Cash: Fund managers cash levels at the equity low in February were 5.6%, the highest since the post-9/11 panic in November 2001, and lower than at any time during the 2008-09 bear market. This was an extreme that has normally been very bullish for equities. Remarkably, with the SPX now 15% higher, cash in May (5.5%) is still near the highs.  Even November 2001, which wasn't a bear market low, saw equities rise nearly 10% in the following 2 months. This is supportive of further gains in equities.

Are Poor Sales and Profit Growth Signaling an Imminent Recession?

Summary: Over the past year, earnings for the S&P have declined 12%. Earnings have declined 5 quarters in a row. Even excluding the troubled energy sector, valuations now are as high (or higher) than in 2007. It's no wonder that there has been little net gain in the S&P since late 2014.

Does the dire state of corporate sales and profit growth signal an imminent recession?

The decline in sales growth that started in 3Q14 corresponds with both the start of a 75% drop in the price of energy as well as the start of a 20% appreciation in the dollar. Currency effects aside, the sales and profits for the majority of sectors are not weak.  Moreover, parallels to the 2000 tech bubble and the 2007 financial bubble are largely without merit. On balance, corporate sales and profit growth are most likely not signaling an imminent recession.

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About 90% of the S&P has reported earnings for 1Q16. And, very simply, these reports are bleak, showing declining sales and declining profits:

Sales fell 2% yoy on a trailing 12-month basis (TTM), the third quarter in a row that sales have fallen.

Earnings per share (TTM, GAAP-basis) declined by 12% yoy, the fifth quarter in a row that profits have fallen. Unless otherwise stated, all data in this post is from S&P (enlarge any image by clicking on it).

May Macro Update: Some Signs of Slowing Growth

Summary: The macro data from the past month continues to point to positive but sluggish growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

That said, data over the past month was on the weak end. For example, employment growth was 1.9% yoy versus 2% or more during most of 2015. Retail sales was 0.9% yoy versus more than 2% during most of 2015. New home sales growth was 5%, but the peak in monthly sales was more than a year ago (February 2015). We will be watching closely to see if flattening growth persists or expands to other indicators over the next months.

The main positives from the main data are in employment, consumption growth and housing:

• Employment growth is close to the best since the 1990s, with an average monthly gain of 224,000 during the past year.  Full-time employment is soaring.
• Recent compensation growth is the highest in more than 6 years: 2.7% in December, dropping to 2.5% yoy in April. 
• Most measures of demand show 3-4% nominal growth. Real personal consumption growth in 1Q15 was 2.7%.  
• New housing sales, starts and permits remain near an 8 year high. 
• The core inflation rate ticked up above 2%, among the highest rates since 2008.

The main negatives are concentrated in the manufacturing sector (which accounts for just 10% of GDP):

• Core durable goods growth fell 2.6% yoy in March. It was weak during the winter of 2015 and it has not rebounded since. 
• Industrial production has also been weak, falling -2.0% yoy due to weakness in mining (oil and coal). The manufacturing component grew 0.5% yoy.

Prior macro posts from the past year are here.

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Our key message over the past 2 years has been that (a) growth is positive but slow, in the range of ~3-4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely.

Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes.

A valuable post on using macro data to improve trend following investment strategies can be found here.

Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.


Employment and Wages

The April non-farm payroll was 160,000 new employees minus 19,000 in revisions. In the past 12 months, the average gain in employment was 224,000. Gains since 2014 have been the highest since the 1990s.

Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low print of 84,000 in March 2015, as well as the 'disappointingly weak' print in September 2015, fit the historical pattern. This is normal, not unusual or unexpected.