Weekly Market Summary

Summary: During the past three weeks, equities have been driven - higher and lower - almost exclusively by the UK referendum on whether to exit the EU. The decision to leave caused one of the largest one-day sell offs since 2011.

Sharp sell offs tend to continue lower in the following day(s). Down momentum normally takes time to dissipate. A lower low is likely still ahead.

But sell offs triggered by a shock event like "Brexit" tend to bottom and then reverse rather quickly.  That is likely now as well as investors realize that the non-binding vote will have little material affect  within the next year or two, if ever. Moreover, several studies related to extremes in volatility and sentiment suggest US equities are nearing a point where a reversal higher is very likely.

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In our last market summary three weeks ago, the near term set-up was for a mild mid-June swoon: the SPX had reached a prior resistance zone, some measures of short-term sentiment were excessively bullish and June is a seasonally weak month, with most of that weakness taking place during the middle 3 weeks. Since then, SPX has lost 3%. That post is here.

Our longer term view was that further gains lie ahead for the US indices: a sell off in June is frequently a set up for higher prices into summer. That is still our view.

Three weeks ago, the SPX was within 1% of its all-time highs (ATH) where every rally in the past 16 months has failed (blue arrow). Moving through this thick overhead resistance has once again proved difficult. At the end of this week, SPX closed about 1% above mid-May support near 2020. Below this level, and SPX will have made a "lower low", raising the risk of reentering the "hot mess" from August/September 2015 and January/February 2016 (enlarge any chart by clicking on it).

Fund Managers' Current Asset Allocation - June

Summary: Through early June, US equities had risen 17% from their lows in February. Equities outside the US had risen 15%. A tailwind for this rally was the bearish positioning of investors, with fund managers' cash in February at the highest level since 2001. Similarly, their equity allocations in February had only been lower in mid-2011 and mid-2012, periods which were notable lows for equity prices during this bull market.

Remarkably, allocations to cash are now even higher than in February, and allocations to equities dropped to a new 4-year low. Fund managers have pushed into bonds, with income allocations rising to a 3 1/2 year high in June. Overall, fund managers' defensive positioning supports higher equity prices in the month(s) ahead.

Allocations to US equities remain near their 8-year lows, 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 five months and are now the most overweight since September 2014, a high from which emerging market indices fell over the next half year.

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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 having since risen 17%, cash in June is now even higher (5.7%) and at the highest level in 14 years (since November 2001).  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.

Weekly Market Summary

Summary: SPY has moved nearly 3% higher over the past two weeks. The S&P is now within about 1% of where every rally in the past 16 months has faltered. Is it likely to falter now as well?

Some short-term measures of sentiment may show excessive bullishness. The seasonal pattern is also a slight headwind. Taken together, it's not hard to imagine upside being limited in the near term.

But longer-term measures of sentiment, especially fund flows, suggest that further gains are still ahead. This means that any short term weakness is a set up for higher prices into summer.

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In our last market summary two weeks ago, the near term set-up was for higher prices in the following weeks. In the event, SPY has gained nearly 3% since then. That post is here.

The S&P is now back to within 1.2% of its all-time highs (ATH). This is where every rally in the past 16 months has failed. It's not hard to imagine upside being limited in the near-term as the index tries to move through thick overhead resistance (enlarge any chart by clicking on it).

June Macro Update: Employment Data Weakens

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

A month ago, we highlighted creeping weakness in employment growth, some measures of consumption like retail sales and new home sales data. This was a watch out for future months.

The good news is that consumption rebounded in April: real retail sales grew 1.8% yoy (to a new all-time high) and personal consumption grew 3%. Better still, new home sales made a new 8 year high. 

The bad news is that employment continued to weaken: employment growth had been 2% yoy during most of 2015. In May, that fell to 1.7% growth. As employment and wages drive future consumption, upcoming employment data will remain the key watch out. 

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

• Although employment growth has slipped, monthly gains have averaged 200,000 during the past year.  Full-time employment is leading.
• Recent compensation growth is the highest in more than 6 years: 2.5% yoy in May. 
• Most measures of demand show 3-4% nominal growth. Real personal consumption growth in April was 3.0%.  Retail sales reached a new all-time high.
• Housing sales in April reached a new 8 year high.  Housing starts are near an 8 year high but growth is flat over the past year. 
• 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 -4.7% yoy in April. It was weak during the winter of 2015 and it has not rebounded since. 
• Industrial production has also been weak, falling -1.1% 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 May non-farm payroll was 38,000 new employees minus 59,000 in revisions. This was the weakest monthly report since September 2010.

In the past 12 months, the average gain in employment was 200,000.

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 today's print, fit the historical pattern. This is normal, not unusual or unexpected.