Weekly Market Summary

Summary: US equities are trading at all-time highs. The trend is higher, supported by strong breadth, resilient economic data and improved corporate financials. Even after the strong advance, longer term measures of sentiment continue to show skepticism among investors. Together, this is a set up for higher equity prices in the month(s) ahead.

All of this said, there are reasons to be on the alert for a retracement of recent gains in August. The SPX consistently reacts negatively as it approaches each "round number" milestone (like 2200) for the first time. NDX has returned to its late 2015 resistance level. Some measures of shorter sentiment are heady. And August is seasonally weak and prone to a larger interim drawdown. Importantly, none of this is likely to be trend-ending.

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In our last market summary at the end of June, the near term set-up was for higher equity prices in July (that post is here). For the month, SPX gained 3.5%. The leader has been NDX, which gained more than 7%. Outside the US, Europe gained 3.6% while emerging markets continued to outperform the rest of the world, gaining more than 5%.

Recall that the Brexit vote knocked 6% off US equity prices to close out the month of June. As we wrote then, non-economic shocks (like Brexit) tend to leave minimal damage to stock indices. In a study of 14 non-economic shocks since WWII, S&P Capital found that US indices bottomed within 6 days and had regained all of the losses within 2 weeks (read more here).

Fund Managers' Current Asset Allocation - July

Summary: Since February, US equities have risen nearly 20%. Equities outside the US have risen 12%. A tailwind for this rally has been 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 fund managers are now underweight equities for the first time in 4 years. Fund managers have pushed into bonds, with income allocations rising to a 3 1/2 year high in June and July. Overall, fund managers' defensive positioning supports higher equity prices in the month(s) ahead.

Allocations to US equities had been near 8-year lows over the past year, during which the US has outperformed most of the world. That has now changed: exposure to the US is at a 17-month high. There is room for exposure to move higher, but the tailwind for the US due to excessive bearish sentiment has mostly passed. That's also the case for emerging markets which have been the best performing equity region so far in 2016.  European equity markets, which have been the consensus overweight and also the world's worst performing region, are now underweighted by fund managers for the first time in 3 years.

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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 nearly 20%, cash in July is now even higher (5.8%) 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; that rally failed when cash levels fell under 4%. This is supportive of further gains in equities.

July Macro Update: New Highs In Wage Growth and Retail Sales

Summary: 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.

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

• Monthly employment gains have averaged more than 200,000 during the past year, with annual growth of 1.7% yoy.  Full-time employment is leading.
• Recent compensation growth is the highest in more than 6 years: 2.6% yoy in June. 
• Most measures of demand show 3-4% nominal growth. Real personal consumption growth in May was 2.7%.  Retail sales reached a new all-time high in May.
• Housing sales and starts in May remain near their 8 year highs. 
• 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 -0.9% yoy in May. It was weak during the winter of 2015 and it has not rebounded since. 
• Industrial production has also been weak, falling -1.4% yoy due to weakness in mining (oil and coal). The manufacturing component was flat 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 June non-farm payroll was 287,000 new employees minus 6,000 in revisions. This was the strongest monthly report since October 2015.

In the past 12 months, the average gain in employment was 205,000.

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 and 11,000 in May 2016 fit the historical pattern. This is normal, not unusual or unexpected.