Saturday, December 8, 2018

Weekly Market Summary

Summary:  Emerging markets are in a bear market. Europe and the Nasdaq are getting close. After falling 10% in October, SPX has been unable to sustain a rally. Even bearish sentiment, washed out breadth and the prospect of Santa Claus can't seem to rally stocks.

In real time, corrections always feel like they are the end of the bull market: the price pattern is bearish and the news emphasizes stories about a likely recession, poor forward earnings and geopolitical risks. Yet corrections usually happen every 18 months, and the current one has so far not been especially long or deep.

That is not to suggest that investors be complacent or dismissive of mounting risk. SPX had formed a topping pattern in August, and events since then have only strengthened this pattern. But there is little evidence of the underlying stress that is normally associated with big problems. For all the recent volatility, it is worth noting that the low in SPX was in October, 6 weeks ago. Everything since then has been a hot mess.

This is not a market trying to efficiently discount next year's growth; it's a market mostly driven by fear and emotion.

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The correction from the September all-time high (ATH) is now in its 11th week. Aside from the NDX, all the US indices are now negative for the year. So are treasuries (TLT). What's worked well so far in 2018? Volatility, which is up more than 40% (table from  Enlarge any chart by clicking on it.

Friday, December 7, 2018

December Macro Update: Recession Risk Low, But Starting To Rise

SummaryThe macro economic story is starting to change. The data from the past month continues to mostly point to positive growth, but there is a very important exception: weakness in housing is apparent. If this persists and other measures, especially employment, start to also weaken, a recession in 2019 is possible.

For now, the bond market sees continued growth. The yield curve has 'inverted' (10 year yields less than 2-year yields) ahead of every recession in the past 40 years (arrows). The lag between inversion and the start of the next recession has been long: at least 8 months and in several instances as long as 2-3 years. On this basis, the current expansion will likely last into mid-2019 at a minimum. Enlarge any image by clicking on it.

Friday, November 16, 2018

3Q Corporate Results Were Great. The Outlook for 2019 Looks Far Too Optimistic

Summary: Overall, corporate results in the third quarter were excellent. S&P sales grew 11%, earnings rose 30% and profit margins expanded to a new all-time high of 12.2%.

Fundamentals have been driving the stock market higher, not valuations: earnings during the past 1 year and 2 years have risen faster than the S&P index itself (meaning, valuations contracted). The strong growth in company profits is not due to a net share reduction (e.g., buybacks) either.

Looking ahead, expectations for 10% earnings growth in 2019 looks far too optimistic and will likely be revised downward as the substantial jump in margins this year is unlikely to continue. Even maintaining these margins will be a stretch, and earnings are at risk of falling. Dollar appreciation and declining oil prices are additional headwinds.

Valuations are now slightly below their 25-year average. They are not cheap, but the excess from early 2018 has been worked off. If investors once again become ebullient, there is room for valuations to expand. With earnings growth at risk, the key for share price appreciation in 2019 is likely to hinge on valuations expanding.

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90% of the companies in the S&P 500 have released their third quarter (3Q18) financial reports. The headline numbers are very good. Here are the details:


Quarterly sales reached a new all-time high, growing 11% over the past year. On a trailing 12-month basis (TTM), sales are 10% higher yoy, the best growth in 12 years (since 2016; all financial data in this post is from S&P). Enlarge any image by clicking on it.

Interview With Financial Sense on Macro Risks and The Market Correction

We were interviewed by Cris Sheridan of Financial Sense on November 12th. During the interview we discuss the macro-economic environment, specific risks that are unfolding and current market technicals as stocks suffer their second correction in 2018. One theme of our discussion is what to look for over the next several months.

Our thanks to Cris for the opportunity to speak with him and to his editor for making these disparate thoughts seem cogent.

Listen here.

If you find this post to be valuable, consider visiting a few of our sponsors who have offers that might be relevant to you.

Tuesday, November 13, 2018

Fund Managers' Current Asset Allocation - November

Summary: Although US equities are up about 2% in 2018, Europe is down 10% and emerging markets are down more than 15%. Part of the reason: fund managers came into 2018 very bullish, with cash levels at 4-year lows and allocations to global equities at 3-year highs.

How have fund managers responded to an increasingly tough environment for equities?

In one respect, they are still bullish: global equity allocations are still 31% overweight. Into the major lows in 2011, 2012 and 2016, fund managers were underweight. Allocations could easily fall much further before global equities reach a bottom.

But in most other respects, fund managers are already very bearish:
They are overweight cash (by nearly one standard deviation), which is typically a tailwind for equities.
They view the US dollar as the most overvalued in 12 years, which has a very good track record of marking a turn to dollar weakness, a tailwind for US multi-nationals as well as ex-US equities.
Their profit expectations are the most bearish in 6 years, and at a level which also marked equity lows in 2010, 2011, 2012 and 2016. 
Their global macro growth expectations are the most pessimistic in 10 years, more than at the major equity bottoms in 2011 and 2016.  
A third believe the world's largest equity benchmark, the S&P 500, has already peaked. This number holding this view has doubled in just one month.
They believe 'value' will outperform 'growth' stocks; similar peaks (in 2009, 2014, 2016 and 2017) marked excellent times to be long equities, especially growth stocks. 
The US is the most favored region in the world. That's not surprising: during a global equity sell off, the US is usually regarded as the safest haven. It should underperform. Europe is the most hated region and is likely to outperform.

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

Our sincere gratitude to BAML for the use of this data.

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.

Overall: Relative to history, fund managers are overweight cash and neutral equities. Enlarge any image by clicking on it.
Within equities, the US is overweight while Europe, in particular, is underweight. This is a significant change from the past year.
A pure contrarian would overweight European equities relative to the US and underweight cash.