Saturday, February 28, 2015

Weekly Market Summary

At the end of last week, US equities looked overheated short term and in need of break (post). In the event, SPX lost 0.3%. The other indices were similar.

After a violent January in which equities lost 3%, February had a strong rebound. SPX and DJIA gained 5.5%; RUT gained a bit more. NDX was the leader, gaining 7%.

Two months in to 2015, the market is being led by consumer discretionary, materials and healthcare sectors. Recall that in 2014, defensives were the clear leaders all year long. 2015 is starting off very differently; utilities are the biggest laggard and SPY is outperforming TLT. But there's no clear theme so far, with some defensives and some cyclicals outperforming and others lagging (all charts in this post expand when clicked on).

Tuesday, February 24, 2015

Identifying The Correct Risk Associated With Weak Earnings

Even casual observers of the equity markets know that there is always a multitude of risks which threaten the advance of stock prices. It takes little effort to identify these. Focusing on the correct risk is trickier part.

Let's take corporate earnings as an example.

The French bank Societe Generale (SocGen) is warning clients that weak earnings is a leading indicator that the US economy is headed into an imminent recession. Here's their chart (EPS growth in red and GDP growth in blue).

Monday, February 23, 2015

Financial Bloggers Are Bullish. Does It Matter?

Every week, Birinyi Associates tracks nearly 30 financial bloggers and classifies their views as being either bullish on the market, bearish or neutral. The results are published on Mondays at their Ticker Sense website.

This week, bloggers are extremely bullish to an extent not seen in more than a year. Is this a contrarian signal to be cautious? The short answer is no.

Below, similar levels of bullishness over the past 3 years are marked with a vertical line: a price chart of SPY is in the top panel with the views of bloggers shown in the lower panel. It's a small sample but in the seven previous times bloggers were roughly this bullish, SPY continued higher six times. Bullish bloggers were an excellent contrarian signal just once, in September 2012.

Saturday, February 21, 2015

Weekly Market Summary

US indices have now risen 3 weeks in a row. For the week, SPX, DJIA and RUT all rose 0.7%. NDX continues to lead; it rose 1.3%.

For the first time in at least a half year, all four US indices are simultaneously at new bull market highs. SPX, DJIA and RUT are at all-time highs and NDX is at a 15 year high. Theoretically, at new highs, there are no unprofitable shareholders and thus no forced sellers. The path of least resistance is usually higher until the market becomes overbought.

On weekly timeframes, the indices are not yet overbought; note RSI in the top panel in the chart below. SPX is nearing a 5 year channel top but it's about another 2% higher at roughly 2150. Of course, SPX can travel along the top of that channel for several weeks, as it did at the end of 2014.

Wednesday, February 18, 2015

Fund Managers' Current Asset Allocation - February

Every month, we review the latest BAML survey of global fund managers. Among the various ways of measuring investor sentiment, this is one of the better ones as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $700b 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.

To this end, fund managers became very bullish in July, September, November and December, and stocks have subsequently sold off each time. Contrariwise, there were some relative bearish extremes reached in August and October to set up new rallies. We did a recap of this pattern in December (post).

Summary: In February, fund managers increased their global allocation to equities to among the highest since the bull market began. Most of the increase was to Eurozone equities, which now has the second highest allocation in the survey's history. US equities fell out of favor, a set up in which they should outperperform on a relative basis.

Let's review the highlights.

Fund managers increased their cash levels slightly to 4.7%. While this is relatively high on a historical basis, note that cash levels haven't been much below 4.5% since 2013. We consider current levels to be neutral. 

Saturday, February 14, 2015

Weekly Market Summary

SPX has risen two weeks in a row for the first time in 2 1/2 months. For the week, SPX gained 2%, DJIA 1% and RUT 1.5%. The big winner was the previously worrisome laggard, NDX, which gained 3.7%.

SPX and RUT closed the week at all-time highs and NDX closed at a 15 year high. So, is the bottom in?

Let's start with SPY. It is now trading above its key moving averages and making higher highs. This is the definition of an uptrend. The first warning sign will be weakness in the shorter-term trend; an inflection down in the 13-ema (green line). The channel top is above 112. This is all positive.

Wednesday, February 11, 2015

Breadth Divergences: More Noise Than Useful Signal Of A Market Top

It's conventional wisdom that new highs in indices should be confirmed by an expansion in breadth. In other words, you want to see the number of stocks trading above their moving averages expand as the index price moves higher.

That sounds intuitive. All else equal, having an increasing number of stocks above, say, their 50-dma as the index moves higher means that the index is supported by a growing number of stocks that are in an uptrend. Think of it as a wide foundation to support the index.

We find there is a practical problem with this, however. The index has better performance looking ahead when breadth is weak.

Let's take three situations: one where the percentage of SPX constituents above their 50-dma is 80% or more (strong breadth), one where it is less than 80% and one where it is less than 50% (weak breadth).

If greater breadth was a positive, then SPX should do best when 80% or more of its constituents are trading above their 50-dma. In fact, that is when the index does worst. SPX does best when breadth is weakest.

Tuesday, February 10, 2015

Everyone Is Bad At This

The story you hear almost every day goes something like this:

Economists' forecasts for growth and/or inflation are never right. Especially the Fed's.

Fund managers underperform their benchmarks. This is especially true of hedge funds.

Wall Street analysts forecasts are always wrong. A conviction buy list should be shorted.

Retail investors are 'dumb money.'

Journalists write cover stories about trends just as they are ending.

We can summarize by saying that everyone is bad at this. No one is good at figuring out whether stocks or indices or economies are going higher or lower.

Therefore, a suggestion: let's focus attention on ourselves and what we can do better. We can't change what others are doing but we can improve what we do.

It's easy to point out the failures in others. The challenge is acknowledging your own shortfalls and taking the hard, but worthwhile, path to becoming better.

The upside is easy to see. Since everyone else is so bad at this, a small improvement in ourselves should pay huge dividends.

Monday, February 9, 2015

Interview With Financial Sense on Interest Rates and Market Technicals

We were interviewed by Cris Sheridan of Financial Sense on February 3. During the interview, we discuss market technicals, interest rates, the Fed and the macro environment.

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

Listen here.

Saturday, February 7, 2015

Weekly Market Summary

SPX has only risen 2 of the last 6 weeks, including this past one. For the week, SPX gained 3.1% and DJIA 3.8%. NDX is the worrisome laggard, gaining 1.9%.

The equity market is carving out a high volatility pattern: since December, SPX has lost 5%, gained 6%, lost 5%, gained 4%, lost 4%, gained 4%, lost 4% and now gained nearly 5%.

We haven't seen this degree of indecision in more than 3 years. In the past, this pattern has meant that the market is either in the process of changing trend (in this case, from up to down) or it is in a long period of consolidation. There's no clear way to know which one. In the late 1990s, a long consolidation period within a trading range of about 10% happened in 1994, 1996, 1997 and 1999 (blue lines). We haven't seen this pattern recently, but it's hardly unusual.

Friday, February 6, 2015

February Macro Update: A Trend of Consistently Better Growth

In May we started a recurring monthly review of all the main economic data (prior posts are here).

At the time, the consensus view was that growth in wages and employment were accelerating and that this would soon lead to a meaningful increase in inflation above the Fed's 2% target. Our monthly review of the data has consistently shown this expectation to be premature.

This post updates the story with the data from the past month. We are now starting to see consistently better growth. Highlights:
  • Employment growth has been over 200,000 per month for 11 months in a row. This is the strongest stretch of employment growth since 1993-95
  • Moreover, the 4Q14 employment cost index was the highest since the recession
  • Real personal consumption (70% of GDP) grew 2.8% in 4Q14, at the high end of the post-recession range
  • The manufacturing component of industrial production grew 5.2% in December, one of the highest rates in 4 years  
  • Single family housing starts in December were the highest since the recession. Home sales were also the highest in 7 years
  • However, the inflation rate continues to decelerate. It has fallen to its lowest level since 2009  
Our key message has so far been that (a) growth is positive but modest, in the range of ~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. This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels.

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

Employment and Wages
The January non-farm payroll (257,000 new employees) followed the incredible 423,000 in November, the highest since May 2010. NFP has been above 200,000 every month for 11 months in a row. It hasn't been above 200,000 that many months in a row since 1993-95.

In the past 12 months, the average gain in employment was 267,000, the highest since 1998.

What is remarkable is that monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 200,000 (circles). That has been a pattern during every bull market.  The consistent strength in monthly NFP recently is therefore noteworthy.

Wednesday, February 4, 2015

What To Look For When The Price Of Oil Has Bottomed

The price of oil has dropped 60% in little over a half year. In the past few days, the price has jumped 15%. It's the first significant rally in oil since the plunge began.

So, has the drop in oil prices ended? Probably not.

Let's look at other drops in oil over the past 30 years. Below is a monthly chart of crude oil (WTIC). The yellow bars are the size and duration as the current fall in oil since June 2014. Three other instances look similar in that the drop was swift and without a pause (marked with stars: 1986, 1990 and 2008). Two others took twice to four times as long to unfold (1997 and 2000).

Tuesday, February 3, 2015

The Unpopular But Favorable Trade-Off of Low Interest Rates

Low interest rates are not popular with fund managers.

A prominent bond fund manager, for example, thinks that "central banks are 'distorting' capitalism by keeping interest rates ultra low and causing returns on investment to dwindle. Central banks are pushing each other out of the way in a race to the bottom of interest rates" (Financial Times: Central Banks Distorting Capitalism).

Other fund managers contend that low rates severely hurt savers: "Zero (and even negative) interest rates serve to cripple those that now depend on a reasonable interest rate to produce an equitable amount  of interest income, which is needed to sustain a consistent life style expectation and, in many cases, funding retirement" (post).

Are these views fair? Are interest rates unreasonably low and do they harm those most in need?

Among other things, interest rates reflect expectations about inflation and growth: lower inflation and growth will lead to lower interest rates.

In the early 1980s, 10 year yields were 16%; at the same time, inflation was 11%. Today, yields are under 2% and so is inflation.