Tuesday, June 13, 2017

Did you just miss a buying opportunity?

One of our favorite tools for getting a read on the sentiment and psychology of the market is the monthly fund manger survey (FMS) from BAML.  Below are the key takeaways straight from the monthly report:
  • June FMS shows Fed tightening at time of peaking macro momentum, high cash levels, crowded Nasdaq and record # investors saying equities “overvalued” (>1999bubble highs)
  • The FMS suggests “preventative hike” to subdue Wall St speculation best describes likely FOMC action this week; but we say too little, too late to prevent Icarus
  • June FMS cash levels up from 4.9% to 5.0% (>10-year average of 4.5%); means FMS cash too high for “Big Top”
  • Global growth expectations @ 39% vs 62% in Jan...macro momentum has peaked; so June FMS sees defensive rotation to staples, utilities + largest drop since Jun’10 in allocation to commodities
  • Fed hiking 3rd time in 6 months (after hiking once in 10 years) but contrarian bond
    bulls on rise: just 9% of FMS forecast lower/flat bond yields last Dec, now 20% do
  • 3/4 say internet stocks expensive or in bubble: 57% investors say “expensive”, 18%
    “bubble-like”, 15% “fair”, 1% say “cheap” (Exhibit 1)
  •  #1 “crowded trade” in June = long Nasdaq (jumped from 26% to 38%), #2 long EU
    equities, #3 long US/EU corporate bonds
  • But contrast with ‘99 bubble (record June FMS views of “excess valuation” not
    coinciding with fall in cash levels) shows less “irrational exuberance”
  •  And comparison with ‘99 bubble (“excess valuation” is coinciding with high global
    profit expectations) reminder that while vulnerability high, missing combo for
    immediate “Big Top” is higher yields/falling EPS
  • Contrarians sell Europe, banks, tech, buy UK, resources, commodities, bonds
We remain bullish in our thesis and this survey has some interesting contrarian data to support our outlook.  Below are a few items we wanted to highlight.  We continue to hear from pundits that this market is excessive and overvalued as a record number of investors say that equities are "overvalued."  75% say internet stocks are expensive or in a bubble even as it remains the #1 crowded trade.  However, cash levels are up from 4.9% to 5% and there was a rotation into the defensive sectors of staples and utilities.  Outside of valuation metrics we can't find many indicators suggesting sentiment is excessive.  It is quite the opposite as this remains an unloved bull market that continues to climb the so-called wall of worry.

For this market to get irrational we are going to need to see more proof in underlying data.  While Nasdaq stocks may have gotten ahead of themselves the market quickly eroded some of that confidence last Friday and yesterday.  The NDX corrected 4.5% from peak to trough in less than 2 trading days.  These types of shakeouts should be expected in a strong trend and a reminder that we aren't likely to get the slow constructive pullback that everyone wants.

Below we looked at all instances since 1990 where the NDX closed down more than 2% after having just made a new 52-week high on the prior trading day.  From the data, the very short-term (5 days) is neutral but going out further there is a bias to the upside.  It shouldn't surprise anyone if we make new highs sooner than expected.  The one caveat in the data below is many of the data points happened during the super bull of the late 90's.  If we included the crash of 87 the results are worse but it was such an outlier we chose to ignore.  Regardless we thought it was interesting enough to present. 

To include all data points going back to the inception of the NDX (1985) we looked at all 2% down days and then also compared them when they were above the 200 day moving average and below.  The data suggest strong trends persist when the NDX has a 2% down day and above the 200-day moving average (as we are now).

One thing we have talked about and continue to monitor is the length of the current move in the S&P without a 5% correction.  The S&P 500 has now gone 151 days without a 5% correction.  This is the second longest stretch since 2009 and is fast approaching the record of 155 days from Feb-Sept of 2014 since the 2009 bottom.  Nautilus Research put out a nice piece on the current streaks in the NDX and S&P that also confirm we are long in the tooth.

We know this market is extended and due for a pullback at some point.  As we witnessed with the NDX Friday and Monday these pullbacks can come out of nowhere and happen fast.  We expect it to be no different next time.  However, we are still bullish and continue to see mild sentiment as a potential catalyst for further gains.

Wednesday, May 31, 2017

Summer Pullback?

Looking ahead to June:
  • Last 20 years: June ranks 9th in monthly performance with an average loss of 0.30%.
  • Last 20 years: The average daily trend for June looks a bit choppy on the chart below with weakness typically coming in the back half of the month.
  • Since 1950:  June ranks 10th in monthly performance with an average loss of 0.05%. 
  • Since 1950:  If the prior month is positive and the S&P is up YTD, June has an average gain of 0.54%.
  • Since 1950: If the S&P is up greater than 7.5% from January through May, June has an average gain of .98%.
  • Since 1950: If the S&P is up greater than 7.5% from January through May the S&P has never finished negative for the full year in 21 instances.  The average gain for the full year is 23.43%. 


The stats above have something for everyone.   The bullish case supports that momentum will continue with the potential for full year gains to be extremely healthy.  If the year starts strong like 2017 has, that gives the chance for a positive June a higher probability.  However, as we touched on last month, May begins a seasonally weak period and the average June is historically negative.  Something we will be watching is the FOMC rate decision meeting June 14th.  Currently there is an 88% chance of the Fed raising rates at the meeting.  This could bring an extra layer of volatility into the back half of the month (which would support the historical average daily trend of June shown above).  

The overall trend remains very strong as the S&P and Nasdaq continue to ride the high side of their monthly Bollinger bands.  The Nasdaq is the clear leader as it has risen 7 straight months and 10 out of the last 11.  The parallels to 2013 remain as the S&P and Nasdaq traded higher for 7 straight months from the end of 2012 to May 2013 and ultimately 12 out of 14 months.  

We also looked at how the Nasdaq has traded going out 1 to 6 months after a 7-month winning streak.  The data suggests momentum will continue at a higher rate than the whole sample. 

If we look at breadth and sentiment to gauge investor appetite and psychology there are two interesting blog posts I wanted to highlight.  The fat pitch has a well written study on washouts.

"Similarly, markets have a tendency to periodically "washout." One way that can be measured is by the percentage of stocks trading over their 50-dma; a washout would coincide with a reading under 30% (lower panel). It has now been 7 months since the last washout. These streaks have extended to 8 months only twice since 2004 - in February 2007 and June 2015, leading to declines in SPX of 7% and 12%, respectively. Even the powerful 2013-14 run did not go more than 6 months without a washout in breadth."

Ryan Detrick over at LPL Research touched on a recent gallup poll showing that we are nowhere near the euphoric stage that is characteristic of bull market tops.   Meanwhile the CNN fear and greed index remains in neutral territory even as we make new highs. 


The trend remains friendly to the bulls and patience continues to be rewarded.  Heading into the summer months, and the historically weak June, maybe we have the proper setup for a short-term correction and a potential washout in breadth.  While we expect shallow pullbacks during this bull run, trying to time them will be extremely difficult.  With sentiment readings sitting in neutral and the data supporting strength for the remainder of the year, we feel confident in staying the course.

Tuesday, May 16, 2017

Where's my 5% pullback?

With the S&P 500 trading at the highs for the year it's a good exercise to check in on the underlying "health" of the market.

As we have discussed in multiple posts, this market looks very similar to the 2013 when the S&P trended higher all year.  We've also touched on how even steadily trending markets can (and should) experience small and shallow corrections.  For instance, 2013 had just one pullback greater than 5% which was a 7.5% drop that lasted throughout May and June.  Other than that, there were a handful of smaller 3-5% declines along the way.

So far, it's looking as if 2017 will follow a similar path.  If we look at that stats, we know that a 5% correction is due sooner rather than later.  The S&P has now gone 132 trading days without a fall of at least 5%.  Since the 2009 low, there have been just two other periods in which the S&P went longer in between 5% pullbacks.  One of those periods was the 140-day run in the second half of 2013 after the aforementioned June bottom.  It should be noted however that this streak also featured separate pullbacks of -4.8% and -4.9%.  The other post-2009 stretch occurred in 2014 and lasted 155 days.

Current S&P 500



While the S&P 500 has enjoyed its strong uptrend, breadth and momentum have continued to lag.  One breadth indicator we track looks at the % of stocks above their 10, 20, 50, and 200-day moving averages.  As you can see below, all 4 indicators are declining as the S&P is making new highs.  At some point this negative divergence needs to be resolved for the S&P to continue higher.  If not it could be a precursor to the 5% correction everyone seems to want.

One of our favorite tools for getting a read on the sentiment and psychology of the market is the monthly fund manger survey from BAML.  Below are some of this month's key takeaways:

  • May FMS is Goldilocks bullish; we believe this will lead to Icarus upside
  • FMS cash @ 4.9% too high for "big top" in markets, too early to short the "excess valuation" in stocks
  • Contrarians note...#1 "crowded trade" now long Nasdaq and #1 "tail risk" now China deleveraging

Bullish, but not bullish enough... for us to change our Icarus Trade directional view of more upside to risk assets. May FMS sentiment bullish, but irrationality not yet visible despite all-time highs in credit & equity markets, robust global EPS, benign French election result...
FMS cash levels unchanged @ 4.9%: May FMS cash levels too high for "big top" in markets. Note comp with 1999-2000 tech "bubble" when FMS cash "irrationally" declined sharply given widespread "excess valuation" views (Exhibit 1); May FMS shows investor view of "excess valuation" in stocks highest since Jan'2000 but cash not (yet) collapsing.
Macro Goldilocks: Macro expectations of "Goldilocks" (high growth, low inflation) at record high; % predicting >10% EPS growth next 12 months highest since Jul'11; % taking out protection lowest since 2014. Long vol, short cyclicals is contrarian.
Top 3 FMS "crowded trades" are: long Nasdaq (26%), long European equities (15%), long US$ (12%). Healthy news for US$ as 5-month streak of "long US$" as most "crowded trade" ends (Exhibit 3).
Biggest FMS "tail risk" now: China credit tightening, ending EU disintegration as #1 tail risk. But just 22% expect Chinese deleveraging to either cause global volatility or global slowdown. Crash in bonds #2 tail risk but yields far from levels (3.5-4% in US) deemed dangerous for markets.
The longs & shorts of May: Eurozone equities (3rd highest ever); short US stocks vs RoW most extreme since Nov'07; May sees rotation to industrials from utilities; banks, discretionary, tech most popular sectors; UK assets and energy still shunned.
FMS contrarian trades: a contrarian macro bear (expecting falling PMI's) would go long bonds, staples and short banks, Eurozone stocks; a contrarian macro bull (expecting higher CPI) would short discretionary, tech, and buy UK assets and energy.

It looks like the French elections eased some of the concern for the tail risk associated with a potential EU disintegration.  This has coincided with favorable market conditions. 


And now the most crowded trade for the first time in a while is long Nasdaq as the FANG stocks have led the overall market higher.  This also confirms the breakdown in breadth.  The general market has thrived off concentrated leadership as big cap tech seems to be keeping everything afloat.  The performance chart below shows how much of an impact technology stocks are having on performance this year while financials and energy remain a drag.


There's still too much cash parked on the sidelines and this continues to be a catalyst that could drive markets higher.  Meanwhile, according to fund managers, equities look the most overvalued since January of 2000.  This seems to have driven them away from US stocks and into cheaper regions.  Allocations to US equities remain below the long-term average while allocations to Eurozone equities surged to the highest level since March 2015 and the third highest on record.

The S&P and US stocks in general remain in a strong uptrend but worries about valuations and breadth have kept sentiment suppressed.  Cash on the sidelines should provide fuel for a continuation higher but we should also expect short and shallow pullbacks along the way.  If financials and energy turn around we could get a much needed boost in breadth and not be so reliant on tech stocks to hold the entire market up.