Week In Review: Checking Sentiment & Breadth

Big cap stocks essentially went nowhere this week as the S&P 500 was down a whopping 1 basis point.  Some of the "risk-on" traits we've recently highlighted continued however as small caps (Russell 2000) showed relative strength and were up 60 basis points over the last 5 days.  All in all, the marketplace still seems to be digesting the fast and furious gains that were made in late June and early July.

With that in mind, we wanted to take a look at some of the forces at play that will determine whether the recent trend continues higher.  In the very near-term, we continue to see some negative divergences and short-term warning signs that will need to be worked off but overall things continue to look healthy for higher prices.  Hopefully any pullback will be similar to some of the past instances shown in our last blog post i.e. shallow and short

Breadth

• We're seeing some short-term negative divergences as the % of stocks above their 10, 20, and 50 day moving averages peaked out in July (1st chart)
• Also, the number of 52-week new highs on S&P peaked in July  (2nd chart)
• Good news is the longer-term looking indicator of % of stocks above their 200-day is hitting highs with the market
• The advance-decline line is also confirming price strength (A-D line in yellow in 2nd chart).  This is a good thing.

 

Sentiment

• Plenty of cash is still on the sidelines as shown by the 5.4% cash weighting of fund manager allocations (this according to the BAML Global Fund Manager Survey).
• Managers are also only 9% overweight global equities which is almost a full standard deviation below the historical average.
• CNN Fear and Greed Index is has gotten excessive and is now flashing "extreme greed."
• AAII survey is at 5 week high but bullishness is still below historical average.  Still very high neutral readings.

AAII Sentiment Survey:

Optimism is at a five-week high, as more than one out of three respondents described themselves as bullish for just the sixth time this year. 

VIX

The VIX term structure remains historically low but as we have shared in previous posts this doesn't necessarily mean we should be ringing alarm bells.

In the short-term there are a few negative divergences worth watching coupled with some sentiment measures being a bit overheated.  This becomes even more important as we enter September which has historically been the worst month of the year.

However, this is also to be expected at the beginning of what could be a new uptrend.  The so-called "wall of worry."  Case in point, according to the monthly BAML fund manager survey, investors are still pessimistic with only 23% of fund managers expecting a stronger economy in the next year. This explains their low allocations to equities and high allocations to cash.  However, the potential for more to hop aboard the bullish thesis could put a healthy bid underneath the market and keep prices propped up.

Week In Review / July Recap

The S&P 500 continued to take a bit of a breather this week as it continued to digest late-June's / early-July's strong gains.  The index finished the last five days of the month essentially unchanged, falling just 0.07%.

And to be honest, "a bit of a breather" is an understatement.  Over the last two trading weeks, the index has stayed in one of the tightest ranges in its history.  In the last 11 days, the S&P has traded in a 0.61% range (based on closing prices) which makes it the tightest movement over that timeframe since August of 1995.  The research team at LPL Financial ran the numbers on how these tight ranges have tended to resolve themselves.  A number of other research groups also made note of the dull market conditions over the back half of the month.

The NASDAQ on the other hand continued to power higher with an assist from upside earnings surprises by a number of tech's biggest names including Facebook, Apple, Google/Alphabet and Amazon.  The index finished the week with a gain of 1.2%, leading all of the major US equity indexes.

Along with the NASDAQ, the Russell 2000 was also able to finish the week in the black.  This was a theme that played out over the entire month as small caps and the NASDAQ led the way higher with each up more than 5% in July. 

After the massive rebound off the Brexit chaos, all US stock indexes sit comfortably in positive territory in 2016 as we enter the seasonally challenging August - October timeframe.

As the markets and the economy have accelerated in recent weeks and proven immune (for now at least) to whatever fallout may come from Brexit, we've seen renewed talk of the possibility of the Federal Reserve moving to raise rates before year-end.   And while those discussions may have picked up in pace, futures markets are still betting against such a move.  Per Briefing.com: "Rate hike expectations receded throughout the past week. Since last Friday, the implied probability of a rate hike in December, estimated by the fed funds futures market, declined from 47.8% to 33.0%. The fed funds futures market does not expect the Federal Reserve to depart from its current target range until after July 2017."

As mentioned above, August and September have tended to be some of the more volatile months for stocks.  Urban Carmel noted that since 1945 of all the months where the S&P has fallen 5% or more, August and September have combined to provide more than a third of them.  Additionally, August has proven to be the weakest month on average for the S&P over the last 20 years.

So we go into August with stocks at all time highs, trend and breadth looking remarkably strong, earnings season has been respectable and the economic data points suggest a turn better.  Couple that with the tendency for tight ranges like we've seen in recent weeks to resolve higher and it's easy to anticipate further gains for equities.  However, one must consider the historical seasonal weakness of the coming 30-60 days and be prepared for the potential of another quick pullback.  

Timeframes are everything right now and we're prepped with an open mind to consider all scenarios.

Week In Review (7/11 - 7/15)

The markets continued their post-Brexit giddiness this week by gapping higher at every open and finishing higher every day but Friday.  All told the S&P was up 1.15% for the week and sits higher by 3% so far in July.

It wasn't just US stocks that traveled higher this week as international and emerging market stocks (EFA & EEM), commodities, bonds and the US dollar all made advances.  

The S&P is now attempting to confirm its recent breakout to new all-time highs and hold above the 2,130 level that stayed insurmountable for over a year.  We continue to see incredible breadth measurements that suggest this time may be the real deal.  Yet n the very near term we wouldn't be shocked see stocks back off a bit as we're just a little overheated here.  At the same time, the VIX has had a tendency in the past to bounce at these levels (closed Friday at 12.67) suggesting that a pickup in volatility is due.  And as earnings season kicks into high gear this week we may now have the ingredients necessary to see that happen.

We wanted to share a recent study we ran in search of finding markets with similar characteristics.  One that produced some interesting results (no bias here) had the following constraints:

-We used the Dow Jones Industrial Average through June 30th
-We looked for markets with a down trending 200-day (40-week) Moving Average
-We wanted to see a recent uptick in this moving average (weekly close greater than prior week)
-And we wanted to be within 6% of highs on the Dow

Below are all the instances going back to the 1950s and there's some takeaways to note:

1) The average returns are slightly weaker almost across the board relative to the entire sample

2) There's notable weakness in the forward 2 and 3-month timeframes

We've seen some stories comparing the current market to 97-98 currency crisis markets but one big difference we'd be quick to note is that from 1995 to 2000 the 200-day MA on the Dow was trending up pretty much the entire time.  A more similar market might be from 1956-1958 (seen in 2nd chart below) where you actually had the 200-day MA flatten out/decline for a period of time much like now.  That market whipped around for a few years, experienced a decent sized flush and then went on to put in much higher highs from 1959 onward.

We'll see if the breakout that's underway can sustain and we're able to buck the trend of the 2 and 3-month weakness that we've seen in past instances.

1983-2016

1950-1983 - *(1956-1958)*

Week In Review (6/13 - 6/17)

Domestic Index Performance (Past Week)

Domestic Index Performance (June)

Domestic Index Performance (Year-To-Date)

Below is an excerpt from our latest monthly letter to investors & friends that we think sums up the current state of affairs:

If one were to give a theme to the market action and data points we saw over the course of May and so far in June, the word indecision would play well. In early May, it was all but a given that the FOMC and Chair Yellen were not likely to touch interest rates until much later in the year and fed funds futures prices were reflecting that belief. As the month carried on though the market seemed to make an about-face after a number of Fed officials came out and suggested that an increase at their June policy meeting could be warranted. In fact, the minutes from the committee’s April meeting (released in mid- May) echoed that same sentiment:

"Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation marking progress toward the Committee's 2.0% objective, then it would likely be appropriate for the Committee to increase the target range for the federal funds rate in June."

As a result, over the course of a week the fed funds futures market’s probability of a June rate hike jumped from 8% likelihood to over 30%. And the likelihood of a July increase leapt all the way to 55%. And the market appeared to cheer all of this news as it coincided with the rally that held through the end of May and into the beginning of June. Then we got the latest Non-Farm Payroll report on Friday, June 3rd and it was a real stinker. Only 38,000 new jobs were created versus an expectation of 170,000. The April and March numbers were also revised lower by a total of 59,000 jobs. These developments left the trailing 3-month job creation average at 116,000 versus the 12- month average of 212,000 jobs. Not exactly a glowing endorsement of the economy or the Fed’s hope to move forward with a near-term rate increase. And now with the June Fed meeting having come and gone, we know that the jobs report along with other recent economic data was enough to push off a rate hike until July at the earliest.

As the Fed has been doing its job of throwing more confusion into the crowd, there’s been a clear ramp in volatility over the last several days. In fact, the VIX aka the fear index made a near 60% surge over the course of the last week. One could have normally expected the market to wilt in the face such increased volatility yet the S&P was down less than 1% over that span. This stands in complete contrast to historical precedent as the market has averaged a drop of nearly 7% when the VIX has risen 55% or more in a given 6-day period. In addition to the Fed’s lack of movement, the rise in volatility has been aided by investor nervousness in advance of the “Brexit” vote (the British referendum to exit the European Union). It appears investors are doing their positioning on whether Britain will stay or leave via the options market and this has made the VIX even more spastic.

One thing is clear, when we examine the chart below we see that the market has held a great deal of angst ever since the end of QE3, onward through the first rate increase in December 2015 and to present day as we wait to see what will finally push the Fed into action for rate hike #2. There’s been essentially zero price progress made by the S&P in the last 18 months.

Further, besides the charts, there are plenty of other data points that show the level of indecision held by investors and fund managers right now. Bank of America/Merrill Lynch’s latest global fund manager survey shows that despite corporate bond prices and US stocks being at or near all time highs, there appears to be great amount of unease. In fact, BAML’s June measure of fund managers’ allocation to cash in their portfolios was at its highest mark since the post-9/11 panic in November 2001. Higher even than at the depths of the 2008-2009 financial crisis. At the very least, this measure shows that fund managers worldwide are simply running out of ideas for where to invest capital and would rather hold cash. Couple that with the survey’s respondents voting “long quality stocks” (think US Large Caps) as being the most crowded trade and you get a better idea of just how hated the recent moves of the S&P 500 might be. But be aware, these data points have a tendency of being contrarian in nature. BAML’s measure of fund managers’ cash levels sits at 5.7%. It was at 5.6% during the year-to-date lows in February and the S&P proceeded to rally 17% from that level. The same goes for November 2001, which was not a bear market low, the S&P managed to rise 10% over the next 2-months. The difference today being that we’re within earshot of all-time highs yet cash levels are abnormally high.

Have a great week.

Week In Review (5/23 - 5/27)

If you were expecting a calm trading week heading into the long Memorial Day weekend, you were probably caught just a bit off guard by the S&P 500's 2.3% gain and even more so by the NASDAQ's 3.4% rise.

The market's gains came in the face of continued talk by Federal Reserve officials that a summer interest rate hike is now a real possibility.  The fed funds futures market is now showing that expectations of a June hike have risen from just 8% probability a few weeks ago to 30% now.  More telling perhaps is that the probability of a July hike now sits at 62%, up from 55% a week ago.

With just one trading day left in May, the S&P 500 is up 1.6% for the month and 2.7% year to date.  The NASDAQ, meanwhile, has seen a surge of more than 3.4% in May and now sits down only -1.5% in 2016.

One weekly metric that continues to baffle is the sentiment survey taken by the American Association of Individual Investors (AAII).  The survey, which gauges the direction that individual investors think the market will take over the next six months, is generally regarded as being contrarian in nature.  Meaning, when investor optimism is low it is cited as a potential catalyst for the market to move higher and vice versa.  

Interestingly, recent AAII surveys have been sending some fairly rare signals.  The latest data showed that just 18% of respondents are leaning bullish over the next six months.  This is the lowest level since mid-January and, according to Briefing.com, is even lower than the 18.9% reading that was registered the week of March 5, 2009 (i.e. the market bottom during the 2008-2009 financial crisis). While the survey's bearish reading during that week in 2009 hit an extreme 70.3%, the measure sits at just 29.4% bears today.

So what gives?  Well, it appears that a lot of investors just simply cant make up their minds.  The percentage of respondents with a neutral outlook for the next six months currently stands at 52.9%.  This is far higher than the historical average of 31.2% and, again according to Briefing.com, is the highest neutral measure since April of 1990.  With so many investors sitting on the proverbial fence in terms of near-term market direction, Briefing looked at the history of the AAII survey to find similar instances.  Their comments:

"Looking at the data set from the American Association of Individual Investors, which dates back to 1987, the most analogous period in our judgment to the sentiment readings seen today was the week of September 9, 1988, when bullish sentiment was 17%, neutral sentiment was 52%, and bearish sentiment was 31%. For what it's worth, the S&P 500 was up 4.2% four weeks later.

As an aside, neutral sentiment topped 51% the week of December 31, 2015. That was the first time it has been above 50% since the week of February 7, 2003. The survey for the last week of December also showed bullish sentiment at 25.07% and bearish sentiment at 23.62%. Four weeks later the S&P 500 was down 8.7%.

A lot of individual investors aren't expecting any big move for the market over the next six months, so if the market starts to get away from them, that could force a squeeze play that exacerbates the directional bias of the move."

Nothing actionable there but we like the idea of a "squeeze play" that forces these neutral investors to get involved in one direction or the other (buying or selling).

Have a great week.

Week In Review (5/16 - 5/20)

The S&P 500 pinballed back and forth between positive and negative territory all week and ultimately finished with a small gain.  This brought an end to the market's 3-week losing streak and helped to keep the S&P in positive territory for the year.

While the index finished just 6 points higher than where it closed 7 days earlier, it took a rather bumpy course to get there.  The average intraday swing for the S&P on the week was 1.1% and much of this volatility can be attributed to the anticipation of and reaction to the minutes from the FOMC's April meeting.  A number of Federal Reserve officials seemed to be in agreement that a June rate hike could be warranted.  According to the Minutes:

 "Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation marking progress toward the Committee's 2.0% objective, then it would likely be appropriate for the Committee to increase the target range for the federal funds rate in June."

As of last Friday, the futures market was pricing in just an 8% chance of the Fed making a rate move at the June meeting.  That probability had jumped to 30% by the end of this week while the likelihood of a July hike had risen to 55%.

With the last full trading week of the month upon us, the S&P is down 0.63% in May while this week's outperformance by the NASDAQ (+1.1%) helped it climb back toward flat for the month. 

On a year-to-date basis, the NASDAQ and Russell 2000 still lag behind the other domestic indexes by a wide margin.  

It's also worth noting that this week also marked the 1-year anniversary of the S&P making its all-time high of 2,134.  We've observed in this space and elsewhere that even while the index is within spitting distance of the high set last May, investor sentiment readings suggest that we're anything but overly bullish.  Laszlo Birinyi, president of Birinyi Associates, says that this is one of the reasons that an end to this bull market won't be any time soon.

"There are lots of concerns—economic, technical, political, fear that we haven’t topped the all-time high of 2130 from last May, stories about people taking $20 billion out of the market or hedge funds losing billions. But the market is only 5% from the all-time high. To an old trader, this is encouraging. There is an underlying strength. We have a new high in the S&P 500 advance/decline line. Since 2009, so many of the negative concerns have been ill-founded. One of the headlines was “U.S. Stock Rally Narrows, Signaling End.” That was June 2009.

At the end, the market gets narrower, and if you use the historical template, people get excited, money goes into growth funds. That’s not happening. Enthusiasm is tempered, which suggests to me it has a ways to go."

If the past week is any indication, there is going to be a whole lot of Fed watching over the summer months and its actions will play a large role in whatever direction the market takes over the near/intermediate term.

Have a great week.