Archive for the ‘market condition’ Category

All Key Regional Stock Markets Are Now In Intermediate Up Trends

Wednesday, March 22nd, 2017

With Europe and China joining the other key regional markets, they are all now in intermediate up trends, as measured by our 4-Factor Monthly Trend Indicator.  This is not a prediction of the future, merely an observation of the current trend condition of the markets.

(see video description of the indicator methodology and uses; and performance of the US large-caps in tactical allocation since 1901; here).

Each market is plotted below using a proxy ETF, showing the trend indication month-by-month for the last 10 years (4+ years for China ETF).

The trend indicator is plotted in black in the top panel, showing 100, 50 or 0.  A 100 means up trend.  A 0 means down trend.  A 50 means a weak trend or transition between trends.

The 4 factors shown in the main panel are:

  • whether the leading edge of the 10-month moving average is pointing up or down (gold line)
  • whether position of the price is above or below the 10-month average (black vertical bars)
  • whether buying pressure is net positive or net negative (dashed green line, left scale)
  • whether the rate of price change in the direction of the trend is keeping up with a geometric pace  (red dots).

US STOCKS INTERMEDIATE-TERM TRENDS:

(click images to enlarge)

S&P 500 Large-Cap (SPY)

2017-03-21_SPY trend

S&P 100 Mega-Cap (OEF)

2017-03-22_OEF trend

S&P 400 Mid-Cap (MDY)

2017-03-22_MDY midcap

Russell 2000 Small-Cap (IWM)

2017-03-22_IWM Smallcap

Russell Micro-Cap

2017-03-22_IWC microcap

Russell 3000 “total market” (IWV)

2017-03-22_IWV R3000

 

INTERNATIONAL STOCKS INTERMEDIATE-TERM TRENDS:

Europe (VGK):

2017-03-22_VGKtrend

Japan (EWJ):

2017-03-22_EWJ trend

China (MCHI):

2017-03-22_MCHI trewnd

Global Emerging Markets (VWO):

2017-03-22_VWO Trend

Frontier Markets (FM):

2017-03-22_FM trend

 

 

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Equity Market Conditions Assessment & Portfolio Allocation Intentions 2017-03-17

Monday, March 13th, 2017

This note has three parts:

  1. Short summary of our current market view and portfolio allocation implications
  2. Bullet point outline of details behind our thinking in 5 segments (Trend, Valuation, Sentiment, Breadth, Forecasts)
  3. Supporting graphics for most of the bullet points provided in 24 charts and tables.

The short summary is of our market view and intended allocation actions for discretionary accounts, and recommended actions for coaching or “prior approval” accounts

For those of you who want a feel for why we have our market view and why we believe the allocation changes are appropriate; the bullet points will help.

If you want to see what data is behind most of the bullet points, you will want to look at the 24 supporting graphics.

There is an unfortunate need to use some jargon in the bullet points and graphics which may be unfamiliar to some of you, so please call or write in to have any of them explained; and to discuss their significance to portfolio decisions.

THE SHORT SUMMARY …………

Major world equity markets are in up trends — but there is mounting evidence that the US markets are over-extended and significantly vulnerable to a meaningful downward adjustment based on a combination of valuation, breadth, possible turmoil from key elections in Europe; and as Goldman Sachs puts it “rhetoric meets reality” in Washington.

Downside risk exists, but while the trend remains upward, we are remaining invested.  However, we are not committing additional assets from cash positions to US equity risk positions at this time (except for dollar-cost-averaging programs) due to the elevated vulnerability of the US stocks market.  We will be transferring some of the US equity risk assets in portfolios to some international markets that are in intermediate-term up trends that offer better valuation opportunities.

Portfolio changes or recommendations will be framed within the strategic allocation policy level of each client which varies based on individual needs, goals, stage of financial life, preferences, risk tolerance, and other limits or factors.

Based on valuation and long-term forecasted returns, US stocks exposures will transition from the higher end of individual portfolio policy allocations to the long-term strategic objective levels, or a bit below.  We are currently underweighted non-US developed markets and emerging markets allocations, which we will gradually raise to the long-term strategic allocations levels of each individual portfolio’s allocation policy.

Emerging markets have a more attractive valuation level than other non-US international stock markets (although they pose significantly more volatility), and allocation to them may be raised somewhat above strategic target levels within individual permitted allocation ranges.

For determination of intermediate trend status, we relay on our monthly 4-factor indicator. For more information about our trend following indicator and its performance implications, click here to see our descriptive video.

THE BULLET POINTS …………

  • TREND (see Figures 1-6): The intermediate-term stock trends are:
    • United States – UP
    • Non-US Developed Markets – UP
    • Emerging Markets – UP
  • VALUATION (see figures 7-12): Based on history:
    • United States – Expensive on Price-to-Book and Price-to-10yrAvEarnings and not expensive when earnings yield is compared to Treasury yields.  However, when rates rise the comparison will worsen, making stocks more expensive.
    • Non-US Developed Markets – Moderately expensive on Price-to-Book and moderately inexpensive on Price-to-10yrAvEarnings
    • Emerging Markets – Significantly Inexpensive on Price-to-Book and Price-to-10yrAvEarnings
  • SENTIMENT (see Figures 13-17): for US stocks are:
    • Institutional Investors – are reducing equity allocations (a Bearish indication)
    • Investment Newsletter Writers – Bullish at record high levels (a Bearish contra indication)
    • Individual Retail Investors – strongly Bearish this week but neutral last week
    • Options Market – complacent to mixed (jargon terms defined below):
      • Volatility Index – below 200-day and long-term average (complacent, expects smooth ride next 30 days)
      • Skew Index – above 200 day average and long-term trend line (nervous about possible large downside move, next 30 days)
      • Individual Equities PUT/CALL ratio – is 9% above its 200-day and its 10-year average (more cautious that institutional investors)
      • Index PUT/CALL ratio – is 7 % above 200-day average and 4% below its 10-year average (cautious but mixed signal)
  • BREADTH (see Figures 18-21) the trends are:
    • Percent of S&P 1500 stocks in Correction, Bear or Severe Bear have decidedly turned up (Bearish)
    • Percent of S&P 1500 stocks within 2% of their 12-month highs have decidedly turned down (Bearish)
    • The net flow of money is into S&P 1500 stocks over 3 month, 6 months and 1 years, but the leading edge of those flow has turned down
    • The net flow is explained by the net Buying Pressure declining substantially more than the Selling Pressure; and both measures are at levels below the 12-month average indicating reduced overall force driving the market
  • FORECASTS (see Figures 22-24):
    • “Street” consensus 2017 S&P 500 earnings growth 8.9% on revenue growth of 7.2%
    • “Street” consensus 2018 S&P 500 earnings growth of 12.0& on revenue growth of 5.1%
    • Consensus 3-5 year earnings growth for S&P 500 is 8.89%
    • Consensus 3-5 year earnings growth for MSCI non-US developed markets stocks index is 8.76%
    • Consensus 3-5 year earnings growth for MSCI emerging markets stocks index is 10.37%
    • Consensus 3-5 year earnings growth for MSCI core Europe stocks is 8.11%
    • Consensus 3-5 year earnings growth for MSCI Japan stocks is 9.43%
    • Consensus 3-5 year earnings growth for MSCI China stocks is 7.13%
    • Bank of America/Merrill Lynch just raised its 2017 S&P 500 price target from 2300 to 2450
    • Research Affiliates (leading factor based investor) forecasts 10-year real (after inflation) returns:
      • US large-cap stocks 0.7% (with 14.4% volatility)
      • US small-cap stocks 0.5% (with 19.6% volatility)
      • Non-US Developed Markets stocks 5.4% (with 17.0% volatility)
      • Emerging Markets stocks 7.0% (with 23.3% volatility)
    • GMO Bearish Mgr (lowest min fund investment $10 million available) forecasts 7-year real returns
      • US large-cap stocks – negative 3.4%
      • US small-cap stocks – negative 2.7%
      • Large International stocks – positive 0.2%
      • Emerging Market stocks – positive 4.1%
    • BlackRock (fund manager in the world) forecasts 5-year nominal returns
      • Large US stocks 4.1% (with 15.5% volatility)
      • Small US stocks 4.1% (with 18.7% volatility)
      • Large International stocks 5.5% (with 18.5% volatility)
      • Emerging Markets stocks 5.5% (with 23.3% volatility)

Options Jargon Description:

VIX: VIX is the options pricing implied volatility of the S&P 500 index over the next 30 days, based on at-the-money options

SKEW: SKEW measures the relative options “implied volatility” (essentially price) of S&P 500 out-of-the-money PUTs versus out-of-the-money CALLs with strike prices the same distance from the market price – essentially measuring the perceived “left tail risk” (tail risk is the probability of prices going below the level that is predicted by a normal probability Bell curve).

Portfolio managers are predisposed to buy PUTs for protection and sell CALLs for yield, which tends to increase out-of-the-money PUT premiums and depress out-of-the-money CALL premiums.

SKEW of 100 means the market expects equal implied volatility (essentially prices) for out-of-the money PUTs and CALLS.  SKEW greater than 100 means the market expects higher implied volatility (prices) for PUTs relative to CALLS – more perceived large downside risk.

The record low SKEW was 101.9 on March 21, 1991. The long-term average SKEW is around 115, and the high is around 150. The current 200-day average SKEW is about 130, and the current level is about 140. That means there is a heightened concern about a greater than typical risk of a large downside move in US stocks.

INDIVIDUAL EQUITIES PUT/CALL RATIO: The Equities PUT/CALL ratio is the PUTs volume divided by the CALLs volume on individual stocks. This tends to be reflection of actions by retail investors; and is often a contrary indicator.

INDEX PUT/CALL RATIO: The Index PUT/CALL ratio is also the ratio of the volume of PUTS and CALLS, but tends to be a reflection of the actions of institutional investors; and is not considered a contrary indicator.

THE SUPPORTING GRAPHICS …………

(click images to enlarge)

TREND

FIGURE 1: 
Over the past year, US stocks (VOO), non-US Developed Markets (VEA) and Emerging Markets (VWO) are generally in an up trend, although the US is way out front.

2017-03-13_00
FIGURE 2:
Over 3 years, the three regions are up, but the US is way ahead, and did not have as severe down moves as the other two regions.

As you will see the outperformance by the US is related to its current overvaluation, and the weaker performance of the other markets, is related to their more attractive valuation.
2017-03-13_01
FIGURE 3:
Our 4 factor monthly trend indicators ranks each of the three regions as in an up trend.
2017-03-13_02
FIGURE 4:
This time series of our trend indicator for the US shows the up trend established since March 2016.
2017-03-13_03
FIGURE 5:
The up trend in non-US Developed Markets was established in November 2016.
2017-03-13_04
FIGURE 6:
The up trend in Emerging Markets was established at the end of December 2016.
2017-03-13_05

VALUATION

FIGURE 7:
On price-to-book basis the US is very expensive (at the top of its 10-year range). Non-US Developed Markets are “normally” valued (at just above their median level). Emerging markets are inexpensive (price significantly below their median level).
2017-03-13_06
FIGURE 8:
In terms of the Shiller CAPE Ratio (price vs 10-year inflation adjusted average earnings), the US is very expensive relative to is long-term history. Developed Markets are inexpensive, and Emerging Markets are significantly inexpensive.
2017-03-13_07
FIGURE 9:
Based on a variety of valuation metrics the US is expensive. The Developed and Emerging Markets inexpensive by comparison.  Emerging Market have more attractive valuations than the Developed Markets.

In terms of profitability, the US is tops, which partly explains the higher valuation. Developed Markets are less profitable than Emerging Markets.

Emerging markets have competitive dividend yields and the lowest payout ratios.

Emerging markets seem to be a bit less leveraged than US stocks, and the Developed Markets are the most levered.
2017-03-13_08
VALUATION of US ALONE ….

In addition to the price-to-book and Shiller P/E to their respective histories, several other valuation metrics for the US should be considered; almost all of which suggest the market is very expensive

The “equity risk premium” [(stock earnings / price) – (10-yr Treasury yield)] is the only key valuation metric that suggest that stocks may not be overvalued; and that argument depends of the current historically low Treasury yields.

FIGURE 10:

Current equity risk premium for the 10-year inflation adjusted earnings-to-S&P 500 price is 0.90%. Since 1881, the equity risk premium for the S&P 500 and its large-cap precursors was higher 68% of the time.  That suggest modest overvaluation.

However, since the risk premium first went negative in 1964 (except for 4 months in 1929), the equity risk premium was only higher than now 30% of the time — a Bullish suggestion.

The question is whether the 135 history, or the 52 year history is the more important to consider. If the long history is more important, then the S&P 500 is somewhat expensive relative to the yield on 10-year Treasuries; but if the shorter history is more important, then the S&P 500 is inexpensive relative to Treasury yields.  However, Treasury yields are suppressed, and if they normalize to something in the 3% to 4% range before profits increase a lot, then stocks are expensive.
2017-03-13_09
FIGURE 11:
Current equity risk premium for the 12-month trailing earnings-to-S&P 500 price is 1.17%. Since 1881, the equity risk premium for the S&P 500 and its large-cap precursors was higher 68% of the time.  This also suggests moderate overvaluation.

However, since that risk premium first went negative in 1967 (except for 1 month in 1921), the equity risk premium was only higher than now 29% of the time — a Bullish indication.

The question is whether the 135 history, or the 49 year history is the more important to consider. The same logic applies as it does for the equity risk premium based on the 10-year inflation adjusted earnings yield.
2017-03-13_10
FIGURE 12:

S&P 500 GAAP earnings are not much higher than they were 4 years ago, yet the price of the index is a lot higher. That means much of the rise in the price of the index is merely paying more the what you get, not getting proportionately more for paying more.

10-year Treasury rates in 2013 more than doubled from less than 1.5% to more than 3%, yet the S&P 500 continued to rise in price faster than earnings.

Once again 10-year Treasuries have risen in 2016 from less than 1.5% to more than 2.5% and the price of the S&P 500 has continued to rise, even in the face of flat earnings, with falling earnings close behind in the rear view mirror.

If interest rates should make it to 3% in the near-term (not an unthinkable event), the equity risk premium on trailing 12-month earnings would drop from 1.17% to about 0.75%. Since 1881, the risk premium has been higher than 0.75% more than 70% of the time; and since 1967 it has been higher 64% of the time.  That would be Bearish.

This suggests valuation vulnerability in the face of probable moderate interest rate increases.

2017-03-13_11
SENTIMENT

FIGURE 13
The State Street Investors Confidence index is a behaviorally measured sentiment index — a measure of increases or decreases in public equity allocation in actual institutionally managed portfolios, a real measure of market sentiment by large institutions.

The rate of increase in their public equity risk allocations began a decline in around 2 years ago.  They began actually decreasing their public equity allocations in 2016 and continue to do so.

This is not an endorsement of current stocks markets.
2017-03-13_12
FIGURE 14:
Investors Intelligence monitors 100 leading investment newsletters to gauge the Bullish or Bearish sentiment of those writers. Extreme peaks in sentiment tend to be contrary indicators (not perfectly, of course), but when “everybody” is Bullish or Bearish, a trend is often about to be exhausted; because there are few additional people to join the point of view and bring move more money in the direction of the trend.

The current Bull-Bear spread is among the most extreme Bullishness of the last 10 years.  This suggests that a corrective action is likely nearby.

2017-03-13_13
FIGURE 15:
The American Association of Individual Investors conducts a continuous online survey of it members — essentially the retail investor.  Last week when this chart was created, the Bull-Bear spread was 2.29%, barely on the Bullish side of neutral.  In the subsequent week it turned on a dime dropping to negative 16.5%; strongly Bearish.

The chart suggests that this data is more a coincident indicators than a forward indicator, so the drop in sentiment parallels the recent weakness in the up trend.
2017-03-13_14
FIGURE 16:
TD Ameritrade publishes the Investor Movement Index.  It is Bullish at this time.  Here is what they do to make their index.

Each month Ameritrade calculates a short-term Beta (volatility relative to a benchmark such as the S&P 500) for each security.
Then it takes a sample of hundreds of thousands of customer accounts with at least $2,000 in their account and in which at least 1 trade was done the month, from its approximate 6 million customers.
It measures the total equity allocation and the aggregate short-term Beta (volatility relative to volatility of the S&P 500) of the equities in each portfolio (and other undisclosed factors) to develop the risk level of each portfolio.
Then equal weighting each account without regard to size or number of trades, it finds the median equity risk exposure, and puts that on its index scale (scale parameters not disclosed), and plots that versus the S&P 500.
The level and direction of the index is an indication of actual retail investor behavior instead of what they might say about their sentiment.

2017-03-13_15
FIGURE 17:
The options market reveals the actual risk taking behavior of investors in terms of the pursuit of gain (buying CALLs) or seeking protections (buying PUTs).  Here are 4 measures of options market behavior.

VIX measures the expected volatility of the S&P 500 over the next 30 days.  At under 12, the VIX is well below the 10 year average of about 20, and among the lowest levels of the past 10 years.  This is complacency.  Complacency is probably like everybody being on the same side of a boat, which makes the boat prone to tip over.  Volatility is a mean reverting measure, which suggest more volatility in the relatively near future than in the relatively near past.

The SKEW Index (defined above in the jargon section) is a measure of the concern over the size and probability of an unusually large downside move.  That measure is elevated, which gives reason for caution.

The Equity PUT/CALL index (defined above in the jargon section) is a measure of the relative “protection seeking/opportunity seeking” behavior of mostly retail investors.  That ratio is slightly elevated versus average levels, indicating a mildly increased relative pursuit of protection.

The Index PUT/CALL index (defined above in the jargon section) is a measure of the of the relative “protection seeking/opportunity seeking” behavior of mostly institutional investors.  That ratio is slightly lower than average, indicating a mildly lower than average relative pursuit of protection.
2017-03-13_16
BREADTH
This is one of our favorite measures, and one that we directly measure weekly since the beginning of 2014.  Breadth measures the condition or behavior of the overall membership of the broad S&P 1500 index and compares it to the price level of the market-cap weighted S&P 500 index — in other words, it checks to see if the rank and file members of the market are going in the same direction as the mega-cap leaders of the market.

For example, the price movement of Apple and Exxon have a lot more impact of the price of the S&P 500 or the S&P 1500 than 100’s of smaller members of the S&P 500 and S&P 1500.  If the rank and file are going in the same direction as the leadership, that is Bullish breadth.  If they are going in the opposite direction, that is Bearish breadth.  The leaders can only go so far for so long without the rank and file coming along.

FIGURE 18:
The percentage of S&P 1500 index constituents in a Correction or worse (grey line — down 10% or more from their 12-month high) rose dramatically before the November presidential election, then dropped off just as steeply to among the lowest levels in the past 3 years.  Just recently, however, the percentage in Correction or worse sharply turned up — still in “normal” range, but the direction change is a negative for the current stocks rally.

The same is true, but to a lesser extent for the percentage of S&P 1500 stocks in a Bear or worse (blue line — down 20% or more), or in a severe Bear or worse (red line — down 30% or more).
2017-03-13_17
FIGURE 19:
The percentage of S&P 1500 stocks within 2% of their 12-month high was declining prior to the election, turned up sharply to reach the highest level in the past 3 years immediately after the election, but has since declined to the “normal” range with a current downward direction.  The provides a note of caution about the current rally.
2017-03-13_18
FIGURE 20:
The Net Buying Pressure (Buying Pressure / Sum (Buying Pressure + Selling Pressure), which has been net positive since the bottom of the early 2016 Correction, began to decline before the election; resumed growing strength after the election; but has recently been losing steam.  This is not supportive of the current rally.
2017-03-13_19

BuyingPressureMethod
FIGURE 21:

The separate Buying Pressure and Selling Pressure components of the S&P 1500 stocks Net Buying Pressure in the figure above are shown here.

The rising S&P 500 price in 2016 was not matched by rising Buying or Selling Pressure, showing waning enthusiasm for equities.  After the election both Buying and Selling Pressure rose, but Buying Pressure rose more than Selling Pressure.  Recently however, the decline in Net Buying Pressure noted above, is the result of Buying Pressure declining substantially, while Selling Pressure has declined far less.

These data also suggest the fuel of the rally may be running low.
2017-03-13_20

PressureCompnentsMethod
FORECASTS
Looking way down the road with 5-10 year forecasts, and supporting our view that a shift in allocation more toward international equities, and less in US equities is appropriate, are forecasts by Research Affiliates (a noted factor-based asset manager), by GMO ( a Bearish asset manager for the very wealthy — $10 million and up to invest in their funds); and by BlackRock (the largest fund manager in the world).
FIGURE 22:
Research affiliates studies factors with focus on the current Shiller CAPE Ratio (Price divided by the inflation adjusted 10-year average Earnings) relative to its historical median, and historical highs and lows.  They find that to be a good long-term indicator of opportunity.  They view the CAPE Ratio as mean reverting over the long-term.

Based on CAPE and other factors, this chart shows how they see the real (nominal less inflation) return and the volatility of US, non-US Developed Markets (“EAFE”) and Emerging Markets (“EM”) working out over the next 10 years on an annualized basis.  They definitely see international equities as the place to be — but with more volatility.

2017-03-13_21
FIGURE 23:
GMO does not disclose their forecasting methodology, but they are among the most Bearish institutional manager, so worth noting for that.  Over the next 7 years, they see the real return on US large-cap stocks as negative 3+%; the real return on large international stocks as barely positive; and the real return on Emerging Market as positive 4+%.  They also see negative real returns on US and Dollar hedged international bonds, but positive 1+% real returns on Emerging Markets debt.

2017-03-13_22
FIGURE 24:
Over the next 5 years, BlackRock sees nominal return on US stocks as very low, and much lower than international stocks.  They see non-US Developed Markets stocks as generating nominal return  at about the same level as Emerging Markets, but with volatility similar to that of US small-cap stocks; whereas they see much higher volatility for Emerging Market stocks.
2017-03-13_23

 

 

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Intermediate-Term Technical Condition of Domestic & Int’l Stocks and Bonds

Tuesday, November 29th, 2016

There is more to consider than technical condition of markets and securities, but combining technical condition information with fundamental and macro-economic information makes for better decisions.

Let’s look at the intermediate technical condition of US large-cap stocks; EAFE (DM ex US large-cap stocks) and EM stocks; as well as Aggregate US bonds, DM Dollar hedged investment grade bonds, and EM Dollar denominated sovereign bonds.

We used SPY, VEA, VWO, BND, BNDX and VWOB to represent those major categories in Figure 1.

FIGURE 1:

2016-11-29_a1

The red/yellow/green color coded scales in Figure 1 rate each category as trending UP or DOWN or in Transition.  If the category is in Transition, a horizontal arrow shows the direction of the Transition from Up to Down, or from Down to Up.  If the price has crossed the primary trend line in a direction opposite of the trend direction, the rating is noted with an “X”.

Figure 2 presents the 4 essentially non-overlapping monthly factors in the QVM trend indicator, along with how they are scored and summed to an overall rating. The indicator is a price-only indicator, which does not consider distributions, which are part of total return.

FIGURE 2:

(click images to enlarge)

2016-11-29_b2

There are 9 possible configurations of the 2-month leading edge of the Major Trend.  Figure 3 presents those 9 configurations graphically and how each is scored by the indicator.

FIGURE 3:

2016-11-29_c

We use a custom built program to plot a running rating for each security, which is shown in black in the top panel of Figure 4.

The middle panel in blue is ancillary information showing the distance of the price from the 12-month trailing high.

The main panel contains the 4 factors:  Major Trend in gold; Price in black, Buying Pressure in green; and Parabolic Pace in dotted red.

FIGURE 4:

 

2016-11-29_d

In a more compact way, and for easier comparison between charts, we also look at charts from StockCharts.com that contain essentially the same, but not exactly the same data (see Figure 5) — the difference being that dividend adjustments made by StockCharts sometimes cause ratings to differ somewhat when the technical condition is close to a change.  Most of the time, for practical purposes, the StockCharts plots are sufficient.  The StockCharts plots, however, cannot calculate or display the actual rating.

FIGURE 5:

2016-11-29_e

Figure 6 shows the tabular output of our software showing how each of the 4 factors is rated, along with the overall trend rating, with some additional information (Buying Pressure level, distance of the price from the 12-month trailing high, and the position of the price within the 1-year high-low range).

FIGURE 6:

2016-11-29_e2

It is important to note that value and technical condition are not always aligned.

Figure 7 shows the Shiller price to 10-year average inflation adjusted GAAP earnings (“CAPE” for cyclically adjusted P/E), as it relates to the long-term median of that valuation multiple; and the expected 10-year return based on a potential decade-long mean reversion.

Bottom line, US large-cap stocks are in the best current trend condition, and are the most expensive, with the lowest return if valuation revert to the mean over the next 10 years.  Non-US DM stocks and EM stocks are in poor trend condition, and are significantly less expensive, with substantially higher next decade returns in the event of valuation mean reversion (see Figure 7).

Note that US large-cap stocks and DM stocks have similar expected volatility, whereas EM stocks have much higher expected volatility.

FIGURE 7:

2016-11-29_f

A more graphical way to look at the relative valuation of US large-cap stocks versus DM and EM stocks is in Figure 8, which shows the extremes of CAPE valuation, the range where the valuation is most of the time (in green), and the current valuation (black dot).  US large-caps are very expensive by this measure, and DM and EM stocks are inexpensive.

FIGURE 8:

2016-11-29_g

Figure 9 calculates the percentage price change that would be required today for a full mean reversion.  It is unlikely to make such a sudden full jump, but the percentages are another good way to see the disparities in valuation; and the theoretical price gain potential (before consideration of various political, macroeconomic and other factors).  It also shows the Morningstar provided 3-5 year earnings growth expectations, and our calculation of the PEG ratios using Morningstar data.

FIGURE 9:

2016-11-29_h

Figure 10 provides the current QVM 4 factor trend ratings for the 10 sectors of the S&P 500.

Figure 10:

2016-11-29_j

 

These data suggest that for those with a patient, long-term view, a little less US stock and a little more DM and EM stock should prove beneficial; BUT that requires accumulating assets that are in price decline, or maintaining an above average cash position to wait for DM and/or EM stocks to change to an intermediate up trend.  Even then EM stocks will provide a bumpy ride.

The cash holding to wait for a turn in DM or EM stocks is reasonable, because there is a distinct possibility (not necessarily probability) that US stocks could be in decline as DM and EM stock are ascending, in which case emotions may prevent the reallocation, or the gains and losses could substantially cancel each other.

All that is really being suggested here is rebalancing within the investment policy allocation range for each key asset type;, or using cash as in intermediary step between decumulation of one asset and accumulation of another based on trend evaluation.

Those near or in retirement need to make sure that in addition to any such long-term positioning, they maintain sufficient safe, liquid assets to be able to make withdrawals for a few years out of assets that do not fluctuate much in price, in the event of an extended or major market decline. The most vulnerable years are the 5 years leading to and 5 years after beginning to rely on the portfolio to support lifestyle.

In terms of sectors, the trend condition reports the obvious, which is that REITs, Consumer Staples, and Utilities are struggling with pending interest rate increases — and therefore should probably be kept at the minimum of the investment policy range for each portfolio until the trends recover.

The securities used in these trend evaluations were:

  • SPY – US large-cap
  • VEA – DM non-US stocks
  • VWO – EM stocks
  • BND – US aggregate inv. grade bonds
  • BNDX – DM Dollar hedged inv. grade bonds
  • VWOB – EM Dollar denominated sovereign bonds
  • XLB – basic materials
  • XLE – energy
  • XLF – financials
  • VNQ – REITs
  • XLI – industrials
  • XLK – information technology
  • XLP – consumer staples
  • XLU – utilities
  • XLV – health care
  • XLY – consumer discretionary

We will publish a similar review of country ETFs in a future article.

 

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Lowered Long-Term Portfolio Return Expectations: Mean Reversion Impact

Tuesday, August 9th, 2016

QVM Clients:

  • Current stock and bond trends are mostly up and S&P 1500 breadth indicators have normalized
  • S&P 500 is approximately at consensus 2016 price level
  • Mean reversion risk is substantial but timing of realization is unknown
  • Institutional long-term asset return assumptions are lower and portfolio return expectations should be tempered
  • Specific mean reversion risks presented in charts

CURRENT TRENDS
The current trend is generally up, with non-US developed markets struggling, and emerging markets transitioning to clear up trend. Here are the trend ratings for ETFs representing key asset categories commonly found in portfolios. The ratings are based on the monthly four factor indicator used by QVM:

  • Direction of tip of 10-month moving average
  • Position of price above or below the 10-month moving average
  • Net buying or net selling pressure
  • Price position versus a progressive threshold changing at a geometric pace

As additional information, the table provides the price percent below the 12-month high price; the price position within the 12-month high-low range, the overbought or oversold condition based on the money flow indicators, the positive or negative signal from the MACD signal line, and whether the MACD is above or below the center line.

Even though current trends are up, the Bull is aged and probably in late stages, with significant long-term risk associated with eventual withdrawal of central bank market distortions. Cautiousness and conservatism is warranted.

(click on images to enlarge)

2016-08-08_01

DISCLAIMER ABOUT CAUTIONARY LONG-TERM VIEWS THAT FOLLOW
Fear of loss and risk avoidance are important emotional and behavioral factors that are about twice as strong as satisfaction with gains and opportunity seeking emotions and behavior. That gives us some pause talking about long-term risks. We do not want to frighten anybody or cause them to, as Jeff Gundlach said, “Sell Everything”. Market performance problems that are certain to be upon us someday are not upon us now, and within reason, we must take advantage of current positive trends. But we want you to be aware of the nature of the problems that will most certainly be realized some uncertain time in the future. There are important setups of valuations that are too far from long-term mean levels to be permanently sustained, and that are the basis of multiple institutions cautioning investors of subdued returns over the next decade.

PREVAILING EXPECTATIONS FOR YEAR-END S&P PRICE LEVEL

In June a survey of institutional investment strategist saw the S&P 500 ending 2016 at around 2100 to 2200. We are pretty much there now, suggesting not a lot of upside over the remainder of the year, which also dovetails with the likely reluctance of investors to be fully exposed to market risk during this unusual presidential election.

2016-08-08_011

THE LONG-TERM IS MUCH ABOUT MEAN REVERSION

We have been in the Great Distortion for years now, and “mean reversion” can gettcha if ya don’t look out. Unfortunately, while mean reversion is a near certainty, when reversion takes place is not. Wide deviations from “normal” levels can go on for long periods (but can also revert quickly). Our central bank and those of Europe, Japan and China have been doing things to prevent mean reversion for years now. Someday the forces of mean reversion will defeat the central banks if the banks don’t toss in the towel on their distorting efforts first.

Before a general look at overvaluation and mean reversion in the S&P 500, here from 720 Global is one of the worst cases today of yield chasing that has put utilities into rarefied territory with very strong mean reversion risk.

The image below shows the S&P 500 sector ETF (XLU) Price-to-Sales ratio is more than 3 standard deviations above its average since 1990; and the Price-to-EBITDA ratio is nearly 3 standard deviations above. Valuations 3 standard deviations from the mean have odds stacked well against them being sustainable.

The price would be cut in half to get back to average Price-to-Sales ratio, or cut by about one-third to get back to average Price-to-EBITDA. That is not an attractive risk for a slow-growing industry. This problem caused by the frantic search for yield that has raised the price of typically high yield or strong dividend growth companies to unattractive valuation levels.

The need eventually to move valuations back toward the mean levels in key asset categories is the reason so many forecasters see muted portfolio returns in coming years.

2016-08-08_02The current trends in US stocks, and bonds are up right now, which is itself unusual as a pair. They are all marching to the tune of ZIRP and NIRP (zero interest rate policy and negative interest rate policy), which cannot go on forever – a long-time yes, but not forever. When rates normalize (revert to mean), so too will stocks and bonds. Interest rates are at the base of most aspects of investing, and tend to drive valuation of other assets. Having some idea what normalization would be is important to setting expectations.

A wide variety of institutional voices have concluded and published their expectation of lower portfolio returns over the next several years, as a result of the significantly above normal returns of the past several years. They talk of interest rates rising, profit margins declining, revenue growth slowing or not accelerating, valuation multiples compressing, debt servicing costs rising, reduced stock buybacks resulting in less boost to earnings per share, and just general world GDP slowing or moderation.

Looking across their prognostications and generalizing, it seems they expect a 4% to 5% total return over the next 5 to 10 year for a 50/50 stock/bond balance portfolio.

WHAT THEY ARE SAYING ABOUT LONG-TERM RETURNS

McKINSEY & COMPANY (largest independent management consulting company)
In May of this year McKinsey & Company published a report titled “Diminishing Returns: Why Investors Need to Lower Expectations”. They see much lower asset returns, and therefore lower portfolio returns, in effect due to mean reversion.

2016-08-08_03

2016-08-08_04

Based on the mid-point of McKinsey’s view a 50/50 US stock/US bond portfolio would tend to return an approximate 5.25% nominal annual return over the next 20 years.

BLACKROCK (largest asset manager in the world – $4.5 trillion AUM)
BlackRock sees similar lower asset returns.

2016-08-08_05

Based on BlackRock a 50/50 US stock/US bond portfolio should expect a long-term nominal annual return of about 2.55% over the next 5 years and about 3.5% over the “long-term” (undefined length of time).

VANGUARD (second largest money manager – $3.3 trillion AUM)
Vanguard had this to say last December with a less pessimism:

“Vanguard’s outlook for global stocks and bonds remains the most guarded since 2006, given fairly high equity valuations and the low-interest-rate environment …The growth outlook for developed markets, on the other hand, remains modest, but steady … our medium-run outlook for global equities remains guarded in the 6%–8% range. That said, our long-term outlook is not bearish …the high-growth “goldilocks” era enjoyed by many emerging markets over the past 15 years is over. Indeed, we anticipate “sustained fragility” … China’s investment slowdown represents the greatest downside risk.”

JOHN BOGLE (Founder of Vanguard Group)
6% nominal (non-inflation-adjusted) equity returns during the next decade; 3% bond return

Based on Vanguard’s view a 50/50 US stock/US bond portfolio would tend to generate a 4.5% annual nominal over the next 10 years.

STATE STREET GLOBAL ADVISORS (third largest money manager – $2.3 trillion AUM – sponsors of SPDRs including SPY)

2016-08-08_06

Based on the State Street forecast a 50/50 US stock/US bond portfolio should expect an approximate annual nominal returns as follows over various time frames:

  • 1-year: 1.85%
  • 3-years: 3.60%
  • 5-years: 3.95%
  • 10-years: 4.4%
  • 30-years: 4.85%.

JP MORGAN ASSET MANAGEMENT (prominent high net worth, private wealth manager)

This is the long-term view from JP Morgan Asset Management as of their annual outlook for nominal returns over the a 10-15 year time frame:

2016-08-08_07

Based on JP Morgan forecasts a 50/50 US stock/US bonds portfolio might expect an annual nominal return of 5.63% over the next 10-15 years.

NORTHERN TRUST (prominent high net worth private wealth manager)

“We expect developed market equity returns of 5.4% annually, bookended by emerging market returns of 7.3% at the top end, and US returns of just under 5% at the low end. … We expect real assets to perform relatively well, led by a forecasted return of nearly 7% for natural resources. .. We expect the US 10-year Treasury to support a yield of just 1.5% [over five years], capped by the German 10-year yield of just 0.5% and the Japanese 10-year at 0%. … We do expect an uptick in high-yield bond defaults, but project a 5% total return, which is attractive compared to the outlook for the equity markets. … While we expect to see some modest deterioration in corporate credit quality, continued low rates and strong investor demand should lead to further spread tightening for investment-grade bonds [that suggests continued gains as spreads to Treasuries compress]”

By interpolating/hypothesizing perhaps a 3% aggregate bond yield from Northern Trust comments, a 50/50 US stock/US bond portfolio may generate an annual return of about 4% over the next five years.

GOLDMAN SACKS (prominent high net worth private wealth manager)
Goldman Sachs “Last Innings” 5-year nominal return assumptions.

2016-08-08_08

Based on Goldman Sachs forecasts, a 50/50 US stock/US bond portfolio (it’s a little hard to say because they do not specify US aggregate bonds or investment grade bonds), but let’s take the mid-point between their cash return and high yield return (2.5%) and tweak it up to 3%. That would give a possible 5-year expectation of about a 3% nominal portfolio return.

RESEARCH AFFILIATES (pioneer in “factor-based” investing)
1.1% real returns for U.S. large caps (the S&P 500) during the next 10 years; 1.1% real returns for the Barclays U.S. Aggregate Bond Index

Based on Research Affiliates forecasts a 50/50 US stock/ US bonds portfolio would generate about a 1.1% real return (perhaps 3% to 3.5% if inflation were to be in the range of 2% to 2.5%) over the next 10 years.

HOW MIGHT WE LOGICALLY GET TO LONG-TERM EXPECTED PORTFOLIO RETURNS?

The 50/50 forecasts we estimate from the selection of institutions above are:

  • McKinsey 5.25% over 20 years
  • BlackRock 3.5% over the “long-term”
  • Vanguard 4.5% over 10 years
  • State Street 3.95% over 5 years
  • State Street 4.4% over 10 years
  • JP Morgan 5.6% over 10-15 years
  • Northern Trust 4% over 5 years
  • Goldman Sachs 3% over 5 years
  • Research Affiliates 3% to 3.5% over 10 years

Based on their range of thoughts, let’s go with 4% over 5 to 10 years and see how one might get there logically:

  • Stocks return 5% consisting of 2% dividend yield and 3% growth in earnings due to global GDP growth
  • Corporate bonds return 3% average interest, and no capital gains due to rising interest rates
  • 50% x 5% + 50% x 3% = 4% portfolio return.

A 70/30 stock/bond portfolio with the same underlying asset returns would return 4.4% (70% x 5% + 30% x 3%).
A 30/70 stock/bond portfolio would generate a 3.6% return (30% x 5% + 70% x 3%).

One way to potentially do better is to own stocks that pay more than 2% (index level) yield and that are not terribly interest rate sensitive, and that can grow earnings (and revenue) at least at 3% over the next 5-10 years – to get more of the return in regular cash with less reliance on price change.

Another way might be to overweight less popular stock categories, with more favorable valuation, with at least the potential to growth faster than US stocks, perhaps such as emerging markets

A third way could be to have a non-core tactical component of the portfolio that, if successful, could outperform the core.

WHAT ARE SOME OF THE DATA THAT SUPPORT LOWERED EXPECTATIONS

In great part, long-term assumptions come down to reversion to the mean whether analyzing core portfolios, or tactical opportunities — so let’s look at some prime examples of assets far enough from their mean that significant value changes are in store, when the forces of Great Central Banks Distortion are withdrawn.

Before the mean reversion sets in, there needs to be some sort of catalyst. Central banks are expected to provide that catalyst in one way or the other, either by raising rates, or cutting rates with minimal intended effects. Another catalyst could be investor recognition of obvious problematic divergences.

Figure 1 shows an important problematic divergence.

The S&P 500 price is in black and its reported GAAP earnings are in red. Trailing earnings are falling and the price of the index is rising. That is a divergence setting up for a reversion to the mean (unless of course earnings catch up with the strong price rise). Note that the last two time earnings declined for several quarters, the stock index declined significantly as well. This is a cautionary signal.

FIGURE 1:

2016-08-08_09

Figure 2 shows a problematic divergence based on forward operating earnings similar to the one in Figure 1 which is based on trailing GAAP earnings.
S&P 500 forward operating earnings expectations are relatively flat, but the price of the index rising significantly, This divergence is not normal and sets up for a reversion to the mean (a return to a normal relationship). This is a cautionary signal.

FIGURE 2:

2016-08-08_10

Figure 3 shows that not just earnings, but also profit margins are in decline, and are also above their long-term average. This is a set up for return to the mean, which would be a negative for the S&P 500. If all other valuation factor remained constant, profits (and presumably prices) would come down 8.3% for profit margins to reach their 10-year average.

FIGURE 3:

2016-08-08_11

Here are some important comments about profits and mean reversion:

Warren Buffet (1999) CEO Berkshire Hathaway
“In my opinion, you have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%.”

Jeremy Grantham (2006) CIO GMO (Grantham, Mayo, & van Otterloo)
“Profit margins are probably the most mean-reverting series in finance…”

John Hussman (2013) President Hussman Investment Trust
“In general, elevated profit margins are associated with weak profit growth over the following 4-year period. The historical norm for corporate profits is about 6% of GDP. The present level is … above that, and can be expected to be followed by a contraction in corporate profits over the coming 4-year period …”

Jason Zweig (2013) writes Wall Street Journal, Intelligent Investor column
“… regression to the mean is the most powerful law in financial physics: Periods of above-average performance are inevitably followed by below-average returns, and bad times inevitably set the stage for surprisingly good performance.”

Figure 4 shows aggregate public and private corporate profits as a percentage of GDP. There are way out of line with the norm. This is a setup for return to the mean, in a way that would reduce stock returns going forward. If all other valuation metrics remained constant, the value of American corporations would decline by 27% to reach the mean profits to GDP ratio.

Note the use of the 85th and 15th percentiles as indicator lines. When at the 85th percentile, there is 6 times more room below than above that level (5 times to the 15th percentile level); and at the 15th percentile, there is 6 times more space above than below (5 times to the 85th).

FIGURE 4:

2016-08-08_12

Price-to-earnings ratios are the most popular metric. Figure 5 shows the Shiller CAPE ratio (an inflation adjusted 10-year average reported GAAP P/E ratio). If all other valuation metrics remained constant, the price of the S&P 500 would have to decline by 33.6% for the CAPE to reach the mean.

FIGURE 5:

2016-08-08_13

Figure 6 shows the P/E ratio based on the 12-month trailing reported GAAP earnings. It too is way above normal and set for mean reversion. Such elevated P/E ratios may be justified in the short-term due to exceptionally low interest rates, but when rates eventually rise, as they must, the math used to set reasonable P/E ratios adjusts, and lower P/E multiples will be in order. Note that much of the increase in price in the past few years has been due to multiple expansion and not to underlying organic growth of the companies. When interest rates rise, some of those stock multiples must be given back.

To revert to the 25-year median, the S&P 500 would have to decline by 20% at the current earnings level. To revert to the 135-year median, the S&P 500 would have to decline by 40%.

FIGURE 6:

2016-08-08_14

Figure 7 shows the P/E based on forward operating earnings. Like the 10-year inflation adjusted GAAP P/E, and the 12-month trailing GAAP P/E, the forward operating earnings P/E is also well above its average. To revert to the 10-year average, the S&P 500 would have to decline by 16%.

FIGURE 7:

2016-08-08_15

Figure 8 provides a much longer view of the forward P/E ratio (courtesy of Dr. Ed Yardeni, Yardeni Research inc., http://blog.yardeni.com). Here he has plotted P/E isobars, representing what the index price would be at different P/E levels for the forward earnings view at the time. We added the color shading to make it a tad easier to see stages of valuation at different levels. This chart plots from 1979. You can see that the current forward P/E is in the elevated range (light orange) between P/E 15 and 20. That suggests mean reversion vulnerability.

FIGURE 8:

2016-08-08_16

Really it is easier to think of stock valuation relative to interest rates by expressing stock valuation as an earnings yield versus a Treasury bond yield (yield-to-yield, instead of P/E-to-yield). Earnings yield is simply the inverse of P/E. Instead of P/E it is E/P. Figure 9 shows the earnings yield (“EY”) of the S&P 500 for the past 135 years versus the US 10-year Treasury yield (precursors of S&P 500 before 1957 and precursors of 10-year Treasury in early years, based on data assemble by Dr. Robert Shiller of Yale).

As it turns out the earnings yield is just about right at the median level, meaning the index is properly priced for the current interest rate situation. But the current interest rate situation isn’t priced right and has to change eventually, possibly sooner than later. At that time, the S&PP 500 would be overpriced and prone to price reduction.

FIGURE 9:

2016-08-08_17

Figure 10 shows the US Treasury 10-year rate and precursors back to 1881 (135 years). The recent rate is 1.59% and the median is 3.76%. It has been all over the yield range for the past 60 years, showing its can go much higher under some circumstances. But it is currently at the lowest rate in 135 years, which suggests the only logical probability is up (even if down more for a while). When rates rise, all other investments will make adjustments for the relativities to this theoretically zero credit risk vehicle. As it approaches mean level (or shoots past the mean). Mean reversion will be the name of the game for other assets too.

FIGURE 10:

2016-08-08_18

QVM S&P 1500 BREADTH INDICATORS

Back to the present, the breadth damage done in the second half of 2015 and the first quarter of 2016 is healed, and breadth indicators support the current rally.

FIGURE 11: S&P 1500 BUYING AND SELLING PRESSURE
3-month (gray), 6-month (blue) and 1-year pressure within the S&P 1500 is net to the Buying side and rising after a long period of decline and into net Selling territory in 2014 and 2015.

2016-08-08_19

FIGURE 12: PERCENT OF S&P 1500 IN CORRECTION, BEAR OR SEVERE BEAR
The percentage of S& 1500 stocks in Correction, Bear or Severe Bear condition has returned to pre-Correction levels and is improving.

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FIGURE 13: PERCENT OF S&P 1500 NEAR 1-YEAR HIGH
The percentage of S&P 1500 stocks within 2% of their 12-month high is in good shape.

2016-08-08_21

SOME INVESTMENT FUNDS DIRECTLY RELATED TO THIS ARTICLE:  SPY, IVV, VOO, VFINX, XLU, AGG, BND

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Si vis pacem, para bellum — If you want peace, prepare for war

Friday, January 15th, 2016

This is our letter to clients January 13, 2016

  • It illustrates the badly deteriorated and worsening S&P 500 market internals
  • It reiterates our view since last July that high cash positions are warranted
  • We have peace of mind because we prepared for this market war

Before looking at the letter to clients from two days ago, let’s view the charts for key regions around the world, including today’s (January 15) global stock markets turmoil.

  • SPY for the S&P 500
  • IEV for Europe
  • EWJ for Japan
  • VWO for emerging markets
  • GXC for China

Here are ETFs representing those key regions around the world daily year-to-date:

(click images to enlarge)

2016-01-05_world_YTD

Here are the same ETFs weekly over the past 3-years:

2016-01-05_world_3Yr wkly

[ Below is our letter to clients on Jan 13, continuing to suggest more market pain ahead, and that defensive positions and high cash allocations are most appropriate, for those in or near retirement — there will be good entry points after the markets show clear bottoming behavior, but not yet.   That letter also makes sense today, January 15, after the strong sell-off around the world]

………………

QVM Clients:

The stock market is in tough shape and the direction of change is strongly negative.  We have been expressing caution about market deterioration for months now, and have advised reducing equity holdings and maintaining high cash levels since July.  In those accounts where we have authority we made those changes with cash positions ranging from 40% to 70% depending on the account specific mandate.

The condition of the market continues to deteriorate, and today’s sell-off is just part of that.  It may well be that a rally will occur from this level which for the S&P 500 is more than 3 standard deviations below its 3-month daily average.  But even if there is a short-term reversion to the mean, the trend of the mean is still down. This is not the end of the world, and in the long-run all will probably be well, but for now this stock market is not good.

The longer 200-day trend line is also in a downward trend at this time, and the price of the S&P 500 is below that arbitrary 10% Correction definition.  Should the market decide to go to the so-called 20% decline Bear market, we would be looking at about 1700 on the S&P 500.  That compares to a price around 1900 now, and compared to December forecasts by major analysts for 2016 in the range of 2100 to 2300.  We might still get to those higher numbers, but for now cash is king, and better entry points are ahead.  Now is not the time to re-invest.  We need to see some clear bottoming behavior (prices rising above their averages, and the averages ceasing to trend down).

  • We are not with the Royal Bank of Scotland economist who this week said “Sell everything, except high quality bonds” – although it certainly would have been nice if we had gone that far back in July.
  • We do not agree with Denis Gartman, who said “This is a full-fledged Bear market” – although we are certainly on a path that has a full-fledged Bear as one possible outcome – no way to tell for sure.
  • But, we do agree with Jeff Gundlach who said, “This is a money preservation market, not a money making market”; and with Bill Gross who said it is more important at this time to focus on return OF capital than return ON capital.

Let’s stipulate that there are numerous Bulls out there too who point to fair valuations, broad equity index yields higher than 10-year Treasury yields, an economy that is OK, and that the US market is the deepest and safest one at this time; and that the yield curve is still supportive of growth.

However, beside the fact that earnings are declining (probably the first time for 3 quarters in a row since 2009) and margins are compressing, and revenue is declining; we are particularly focused on how all that resolves in the behavior of stocks – and particularly in terms of “breadth” (how the bulk of index constituents are behaving relative to the performance of the overall index, which is dominated by a few mega-cap stocks).

We normally do a breadth analysis of several US and foreign indexes each weekend after the Friday close, but given the nasty day today – and the nervous phone calls we received today, we did a quick breadth study of the S&P 500 (Jan 1, 2014 weekly through today).

Here is a summary of the results:

  • S&P 500 off of 12-month high by 11.56%, but median stock off by 20.24% (best level was off 1.70%)
  • Only 1.42% of S&P 500 stocks are within 2% of their 12-month high (best was 52.31%)
  • 80.77% of S&P 500 stocks off by 10% Correction or worse (best was 14.23%)
  • 50.61% of S&P 500 stocks off by 20% Bear or worse (best was 2.64%)
  • 26.52% of S&P 500 stocks of by 30% Severe Bear or worse (best was 0.61%)

The simple fact is that breadth is the worst it’s been in just over 2 years (probably longer, but our data only goes back to Jan 1, 2014) for the median stock, for stocks in Correction, for stocks in a Bear, and  for stocks in a Severe Bear.  For stocks within 2% of their high, the reading is close to the worst at 1.42% and far away from the best reading of 52.31%.

There is just no way to paint a pretty picture with these breadth data, and we do not think adding to risk at this time makes sense as long as these breath data (and profits) are in decline, regardless of interest rates or Central Bank policy; and regardless of Bullish views of some key institutional analysts.

[ Charts Legend: orange line is percentage distance of S&P 500 index from its trailing 1-year high.  Gray line is weekly data for parameter being studied.  Dashed black line is 13-week (3-month) average of the gray line. ]

(click images to enlarge)

MEDIAN S&P 500 CONSTITUENT STOCK OFF ITS HIGH

2016-01-13_median

 

% OF STOCKS WITHIN 2% OF THEIR HIGH

2016-01-13_2pct

 

% OF S&P 500 CONSTITUENTS OFF HIGH BY 10% OR MORE (CORRECTION +)

2016-01-13_correction

 

% OF S&P 500 CONSTITUENTS OFF HIGH BY 20% OR MORE (BEAR +)

2016-01-13_bear

 

% OF S&P 500 CONSTITUENTS OFF HIGH BY 30% OR MORE (SEVERE BEAR +)

2016-01-13_severebear

 

I will write to you in more depth about this along with other market indicator data this weekend.

Please feel free to call.

Richard

 

 

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International Market Breadth vs US Market Breadth

Monday, December 21st, 2015

In several prior articles, we have explored US stock market breadth as one component of overall market condition and adverse implications for future market direction ( Dec 14, Nov 23, Sep 28, Aug 11, July 30, and times in between).

The breadth observations are not stand alone indicators, and other factors should be taken into consideration (such as the currently supportive yield curve, the currently non-supportive operating fundamentals, such as the negative profits and profit margin picture; but also make reasonable forward judgements about prospective changes to those factors, and your own investment time horizon and short-term risk tolerance).

This article is a quick summary comparison of stock market breadth in selected international markets versus the US.

  • US small-cap breadth is worse than US large-cap breadth
  • US large-cap breadth is poor
  • Europe, Japan and the UK have better market breadth than the US
  • China has very bad market breadth, but signs of possible breadth bottoming
  • The Middle-East is a train wreck

Breadth for US S&P Market-Cap Indexes

You can see by examining the “% in Bear” row (the % of index constituents that are in a Bear or worse condition) that the smaller the size of the market-cap, the worse the condition of the constituents.  The same is true when you examine the “Median % Off High” (the % by with the median stock is below its 12-month trailing high price).

In each case, the median stock is significantly farther below its high than the index is below its high (by about 6.5% to about 11%).

These are all signs of sub-surface trouble with the US indexes.

On the positive side,  the percent of small-cap stocks above their 10-day average is significantly higher than for the large-cap stocks, suggesting some possible nascent recovery.

The other three measures (the % of constituents with the tip of the 200-day average  moving up; the % with the price above the 200-day average; and the % rising, defined as both the tip pointing up and the price above the average), are roughly equivalent  for all the market-cap level indexes.

(click images to enlarge)
2015-12-19_US by Mkt Cap.pmg

Breadth for Total US Stocks versus Selected International Indexes

Looking at the “% in Bear” data, we see that Europe, Japan and UK are in better shape than the US; but that China, Australia and the combined Middle-East indexes are in worse shape.  The Middle-East indexes, are in terrible shape on both a relative and absolute basis, with almost 88% in a Bear condition.

The UK is in the best shape according to the % of constituents within 2% of their trailing 1-year high price, and the Middle-East is in the worst shape, with nearly zero near their high.

When it comes to the median stock % off its high versus the index % off the high, the UK differs from the US and the other international indexes. The median stock is actually closer to its high than the index overall. That suggests the UK index is more balanced in its performance composition, and that the index breadth is positive.

Note that for breadth, the largest constituents can decline to match the median stock (a falling market); or the median stock can rise to match the largest stocks (a strengthening market); or the two can converge by the median rising while the largest stocks decline (uncertain implication).

Even though China has a huge number of stocks in Bear condition, there are signs of a breadth bottoming process.  Unlike the other indexes with about 21% to 37% “Rising” (moving average Tip Up, and price above moving average), China has about 63% rising.  The Middle East is no where near stabilizing with only about 5% rising.

The UK “% Rising” is about the same as the US, but Europe and the Japan are in significantly better shape.

2015-12=19 International

These data (definitely not the only data you should rely upon) suggest that you should avoid Middle East markets, consider Europe, UK and Japan if you want to diversify outside of the US; and perhaps nibble at China if other data support the evidence of bottoming possibly shows in this data.

Here are relative performance charts for the US market-cap indexes versus the SPDR S&P 500 ETF; and international indexes versus the Vanguard/CRSP US Total Market.  The data is dividend adjusted price data from StockCharts.com.

US Market-Cap Indexes

  • US Mega-Cap (OEF)
  • US Large-Cap (SPY)
  • US Mid-Cap (MDY)
  • US Small-Cap (IJR)

2015-12-19_US breadth

Major International Indexes

  • Europe (VGK)
  • United Kingdom (EWU)
  • Australia (EWA)
  • China (GXC)

2015-12-19_ITL breadth

Middle-East Indexes

  • Gulf States (GULF)
  • UAE (UAE)
  • Qatar (QAT)

The Middle-East markets are tiny, but as they are in the general war zone today and are important oil exporters, they are an interesting set to observe.  There is no suggestion that they are appropriate for most persons, but they may be interesting to watch.

 

2015-12-19_ME breadth

 

Saudi Arabia Index

  • Saudi Arabia (KSA)

The Saudi ETF has only a few months of existence, since the market just opened to the outside, but because it is the largest Middle-East market, and because is it the most important oil exporting country in the midst of the historical oil supply war, and the Sunni/Shia war, we thought is would be an interesting market to observe.

2015-12-19_KSA breadth

 

Disclosure:  We have positions only in SPY among the securities mentioned in this article.