“Don’t dwell on what went wrong. Instead, focus on what to do next. Spend your energies on moving forward toward finding the answer.”
Investor concerns still abound, plenty of commentary about raising and holding cash, waiting for a pullback, or just downright abandoning the market now. The main concern revolves around valuations, equities are too expensive. If one is absolutely convinced that the forward PE of 17 – 18 in the present rate backdrop is too high for them to invest, then I doubt any commentary I put forth here will convince them otherwise.
Those waiting for what they refer to as better valuations and prices, will be waiting for the next bear market. Ironically when that comes, many won’t pull the trigger. The typical backdrop while sitting through a bear market will scare most investors to the point of being frozen in place.
A quote on Dr.Ed Yardeni’s blog caught my eye this week,
“Nothing really terrible or wonderful is happening other than that earnings are rising in record-high territory again.”
That simple statement should turn the light bulb on for investors as if the anticipated earnings rebound comes to pass, stocks are going higher. The first step of that rebound is now in the books with a 13%+ increase in year over year profits being reported in Q1. Perhaps this answers the question of what catalyst will take the market higher. PE’s are going to stabilize here and before the bull market is over, more PE expansion.
However, many are looking around for the next boogeyman, and that tells me the wall of worry is firmly in place. Those worrying about investor complacency because of the low VIX readings might be interested to know what FBN Securities says;
“Since September 2001, the S&P has secured 311% of its gains when volatility is as low as it is now.”
Inflation was supposed to end this bull market because of all of the manipulation from Fed intervention five years ago, Hence the rise in Gold to new highs in that timeframe. Plenty are still warning about inflation saying the Fed is behind the curve. The market is significantly higher from when those initial warnings were announced.
Another concern that has been with us since 2015 has surfaced again. The bull market is old and tired. While the eight year anniversary of the financial crisis low was on March 9th, the bull market did not officially turn eight until last Friday when the S&P 500 closed at its first new all time high since March 1st (eight days before the eight year anniversary).
At 2,984 calendar days and counting, the current bull market ranks as the second longest of all time, ahead of the early to mid 1950s bull market by about a year but way behind the granddaddy of them all which spanned from 1987 through 2000.
There has been plenty of debate regarding when this bull market started. I offer a quick refresher on my views as to when the bull market began. First we begin with an earlier secular bull market for guidance. The DJ Industrials made their “nominal” price low in December of 1974, but the “valuation low” didn’t come until 1982, and that secular bull started when the Industrials broke out of that 16 year trading range in the fall of 1982. That bull market ended in 2000.
Fast forward to the present, the nominal price in this cycle came in March of 2009. However, the “valuation low” came in October 2011 and the Industrials did not break out of the 13 year trading range until April of 2013.
No one measures the 1982 to 2000 secular bull market from the “nominal” price low of December 6, 1974, but rather either the “valuation low” in early 1982 or the upside breakout of the trading range in the fall of 1982. Therefore, as I have maintained all along, the correct starting point for this secular bull market is March/April 2013. Going with my thesis suggests this present run is not that far along in comparison to others.
Regardless of when one thinks this bull market started, the bottom line, this is a secular bull market, and it has much more to go before it is over. That is not to say there won’t be draw downs along the way and I won’t rule out a cyclical bear market (20% decline) that could be thrown in.
LPL Research shares their view on the typical summer pattern: weakness into a June low sets up a good July gain; then a 2nd low in August -September sets up a year end rally.
Chart courtesy of LPL Research
Given the backdrop being presented on many fronts, with earnings topping the list, investors need not be overly concerned over any short term seasonal pattern. As always watching the data from both the technical and fundamental side should be an ongoing exercise.
A relatively light week for economic data releases.
GDPNow revised its 4.3% outlook for 2nd quarter GDP to 3.6% this past week. Consensus forecasts are calling for 2.7% growth.
NFIB Small Business optimism remained strong beating expectations
The media headlines read, rough week for retail, the retail wreck continues. Individual retailer results weren’t impressive and the quantum leap that the consumer is in bad shape becomes reality in the minds of some. In my view, all of the poor results are company specific and not a good indicator of what the consumer is doing. If people haven’t realized that all of this can be explained in one word, they haven’t shopped online. That one word is Amazon. That retail company and its stock are growing like a weed.
Retail sales rose 0.4% in April up from the revised reading of 0.1% in March. Consumer sentiment remains at elevated levels reported at 97.7 versus the previous read of 97, further supporting the view that all isn’t that bad in the consumer world.
Bureau of Labor statistics JOLTS report revealed that job openings remained little changed at 5.7 million. Hires and separations were also little changed. A rather benign report.
The Financial Times reports;
“Over the past year or so, an unaccustomed sentiment has spread through the chancelleries of Europe: a sense of confidence in the EU’s economies. The sovereign debt crisis has receded, with the unfortunate exception of Greece, which nonetheless appears well-insulated from the rest. Unemployment, the bane of Europe’s economics and often its politics, has fallen.”
Macron is the next President of France. After the results were announced the euro rose to a six month high. That uncertainty is now scratched off the worry list. French manufacturing output exploded in the latest report, rising over 4% month over month.
Eurozone Sentix Economic Index rose to 27.4 beating estimates and topping the prior reading of 23.9.
The British Retail Council’s estimate of real retail sales spiked and indicated a recovery in British consumer spending.
Headlines on company earnings reported each trading day are compiled for the week, and can be found here.
Urban Carmel reminds us with this graphic that growth continues to be driven by higher profits; impact of share reduction is minor.
Chart courtesy of Urban Carmel
Factset Research reports results for Q1 2017;
The blended earnings growth rate for the S&P 500 is 13.5%. Blended sales growth rate for Q1 2017 is 7.6%
The forward 12-month P/E ratio for the S&P 500 is 17.5.
75% of the S&P 500 reported actual EPS above estimates compared to the 5-year average. In aggregate, companies are reporting earnings that are 6.2% above the estimates, which is also above the 5-year average.
66% are reporting actual sales above estimates compared to the 5-year average. In aggregate, companies are reporting sales that are 0.9% above estimates, which is also above the 5-year average.
The difference in growth this quarter is coming from the energy sector. Many questioned how earnings could possibly improve, scoffing at some of the estimates. They did not account for the sector no longer being a drag on the S&P. The Energy sector is reporting earnings of $8.5 billion in Q1 2017, compared to a loss of -1.5 billion in Q1 2016.
If energy was excluded that growth rate would fall from 13.5% to 9.3%. One issue that now jumps to the top of my watch list is the price of crude oil. Stabilization and/or an increase from these levels will keep the energy sector contributing to the S&P earnings picture. A severe decline form here and that earnings picture may be impacted dramatically.
The Political Scene
Gary Cohn director of the National Economic Council was quoted as saying said the proposed Tax Plan will offer CEOs a one time incentive to bring cash back to the U.S.
Commerce Secretary Wilbur Ross speaking about the economy;
“The U.S. economy will fall short of the Trump administration’s goal of 3 percent growth this year and will only achieve that when its regulatory, tax, trade and energy policies are fully in place, Commerce Secretary Wilbur Ross said on Tuesday.”
No surprises here. Only the pollyannas out there believed that the ship could be turned quickly to generate 3% growth in this calendar year. One of many reasons for the view offered by Mr. Ross. There are 235 more days until 2018. Congress is in session only about 50 more times this year. That is an amazing statistic !
Don’t despair, the market is looking where it always does, ahead. For the moment the market see changes that are positives.
I will mention the firing of FBI director James Comey by simply writing the words you just read. After that, the entire issue is noise.
Deutsche Bank reports;
“In 1996, the average Federal Open Market Committee participant gave 4 speeches per year. This year, the average FOMC participant is on track to give 14 speeches, In fact, the entire committee is on track to talk more this year than ever before.”
St. Louis Fed President Bullard indicated that the Fed should begin trimming its balance sheet in the second half of this year.
Federal Reserve Bank of New York President William Dudley added his two cents.
“The Federal Reserve is on track to begin unwinding its balance sheet this year or next, although U.S. central bankers are not in a rush to tighten and will take care to ensure their actions don’t trigger disruptions that harm the global economy.”
With the Nasdaq reaching the 6,000 level recently the talk is another bubble could be in the making. It is always wise to look back and compare the present sentiment and backdrop to what prevailed at Nasdaq 5,000 back in the year 2000 before jumping to conclusions.
The PE ratio for the Nasdaq in March 2000 on current year estimates was 107, versus 22 today.
Price to book ratio at the peak in March 2000 was over 7, compared with 3.9 now.
Cash Flow multiples were near 100 then, compared to the mid 20’s now.
Investment Company Institute data shows net purchases of equity mutual funds by individuals exceeded $25 billion per month at the peak in early 2000, compared with outflows for each month over the past year except for February 2017. Roughly $14 billion flowed out of equity mutual funds during March 2017.
The American Association of Individual Investors survey showed the percentage of bulls reached a record high of 75% during January 2000 (a record that still stands), and averaged over 60% for an eight-week period over December and January. Today’s bullishness readings have been much more tempered with is much more tempered, The level of bullish investors has been under 50% for 123 weeks.
Finally, I have pointed out the gradual, measured stair step climb to new Nasdaq highs that has occurred in the last year or so. That is in stark contrast to the parabolic move the index achieved in the first quarter of 2000.
In summary, the Nasdaq is on solid ground with virtually no euphoria present. In my view the Nasdaq is fairly valued to slightly undervalued given the backdrop in place. The message here has been stated over and over. Stay with growth in a pro growth environment. Nothing has changed.
Confirming the statement on investor sentiment, the AAII weekly survey, showed bullish sentiment dropped from 38% down to 32.7%. The largest weekly decline since March 9th. This week’s reading also extends the streak of sub 50% bullish readings to a record 123 straight weeks.
Up and down trading based on the weekly inventory reports continues. This week latest crude oil inventory report from the Department of Energy showed larger than expected declines in both crude oil and gasoline stockpiles. In the case of crude oil, stockpiles declined by 5.2 million barrels versus expectations for a decline of just 2 million barrels. This week’s decline was also the largest weekly decline of the year. In terms of gasoline stockpiles, this week’s report showed a modest drawdown of 150K barrels compared to expectations for an increase of 300K
That sparked a mid week rally lifting the price of WTI 3+% on the day, a welcome sight for anyone bullish on the energy sector.
The price of WTI closed the week at $47.84, up $1.40 for the week.
The Technical Picture
It sure looked like a solid breakout to the upside I thought was imminent with these comments last week had arrived as trading began last Monday.
“Probabilities suggest the S&P uptrend should be confirmed with a new high soon. However, as we have seen before the market doesn’t always act the way we believe it should.”
The S&P did give us a new high but struggled to do that. When there was no follow through, the index pulled back and settled in a narrow range.
Chart courtesy of Chris Ciovacco
What bulls are waiting for now is that definitive breakout higher to confirm what is shown above. In the meantime the narrow trading range has many investors confused. The average daily range for the S&P 500 so far this year is only 0.56%. The previous record was in 1993 at 0.71%. Maybe it is time to visit and respect the old saying, “never short a dull market”, as once again i remind everyone that 1993 was up 10+%.
Chart courtesy of FreeStockCharts.com
This weeks price action shows that narrow trading range continuing, more importantly the 2380 level held on a couple of retests this past week. An interesting development on the daily chart of the S &P shows that there is a gap between 2361 and 2369. It has me wondering if we will see that gap filled, then move higher. A much different scenario would take place if that gap is filled and the index keeps falling. However, one step at a time. There are plenty of strong support levels that give me the confidence to say the risk/reward remains tilted to the upside.
All of this is short term oriented commentary that any passive long term investor need not pay attention to. Just sit back and watch. The more active investor trading around his or her long positions can use some of this info to pick their spots. With the support and resistance levels so compressed now it minimizes the risk of getting involved in a stock too early unless one stumbles upon a negative surprise. If I like a situation here I am acting on it, and not concerned if the market does indeed trade down to the lower support levels.
The dreaded Hindenburg Omen was triggered last week. An indicator the bears are in love with, has been correct less than 30% of the time.
How many times have we heard this in the last few years? Financial engineering, manipulating earnings and corporate buybacks, as reasons for why stocks are higher. Basically telling us that all of this is a mirage. It is all contained and detailed for us in Chapter 3 Page 121 of the Bears handbook.
Bank of America Merrill Lynch just reported that Stock buybacks are tracking their lowest of any comparable period since 2013, down 30% year over year. How can this be with the S&P near all time highs? So what is pushing stock prices higher? Might it be fundamentals and earnings? That info is contained in Chapter 1 Page 2 of the Bulls handbook.
Oh and these new highs for the index mean lofty valuations don’t they? The argument that we need to head for the hills is being tossed around once again. In my view this is repeating the same mistake that has been made numerous times during the upside run.
There’s any number of indicators to suggest that the market is trading at a lofty valuation. But the one I am about to discuss has Warren Buffett’s name attached to it, so it is assumed by many that it must be a genuine threat to the bullish view. The Buffett Valuation Gauge was rolled out in an article for Fortune Magazine back in 2001. Mr. Buffett one of the world’s greatest investors compared the market cap of the U.S. equity market to Gross National Product.
Today, the ratio is often shown as market cap as a percentage of GDP, but the trend is the same. When market cap exceeds GDP by a wide margin, it indicates that equities are overvalued. Conversely, when the ratio drops below one it indicates that equities are cheap.
So, what is the indicator telling us now? U.S. equities currently have a market cap that is over 25% greater than U.S. GDP which is extremely high by historical standards. At the peak in 2000, this ratio topped out at 151.3%, while in 2007, the ratio peaked at a much lower level of 110.6. At a current level of 125.2%, the current ratio is more than 80% higher than the historical average of 68%.
Based on the Buffett Valuation Gauge, U.S. equities would appear to be wildly overvalued, but like any indicator, there are caveats here. These include interest rates, trends in public vs private company distribution, type of companies that make up the largest market cap (capital intensive vs services), and that is that the US equity market is a lot more geographically diverse today than it has been in the past, even relative to 2000. Of course the fear mongers like to avoid the caveats and run with the headline.
In the case of geographical diversification, take a look at the chart below which shows average international revenue exposure by sector for Russell 1000 companies. The average company in the Russell 1000 generates 26.6% of its revenue outside of the United States, and three sectors derive more than a third of their revenues abroad. Within the S&P 500, the averages are even greater as companies with larger market caps tend to have greater geographical exposure.
The issue that becomes evident, we are comparing equity valuations based on incomes that do not take into account the impact of international revenue. Plenty of well educated economists can and usually do offer push back to the oversimplification just presented.
One thing that is for sure, though, that in the pre 1990s period, before the internet and technological improvements when the ratio was significantly lower, U.S. companies were a lot more U.S. centric than they are now. Hence the new normal we have come to know as the global economy.
The bottom line if one wants to use the Buffet indicator to make their case that stocks are overvalued, be my guest. But if one did do just that, they would have sat out the market since analysts started rolling out the warnings in 2014. That was about 400-500 S&P points ago. I’ll stick with my simple common sense approach to the markets and leave the searching for why the market can’t go higher to others.
Individual Stocks and Sectors
One of, if not the best, authors here on SA is Jeff Miller. He gave his usual succinct view on the equity markets last week. That update contained a piece on a stock that I own and one that could be ready to move much higher. Nvidia (NASDAQ:NVDA) has morphed into a powerhouse growth situation. Have a look at Mr. Miller’s Dash Of Insight blog where he gives us a detailed analysis of the company. The latest earnings report was solid and the shares were up 18% to a fresh new high following that report.
About a month ago I prematurely commented that Alibaba (NYSE:BABA) had made a new all time high. Well the stock has now done just that this past week, eclipsing the old high, settling at $120. I continue to like this growth story, as the company matures and adds to its footprint in one of the most robust consumer markets on the planet.
Applied Optoelectronics (NASDAQ:AAOI) vaulted to a new high this week as well. A delayed reaction to the explosive earnings growth that was recently reported. The company was brought to the attention of readers here back on March 18th at $47.
Price targets have been raised by analysts ranging from $70 – $100. With an estimate of $5.50 – $5.80 in earnings for 2018, the shares trading hands at $65 are selling at 12x earnings. A stock that should be researched and put on a watch list as a candidate for purchase. The run isn’t over and if earnings continue to explode at this pace, the run may be just beginning.
I took profits on a portion of my Apple (NASDAQ:AAPL) holdings on Friday. Specifically the shares that were added last June in the $92 range last May. My actions should not be taken as a change in my attitude towards the company. It is a simple matter of rebalancing what became a large portion of my overall holdings due to the rapid 33% price increase in the past 5 months. In addition, the recent move to $155+ had a hint of a parabolic move that in my view will revert soon.
The idea that we would see new highs for the S&P that I spoke to last week, did come to pass. The index finally joined the Nasdaq which made yet another new high itself. However, there was little celebration over the move in the S&P as the gains were muted with no follow through. The bulls can take solace in a calm stair step move higher rather than a parabolic blowoff to the upside. They will feel a lot better if the index can now post more gains in the next week or so.
The narrative naysayers are peddling suggests the world is loaded with uncertainty. They add in what they conveniently call the Trump Factor and they literally shake when they speak. The VIX is then cited demonstrating the complacency that is around.
Headlines highlighted that the VIX, a measure of market volatility, closed at its lowest level since late 1993 this past week. The commentary then shifts to investor complacency, pointing out that anyone positive on equities are sheeple being led to slaughter. One only has to go back to that same low VIX reading back in 1993 to note that the S&P was up 10% that year. Using one data point (VIX) to make a case can be a threat to your financial health.
Newsflash, the world is always filled with uncertainty, and the stock market trades on growth in corporate profitability, not who is in the White House.
The quandary some investors find themselves in when they listen to that commentary revolves around new highs in the market with what is described as a weak economic backdrop. The answer to that is simple and is always the same when that scenario is presented. The stock market is forward looking. First quarter GDP of 0.7% is in the rear view mirror. The S&P has traded to the present level based on the continued economic upturn in the Eurozone, other positive global data, and the resurgence of U.S. corporate earnings.
The goal of every investor should be to get into the driver’s seat. Shifting from worrying about things you can’t control to something constructive. A strong earnings season and improving global growth are seen as tailwinds for equities, while valuations and a lack of near term, high profile catalysts are impediments. If earnings continue on their ramp higher that solves the catalyst issue.
That said, a scenario where the S&P cannot vault higher in the next few days, succumbs to any one of the noisy headlines and falls back to the March lows is certainly plausible. That is 3% from present levels. The risk/reward remains tilted to the upside, and until that changes, investors can concentrate on adding quality companies to their portfolio. Solid growth stories tend to shun the market noise.
Best of Luck to All !
Disclosure: I am/we are long AAOI,NVDA,BABA,AAPL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The opinions rendered here, are just that – opinions – and along with positions can change at any time. As always I encourage readers to use common sense when it comes to managing any ideas that I decide to share with the community. Nowhere is it implied that any stock should be bought and put away until you die. Periodic reviews are mandatory to adjust to changes in the macro backdrop that will take place over time.