“What we try to do is take advantage of errors others make, usually because they are too short-term oriented, or they react to dramatic events, or they overestimate the impact of events, and so on.” – Bill Miller
I can’t tell you how many times analysts, research firms, market pundits and authors here on SA have called for investors to be wary that THE market top has been put in. It’s been years now that this phenomenon has been going on, and to date all have been wrong.
There is a variety of reasons for this. Some just want to get the notoriety of being the person making that call. Of course, they are assuming the call will be correct. It could be that it is someone taking advantage of the fear present at the moment, and to them it seems like the right thing to do. August 2015 and January/February 2016 saw an abundance of pundits come out of the woodwork to tell us all how we saw the market top and we should be prepared to look into the abyss.
For the most part though, they come upon the first sign of market weakness and their minds immediately go to the idea that they have the odds in their favor. In reality they fail to see or mention what really does happy at market tops. So they are wrong once again.
Major market tops are accompanied by explosive, often parabolic moves. Regular readers also have come to know that I believe euphoria has to present itself before we can even contemplate a market top. Not only does that mean the majority is viewing the market positively, but they are backing up their thoughts by heavy inflows into the market. That triggers the explosive parabolic upward move.
Bank of America Merrill Lynch assembled the following graphic showing the performance of stocks heading into historic bull market peaks, 24, 12 and then 6 months prior.
Of course there are plenty of other signals that tell us the underpinnings of the equity market while looking fine on the outside are slowly deteriorating. This often occurs at market tops. Far too many to include in just one article, but trust me they will be mentioned here when the time comes.
First let’s take a look at what IS happening now and review why so many continue to still have the story wrong. By looking at all of the data we can make a reasonable evaluation to see if the recent high may be THE top that so many are concerned about.
Recent updates here have presented this graphic illustrating what I refer to as a stair-step pattern. It reads like something out of a textbook but I assure you it is real.
The chart has been recently updated, and what you are looking at is one of the most strongest patterns that a stock or index can present. The short term excesses are worked off in the form of sector rotation, consolidation, etc. This is where we find the S&P today. Of course, each of us can look at a chart at specific points in time and possibly interpret the scene differently. One of the most important traits to have when looking at any chart or data point is PATIENCE. Investors simply can’t jump to conclusions and be successful. The two do not mix.
The skeptics keep stumbling over the same issue. EVERY charge higher is met with the idea that this is it. Maybe they believe a bull market has a time clock that has to be punched. I don’t know. As soon as there is strength in the equity market, the wary mind goes right to the wall of worry issues. Every data point that has already been debunked now for YEARS is brought back. The FED, margin debt, corporate buybacks propping the market, and so many more I can fill another paragraph.
Add present day worries, the blinders go on, and when that is all put together, conclusions are formed without looking around at all of the facts. Basic facts like the long term trend in place and what is happening beneath the surface of the market. A regular reader here and an excellent technician LTTFTrader recently posted this gem in a recent article here on April 22nd.
“Daily NYSE cumulative breadth made another new high today. The market has made a nice move up from the very oversold Arms (TRIN) values on 4/13, both daily (2.53) and 10-day average (1.43).”
Ladies and gentlemen that data point on breadth tells us that the underpinnings of this market are strong and aren’t weakening. These two simple examples, the long term chart and the breadth indicator have a lot of company. For every point that is being used for a reason to raise cash, hedge and outright sell short, I have enough ammunition to keep reminding everyone to LOOK at the entire picture being presented. My argument starts and ends with the long term trend in place. That trumps all of the conjured up reasons why the market is depicted as scary, vulnerable and ready to crash.
The Bureau of Economic Analysis reported its advance estimate of first quarter economic growth on Friday.
In recent years, the National Income and Product Accounts have exhibited what’s called “residual seasonality” in Q1 growth. That is, first quarter growth has tended to be below that of the rest of the year. Over the past 10 years, the average for all first quarters has been exactly zero real growth, while the average for the other three quarters has been 1.8%. Therefore, I am not running to sell stocks based on what was just reported.
U.S. Markit Flash PMI came in at a seven month low and as you will see later it is the outlier when it comes to the recent PMI releases. The U.S. is now at the lowest level among major economy PMIs (tied with Japan), indicating just how much of the recent resurgence in global activity is coming from outside the U.S. economy.
Consumer confidence fell sequentially but is currently at a pretty respectable level of 120.3.
Last week we saw both the headline Philly and Empire PMIs fall markedly in April. A reminder that they both remain in expansion territory. After looking at the report, it was noted that capital expenditures expectations reached their highest level since February 2000 in the Philly survey, and capex plans hit a 2 year high in the Empire survey.
Richmond Fed Manufacturing was a positive data point, coming in at 20 versus the expectation of 16. That was down from the March reading at 22, but it is the first time since 1994 that the index had back to back months at or above 20.
Chicago PMI for April posted its third consecutive rise moving up from the 57.7 read in March to the current print of 58.3. New Orders segment came in at a three year high.
Recent data suggests that Housing Starts, Building Permits have yet to show any signs of a downturn. Both series hit a new high for the expansion in March. Permits showed signs of rolling over in early 2016, but have since recovered and are actually at the exact same average level as Housing Starts (1.201 million) over the last 12 months.
The fact that both Housing Starts and Building Permits are at their highest levels of the expansion is not only a positive sign for the broader U.S. economy but also the long term picture for homebuilder stocks.
New home sales for March were solid, gaining 5.8% for the month, the second highest reading for the expansion. Bespoke Investment Group provides a graphic indicating the relationship between new home sales and recessions.
Pending Home Sales slipped 0.8% in March.
“Lawrence Yun, NAR chief economist, says sparse inventory levels caused a pullback in pending sales in March, but activity was still strong enough to be the third best in the past year. Home shoppers are coming out in droves this spring and competing with each other for the meager amount of listings in the affordable price range. In most areas, the lower the price of a home for sale, the more competition there is for it. That’s the reason why first-time buyers have yet to make up a larger share of the market this year, despite there being more sales overall.”
This past week the IMF raised its growth forecast for 2017 to 3.5%.
Eurozone Consumer Confidence Indicator for April declined less than expected at -3.6.
The global growth story stays on track in the Eurozone as the Markit Flash Manufacturing PMI came in 56.7, the highest level in six years.
The positive results continued as German Business Confidence rose to the highest level in six years. French INSEE indices of business confidence for April remained strong while reaching a new high at 108.
Japan’s Flash PMI rose in April with the index coming in at 52.8. The report noted that Output, New Export Orders, Employment, and Backlogs all accelerated. Additionally, the Japanese Reuters Tankan index for April showed manufacturer’s confidence at its highest level since the financial crisis.
Japan’s all industry activity index beat expectations with a 0.7% month over month rise in February.
U.K. Retail Sales for March declined sharply, continuing an ongoing trend. Uncertainty of possible negative economic impacts surrounding Brexit are weighing on consumers there.
A senior Deutsche Bank executive has warned that nearly half the German lender’s 9,000 staff in the UK could be forced to leave the country under pressure from regulators because of Brexit.
As I looked at the earnings results being reported last October it was evident that the so called earnings recession was finally over. After taking a peek at what that picture would look like when we got into the January reporting period this year, I concluded that the next leg of this bull market might well be earnings driven.
“There have been many periods in stock market history during which earnings growth improves, interest rates increase, PE multiples contract, and a bull market continues. They are called earnings driven bull markets.”
January results didn’t disappoint and the early results for the April reporting season appear to be continuing that upward trend. The earnings headlines that I compile for each season can be found here. The quick takeaway, plenty of earnings beats, and more raised guidance comments then reported in past seasons.
LPL Research reports;
“Solid start to earnings season; S&P 500 for Q1 2017 tracking to +11.2% year over year vs. +10.2% on 04/01/17. Financials are biggest driver of the upside, tracking to +20%, 4% above estimates from April 1,2017.
Factset Research reports that as of April 28th;
“With 58% of the companies in the S&P 500 reporting actual results for Q1 2017, 77% of S&P 500 companies have beat the mean EPS estimate and 68% of S&P 500 companies have beat the mean sales estimate.”
“For Q1 2017, the blended earnings growth rate for the S&P 500 is 12.5%. If 12.5% is the actual growth rate for the quarter, it will mark the highest year over year earnings growth for the index since Q3 2011 (16.7%).”
“The forward 12-month P/E ratio for the S&P 500 is 17.6. This P/E ratio is above the 5-year average (15.1) and the 10-year average (14.0).”
How many times have we heard that it’s a handful of stocks moving the indexes, and it can only be construed as a negative. The comments that the FANG stocks are the only Nasdaq issues making new highs and that can’t continue, always pop up at market highs. How about the rhetoric that Apple (NASDAQ:AAPL) represents the lion’s share of the NASDAQ gains. Another way of deflecting investor attention by suggesting that this is a new phenomenon and highlight it as a negative. Ben Carlson puts the issue in context for us:
“In 2015 84% of the profits of all publicly traded U.S. companies came from the top 100 firms. That number was 53% in 1995 and 49% in 1975, which means that the most profitable companies keep taking a bigger and bigger chunk of the earnings pie.”
That is confirmed by the data that reveals the market cap of the 4 largest companies in the S&P 500 (AAPL, GOOGL, MSFT, AMZN) is greater than the market cap of the Russell 2000.
This narrow concentration is also true of returns in the stock market, as we have repeatedly noted the disproportionate effect the largest companies have had on the major indices the last couple of years.
LongBoard Funds completed a study which shows that;
“Just 20% of stocks accounted for ALL of the market’s gains from 1989-2015 while the other 80% contributed nothing.
“From 1989-2015 the S&P 500 was up almost 1200% in total. The majority of that gain came from a small number of stocks.”
My conclusion, it’s hardly the negative it is made out to be.
The Political Scene
By the time you read this you will have the answer to the question of whether the potential government shutdown has become reality. A stop gap measure was scheduled to be voted on before the Friday deadline.
The highly anticipated tax plan was unveiled this week. As expected the pundits and critics were out in full force telling anyone that wanted to listen what is wrong with the proposal and why this or that can’t work, etc. It’s sheer noise from the skeptics, naysayers and anyone that just can’t agree with what this administration has to offer. Therein lies the biggest problem. Unmitigated political bias that is selfish continues to run with self-serving agendas, and has no concern for the well being of the American public.
From my research NO recession has followed a round of tax cuts, so taking that path leads to growth. And the difference in Federal revenue between 1.9% growth and 3% growth pays for all of this and then some. It amounts to trillions of dollars. That data comes from the many independent agencies and the congressional budget office itself. Of course there are studies that refute that, most of those studies do NOT take into account the increased receipts for the growth that develops.
Instead of opposing this change, what lawmakers, lobbyists, political pundits, etc. should be opposing is the path that the economy is on. I am perplexed why the naysayers don’t have an issue with that problem. Haven’t we seen that large deficits with little to no growth will not solve the deficit issue? A growing economy goes a long way is solving the massive deficit that the same naysayers are complaining about.
We are at a point in time whether we want to stay in a 2% growth pattern or do something to change that. I for one have no more tolerance for those that now say this or that can’t work while offering no solutions for the status quo growth.
Global fund managers drop U.S. equity exposure to a 9-year low. Cash balances remain high.
Source: Bank of America Merrill Lynch
The evidence suggests caution or outright skepticism that the S&P can go higher from these levels. In other words there is no all in, or I have to be in the equity market euphoria present.
According to the weekly survey from the American Association of Individual Investors after the previous measure of 25% the previous week, more than 38% now put themselves in the bullish camp. It has now been 121 straight weeks since bulls were in the majority.
Crude Oil and the US Dollar
Liz Ann Sonders shared these interesting graphics on crude oil breakeven pricing by region here in the U.S.
The topsy turvy crude oil inventory situation now shows the largest drawdown in inventories this year took place last week.
The price of WTI closed the week at $49.15, down $0.48 for the week.
The calls for a superman dollar haven’t come to pass in the last 5 months or so. The daily chart below illustrates a possible inflection point may be near, the short trend downturn meets the longer term uptrend.
For the moment it appears the beak is to the downside, but it does sit at support from the 200 day moving average. The dollar’s weakness has clearly been showing up in the performance of S&P 500 stocks based on their international revenue exposure, as stocks with more international exposure are outperforming stocks with domestic exposure by a wide margin.
The Technical Picture
The Nasdaq, Russell 2000, and S&P 400 Midcap index all reclaimed their 50 day moving averages by April 22nd. This past week the S&P joined that group. The index that the skeptics homed in on to make their case, the Russell 2000, also put in a new high as the consolidation phase for that index has been resolved to the upside.
However, the story of the week and the year is the Nasdaq as it streaked to another new high this week and sits above the 6,000 mark. Participation in the index has been quite good. 59 of the 100 stocks in Nasdaq 100 are up 10%+ YTD. The first thing that comes to mind is the thought of another year 2000 episode when the Nasdaq reached the 5000 mark.
It’s quite a different picture this time around. The short term daily chart below shows a steady climb to new highs.
The short term daily chart below shows a steady climb to new highs,
unlike 2000 when the chart depicted a parabolic move with euphoria at a peak.
Furthermore, after the massive decline the index consolidated for the better part of 14 years before breaking out in 2016. This breakout is fresh and with speed bumps expected, it has a long runway of further gains ahead. It took the better part of 5 years before the Nasdaq peaked from the breakout in 1995 to the peak in 2000.
The forward PE for the Nasdaq is 20. Regular readers know that technology has been the clear leader when it comes to producing solid earnings results while other sectors were struggling. The tech sector has also been the clear leader when it comes to posting above average growth. That is a recipe for further gains. We may see a blowoff top similar to 2000 to mark the end, but that could be well down the road. In the meantime, technology stocks are a buy on any weakness.
Last week the short term technical picture revealed;
“A choppy pattern that left the S&P still below its 50 day moving average, and that tells me the consolidation period may not be over. The bulls will look for a retake of that moving average and a break in the short term downtrend line depicted in the chart.”
The S&P 500 did retake that 50 day moving average. Now we swing back to the top of the trading range and I have to go back to April 1 when it, as noted at that time;
“If this rally is to have legs it has to challenge, then overtake the 2385 pivot.”
That was accomplished early in the week. The short term downtrend line has been broken to the upside. Unless this is a false breakout, the S&P could be setting up for a challenge of the old highs. The breadth picture remains positive. Advance/Decline has moved back to new high territory as seen by this Bloomberg Cumulative Advance/Decline line for the NYSE.
After reviewing the trading action in the past two weeks, nothing has changed in what I have mentioned in the last month or so. The downside is limited. Specifically, my worst case scenario, a drop to the January breakout level in the 2280- 2290 area on the S&P, or some 4% from here.
Short term support is now at the 2385 pivot and SPX 2369 (last Monday’s low), with resistance at S&P 2401 and the 2411 pivots.
I often like to point out what investor mindset is in place at any given point in time. It renders a sense of what many analysts and pundits are advising these days. Now it would be one thing if I had to feverishly search the internet spending hours of research to find headlines to make my point.
Finding these highlights cost me about 20 minutes of my time. The dates on these articles are all within a 10 day period. Those two facts are telling. All convey a current theme urging caution, adding hedges, raising cash and being short the equity market. They also have other things in common that weigh on an investor’s mind. Thoughts of corrections, outright fear and possible market crashes are all results that are conjured up after reading them.
While I cannot agree with ANY of the reasoning being put forth in the views of the skeptics, market participants need to view commentary from both sides when investing. It is not my intention to disparage any individual or opinion rendered in these headlines. The message here is that these types of articles dominate the scene today, and I for one have never seen this type of commentary in both abundance and fervor at market tops. There continues to be a fair bit of skepticism still around. There is no euphoria present no matter how one wants to spin sentiment levels.
Individual Stocks and Sectors
Reviewing the statistics that were presented on crude oil breakeven levels leaves me with the idea that Marathon Oil (NYSE:MRO) is a solid choice here. Shares are trading in the $15 range, and that represents a decent risk/reward entry point. Concho Resources (NYSE:CXO) and Oasis Petroleum (NYSE:OAS) round out my top picks and holdings in the sector.
My broken record reporting on the Biotech sector continues, as the long downturn and the ensuing bear market appear to have ended. Biogen (NASDAQ:BIIB) started off the large cap biotech earnings parade with a solid earnings report. According to this report money is starting to flow into some of these names on upbeat news on the M&A front.
With the Nasdaq Biotech index (NASDAQ:IBB) sitting at 297 on Friday, a close above 304 will be a break above the highs that capped the advance back in March. That will surely get the attention of both momentum players and institutional trading desks. Companies I have mentioned here before, Alexion (NASDAQ:ALXN) and Celgene (NASDAQ:CELG), both beat estimates. Edwards Lifesciences (NYSE:EW), a stock given to us by Alexander Poulos a fellow author here on SA, appears to have turned around. The company reported a blowout quarter on all fronts and raised guidance.
The equity market has been quite choppy, with a downward bias, since the S&P topped at 2401 in early March. It appears to have changed this week. The French election came and went. Those wrongly positioned expecting the worst, helped fuel a rally this week. However, let’s not forget the solid earnings reports that also helped.
I started the week feeling very comfortable on Monday, when in a matter of hours, the analysts, pundits, et al, changed their tune. Realizing that the French election wasn’t going to be the Armageddon some thought, they switched their focus to the next set of worries.
The week ended with the conversation: “If we didn’t have the French election bounce the S&P would be down.” That convoluted logic set the tone for a good weekend for me, as many are still searching for that reason why stocks should weaken and sell off. It’s the same mistake that has been repeated over and over. Find a reason to sell instead of reasons to stay on board.
The Sell in May commentary will begin now. In the last 20 years the month of May has shown to be a flat month. Admittedly May through October can be a challenging time for investors, but given the technical patterns in place, I do not see this period doing a lot of damage to upset the long term trend. The earnings picture looks to be coming along as analysts have predicted, with solid growth being shown.
Perhaps it is time to go back and read the opening quote from Bill Miller. It’s a gem that has held true for quite some time. Short term oriented market participants have compounded the mistake by overestimating the impact of events. Most taking that approach have made plenty of mistakes along the way. It is best to avoid that mindset, instead take advantage of those miscues.
That simply leads us to the same conclusion that needs to be repeated over and over. Keep the long term trend in focus, and stay the course until that changes.
Best of Luck to All!
Disclosure: I am/we are long ALXN, AAPL, CELG OAS,MRO,EW.
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.