Archive for the ‘market conditons’ Category

July ChartBook – Trend Indicators, Relative Performance & Top Momentum ETFs And Stocks

Monday, July 30th, 2018

Some of the information in this post:

  • Intermediate trend indication for 45 key asset categories.
  • S&P 1500 Net Buying Pressure.
  • Compare relative performance (momentum) of sectors, regions, countries, mkt-cap, styles, factors.
  • Identify leading relative performance stocks and ETFs.

This week I’m sharing with you a chart book that I put together for myself periodically to attempt a wide-angle view of markets. You may find bits of it here and there interesting, or the basis of questions you would like to discuss. The chart book contains chart and table data only and is color-coded in most places to be data visualization friendly as you scroll through the pages.

You can download the chart book here.

Important Note: This ChartBook focuses on relative performance and chart patterns, and does not consider thematic issues, forward earnings or revenue forecasts, valuation or company fundamentals or credit rating. Those are important factors that should be evaluated before any of the securities identified in this ChartBook are purchased. Relative performance is not a substitution for strategic allocation, and may not be a suitable subject matter for many investors. It may be useful to those with tactical ranges within their strategic allocation, or those seeking to make security substitutions within their allocation based on relative performance, or those operating a short-term tactical sleeve within their portfolio. Do additional research on any security listed here before purchase. These are not recommendations. They are filtered observations of performance over the past 12, 6, 3 and 1 months. This is an investment decision aid, not an investment decision solution.

Based on relative price performance to the S&P 500, this ChartBook identifies small-cap and large-cap growth as leading performance categories among mkt-cap, style, factors, and dividend approaches, as represented by these ETFs:

IJR, RPG

Based on relative price performance to the S&P 500, this ChartBook identifies the outperforming US sectors, as represented by these ETFs:

XLY, XLK, VCR, VGT

Based on relative price performance to the US Aggregate Bond index, this ChartBook identifies no favorable ETF categories. Note that ultra-short-term, investment grade, floating rate debts, tend to have minimal price fluctuation, but competitive total returns in a rising rate environment. That means that securities such as these might be considered as outperformers:

BIL, FLRN and FLOT

Based on relative price performance to the S&P 500, this ChartBook identifies none of the top 10 developed markets countries and none of the top 10 emerging market countries, nor the world, total international, Europe, emerging markets or frontier markets as outperforming.

Based on relative price performance, a minimum cumulative total return and visual chart pattern inspection, this ChartBook identifies these 12 ETFs as outperforming:

FDN, FINX, IBUY, IGM, IGV, IHI, IJT, PSCH, SKYY, SLYG, VGT, XHE

Based on relative price performance, a higher minimum total return than for ETFs, and visual chart pattern inspection, this ChartBook identifies these 11 members of the S&P 100 as outperforming:

AAPL, AMZN, BA, COP, COST, GOOG, GOOGL, MA, MSFT, UNH, V

Based on relative price performance, a higher minimum total return than for members of the S&P 100, possession of both quality and value attributes (as defined by Vanguard in their VFMF multifactor ETF) and visual chart pattern inspection, this ChartBook identifies these 12 stocks as outperforming:

ADBE, ALGN, CECO,CPRT, CWST, INGN, MED, NSP, TTGT, VRNS, WCG, WWE

Based on relative price performance, a lower minimum total return than for S&P 100 stocks, and visual chart pattern inspection, this ChartBook identifies these 12 quality dividend stocks (as defined by Northern Trust in their QDF quality dividend ETF) as outperforming:

AAPL, BA, BR, CDW, FIS, MSFT, NTAP, SSNC, TSS, UNH, UNP, V

 

A panoramic data document like this ChartBook is intended to not only give a wide perspective on the markets, but also to help unusual or abnormal data to stand out. Scroll through the pages to see what may be of interest to you.

To give you a starting point of reference on many of the pages here are some comments by page number. The comments are not complete, They may help you get into the data on each page .

  • Page 2 – Yield Curve: the yield spread between short-term rates and intermediate-term rates is compressing rapidly but still positive; and in the past when shorter-term rates become larger than longer-term rates it has signaled a coming recession and the decline in stock prices. We aren’t there yet, but this is a risk factor to be closely watched.
  • Page 3 – Forward Earnings Estimates: the 20% earnings growth rate expected for 2018 contrasts with the 10% earnings growth rate projected for 2019. The growth rate for 2018 is exceptional, and is partly due to a quantum, one-time increase in corporate profits due to recent tax legislation. Slower growth in 2019 may cause some compression of price-earnings multiples
  • Page 4 – PEG ratios (price earnings ratio divided by five year forecasted earnings growth rate) appear to be most attractive for Consumer Cyclicals among large-cap, mid-cap and small-cap US stocks; and you will see on page 19 that they show favorable momentum as well; but on page 5 they look a bit expensive versus historical valuations.
  • Page 5 – telecommunications services looks inexpensive, but in September that sector will be redefined as Communication Services and will include some stocks from Consumer Discretionary and from Information Technology, so those numbers really aren’t useful now. If we’re lucky analysts will restate history based upon the reconfigured sectors sometime later this year.
  • Page 6 -US stocks are in good trend condition as are international stocks overall, but Europe is wavering and emerging markets are down (as are real estate and gold). Even though the China ETF MCHI is still in an intermediate uptrend, you will see later on page 14 that the overall China market is doing poorly, and the larger-cap stocks represented by the ETF have broken down on a daily chart basis.
  • Page 7 -shows fundamental data for key equity categories revealing more attractive price to cash flow multiples for foreign stocks versus domestic stocks as well as higher yields: and it shows better Sharpe Ratios (basically return divided by volatility) for minimum volatility and momentum factor funds, and attractive ROE levels for quality minimum volatility and momentum factor funds.
  • Page 8 – taxable bonds are all in downtrends and some municipal bonds are not trending upward or are wavering.
  • Page 9 – Some bond categories show extraordinary interest rate risk as evidenced by the duration being substantially larger than the yield. As a rule of thumb, if the interest rate on the fund rises by 1% over a short period of time, the price will decline by the duration times the change in interest rate. Long-term government bonds are less than 3% and have more than 17 years of duration – dangerous. Long-term corporate’s pay less than 5% and have almost 14 years of duration – also dangerous in this time of rising Federal Reserve rates, rising GDP, and rising inflation.
  • Page 10 – S&P 1500 Buying and Selling pressure: net buying pressure began to decrease in the beginning of 2017 and has become flat to negative this year. It is a divergence from the rise in stock prices during that time. This is a cautionary sign. The indicator measures the total amount of money flowing through rising stocks divided by the total amount of money flowing through all stocks.
  • Page 11 – the percentage of stocks in Correction, Bear or Severe Bear have been in rough synchrony with price movements of the Standard & Poor’s 1500 stocks since 2017, and no particular signal is generated there.
  • Page 12 – the percentage of stocks within 2% of their high is in a normal range and is acting in synchrony with stock prices. There is no signal there.
  • Page 13 – the percentage of stocks above their 200-day moving average is at a healthy level, continuing to support rising stock prices.
  • Page 14 – breath is best in the USA, second-best at okay levels in Europe. Japan is in a week third place. Larger China market is doing badly with the median stock off more than 30% from its high, and 90% in a Correction and 75% in a Bear or worse. The chart below the table, however, shows the effect of what is called “sequence risk”. Someone who invested in China a year ago is doing okay, but someone who invested at the beginning of this year is doing very badly. The intermediate trend for China shown on page 6 is still positive, but a detailed review of the chart shows that it is near a turning point, and this daily chart on page 14 reveals that breakdown more clearly.
  •  Page 15 – looking at stocks in terms of regions, market-cap, style, factors, dividends and real assets; only small-cap and large-cap growth show good price momentum, as indicated by the light green shading on the symbol and name
  • Page 17 – looking at bonds only T-Bills and ultra-short-term investment grade floating rate bonds show price behavior that is positive. Note these are price returns , not total returns. The total return on US investment grade ultra-short-term floating rate bonds is higher than for T-bills. We have effectively shifted virtually all of our bond allocation to ultra-short-term investment grade floating rate bonds some time ago, and expect to remain there through the Fed rate hike cycle. You can see the steady positive return of ultra-short-term investment grade floating rate bonds relative to the aggregate bond index in the middle chart in the top line of page 18.
  • Page 19 – among US sectors Technology has the strongest price momentum, even though the last week was tough for some. Consumer Discretionary sectors also have good momentum.
  • Page 21 – none of the top 10 Developed market countries or top 10 Emerging market countries have favorable price momentum.
  • Page 23 – there are some ETF’s with favorable price momentum. They are primarily found in the Technology and Healthcare sectors.
  • Page 25 – less than 15% of the Standard & Poor’s 100 stocks have good price momentum, and they come from various sectors
  • Page 27 – within the Russell 3000 (essentially the entire US market of stocks of consequence) there are 100 or so stocks with good momentum that also have good Quality and Value characteristics. This page shows those with the largest 12 month price gains, and the following page 28 shows those that gained at least 200% over three years and have the best shape curves among those with favorable momentum.
  • Page 29 – looking at the 150+ stocks selected by Northern trust as “quality” dividend stocks, a limited number have favorable price momentum, and page 30 shows those 12 with the best shaped three-year curves among them.

 

Extremes and Divergences for the S&P 500

Monday, April 2nd, 2018
  • Two conditions often precede market trend reversals: extremes and divergences.
  • S&P 500 may have difficulty achieving a 10-year annualized nominal 5% return.
  • Buying Pressure is now less than 1/2 of combined Buying Pressure and Selling Pressure, after many months of decline.
  • Allocate Own and Loan at low end of personal investment policy
  • Hold dry powder

Two conditions that often precede market trend reversals are extremes and divergences.

Extreme conditions tend to revert toward median levels, and divergence between functionally linked dimensions is unnatural, and tends to cause them to adjust until they are generally aligned again.

There are significant current extremes and divergences in US stocks that provide reason for caution and expectation of continuation of the current Correction.

Extremes and divergences are the setups, but they need something to cause investors to change their outlook and trigger the trend reversal — often a surprise or shock from outside of the stock market, but we don’t know what, when, where or how great they will be — otherwise they would not be surprises or shocks.

We can, however, measure how far the rubber band is stretched – how extreme a condition is, or how large a divergence is between related dimensions. The more the rubber band is stretched, the more likely is it to break, or how hard it will snap back to its normal shape when the force stretching it lets go.

The most widely referenced valuation metric is the trailing P/E ratio. It is high now at nearly 25. Here is a chart of the annualized returns for the 10 years following various P/E ratios:

(click images to enlarge)

Based on history of quarterly rolling years from 1881, there is little prospect of a nominal annualized turn as high as 5%, and a reasonable chance of an annualized return less than 0%
The Shiller CAPE Ratio is also popular. It is the price divided by the inflation adjusted 10-year average earnings of the S&P 500 (meant to capture a business cycle, not just a single year somewhere within a cycle).
The picture is worse for price appreciation prospects. A 5% nominal return is not likely and the potential for a negative return is higher than when considering the traditional 12-month trailing P/E.

Looking beyond just P/E multiples, here are some of the stretched and extreme measures for the S&P 500:

If the earnings of the S&P 500 grow over the next 10 years at the long-term historical rate of 6.6% per year, and if the valuation reverts to the median levels (a plausible scenario, not a specific forecast) earnings would increase about 89%, but valuation multiples would decrease, causing the price to rise less than 89%. If one of the average percent change to median measures in the table above prevailed, this would result:

  • 14.79% change to median: net price rise by 61%, 4.90% annualized return
  • 27.73% change to median: net price rise by 37%, 3.19% annualized return
  • 40.67% change to median: net price rise by 12%, 1.18% annualized return.

There are some important breadth divergences now that deserve attention (as of 03/30/2018).

Net Buying Pressure is less than 50% (= Net Selling), as this chart illustrates. This is not a value indicator like those we just discussed. It is trend indicator. The Buying Pressure has been deteriorating for many months, while the price of the index was rising – a key divergence. The index is in Correction which is in alignment with the Pressure. We need to see Buying Pressure turning up before the index can be expected to exit Correction.

S&P 1500 Constituents in Correction, Bear or Severe Bear have been above the 4+ year median but were improving until the current Correction. The percentage of constituents in Correction is in harmony with the index Correction, and the Bear and Severe Bear levels are beginning to harmonize. We will want to see these indicators turn back down for any recovery in the index price to be believable.

Popular Trend Indicators:

The press has made the position of the price versus the 200-day average a popular indicator of Bullish or Bearish conditions; and to a more limited extent popularized the direction of the leading edge of the 200-day average. Here is where they stand as of the end of market today (04-02-2018).

These are not divergences, but confirmation of the underlying deteriorated underlying index conditions:

With 40% to 45% of stocks showing a downward sloping tip to their 200-day trendline, and more than half with prices below the trendline; and 45% to 50% with the price below the 200-day trendline for at least 3 days, the Correction is still firmly entrenched.

Other Oddities:
Typically, in Bull markets, analysts reduce their earnings forecasts as the quarter proceeds. During the last 20 quarters they reduced their estimates on average by 3.9%, and by 5.5% during the last 40 quarters, and by 4.1% over the last 60 quarters. However, in Q1 of this year, they increased their forecasts by 5.4%; the largest increase in any quarter since FactSet began tracking the changes in 2002. The previous largest increase was 4.8% in 2004, an early Bull market recovery period.

At the same time, they raised estimates, the stock market has been in correction – an interesting divergence.

How Are We Positioned?
Our client managed and advised portfolios have widely varying allocations, because they are customized, and the clients have widely varying ages, wealth, withdrawal needs, other income, and other assets; including private funds, venture capital and direct real estate ownership and development.

Of the marketable assets we hold or advise for them, the OWN allocation ranges from 100% to about 50%. LOAN allocations range from 0% to about 35%, with various combination in between.

Current general advice for those who have completed all or most of their accumulations is to have an OWN allocation at or near the bottom of their policy range, to have LOAN allocation at the bottom of their policy range, and to focus on quality credit and variable rates; and to hold the balance in RESERVE until the current Correction shows credible evidence of recovery.

This is a 3-year weekly chart of the price performance of the S&P 500 (blue) and 10-year US Treasury (gold):

1-Yr Daily Volatility of Key Asset Categories Over 10+ Years (Watch Out)

Tuesday, December 12th, 2017

The level of calmness in the markets, as evidenced by daily volatility, is unusual and disconcerting.  Rising interest rates and probably peaked out corporate leverage and profit margins are likely to increase volatility; and unintended consequences of US tax law changes may add surprises on top.

There is not much room for less volatility.  Don’t get too comfortable.  2018 is likely to be a bumpier ride than 2017.

These charts of 1-year daily percentage volatility beginning in 2005  or 2006 show the very low, in some cases 10-year low volatility for key asset categories.  The exception is very short-term Treasuries which are increasing in volatility from a depressed level, as the Fed begins to raise the overnight rate.

(click images to enlarge)

S&P 500 Stocks (SPY)

Non-US Development Markets Stocks (EFA)

Emerging Market Stocks (EEM)

Gold (GLD)

Long-Term Treasuries (TLT)

Short-Term Treasuries (SHV)

QVM Market Notes: Bull and Bear Markets and U.S. Large-Cap Stocks Valuations

Friday, June 16th, 2017

QVM Clients (May 6, 2017):

The current Bull market is the second longest with the second largest cumulative gain since 1900. In another 16 months, if it continues as according to the “Street” consensus, it will be the longest running Bull since 1900.

(click images to enlarge)

20170506_1

Augmented valuations based on expectations of Trump getting his key economic agenda implemented soon (including tax reform, overseas capital repatriation, and massive infrastructure investments) is substantially diminished at this time due to all the conflict and dysfunction at the Federal level. Accordingly, most or all of any “Trump Bump” in U.S. stock valuations may be unwarranted.

There are also many risks facing stocks. I have my list. You have your list. They are both good. Both lists are significant, ranging from Central Bank actions, to globally shifting national political profiles, to spreading terrorism, to highly indebted governments, to disappointing strength of GDP growth, etc.

Valuation is an issue, but not likely to be a cause of the next Bear market. Markets can remain overvalued or undervalued for extended periods. A market peak is created not by overvaluation, but by an event or circumstance that causes investors to lose confidence or become fearful.

Of valuation and inevitable Federal Reserve actions, famed investor Bill Gross, formerly CIO at PIMCO, said last week “Instead of buying low and selling high, investors are buying high and crossing their fingers”.

Independent of the Trump goals, there is growth in the U.S. and the world, which is keeping stocks moving forward, but in the U.S. stocks may be a bit ahead of themselves.

In the face of most U.S. stock valuation multiples being well above median levels, one key measure is much better than median and helps keep money flowing into stocks — that is the spread between the yield on Treasuries and the earnings yield (earnings divided by price) of stocks. One other key measure is in the attractive zone:

  • Earnings yield spread to 10-Yr Treasuries yield is well above the 50-year median, and the internet era median, and only a bit below the 145 year median — ATTRACTIVE
  • Dividend yield is approximately at the median level during the internet era — ATTRACTIVE
  • BUT, other price multiple measures are in the expensive range.

Earnings Yield Spread

Due to depressed interest rates, stocks continue to generate an earnings yield greater than Treasuries — and in a world where investors chose between alternatives, they are choosing stocks while the yield spread is positive in favor of stocks.

Very few living and currently active investors have more than 50 year of investment experience, which means for almost every investor, the current earnings yield spread makes stocks more attractive than bonds from a return perspective (although not from a maximum drawdown risk perspective).

Before the 1960’s (and before the academic field called “Modern Portfolio Theory”) investors required a lot more yield advantage from stocks than bonds. Will those days every return? Probably not, but it is not impossible.

20170506_2

S&P 500 Large-Cap Valuation Multiples in the Internet Era

  • Price to Earnings
  • Price to Cash Flow
  • Price to Sales
  • Price to Book Value
  • Dividend Yield

All multiples are above median, except for dividend yield which is at the median level. Only price to sales is very high in historical terms. Conclusions, S&P 500 is expensive by these measures (except for dividend yield), but is not excessively expensive.

20170506_3

 

Here are 10-year charts of the trailing and forward P/E ratio of the S&P 500 from FactSet.  Both are well above their 5-year and 10-year averages.

20170506_5

20170506_6

 

Growth at a Reasonable Price

Five-year forecasts are aggressive, because they see historically high earnings growth rates, and earnings continuing to outpace sales signficantly – that can’t go on perpetually. The S&P 500 is priced in the upper part of the mid-range of history with the 1 year forward P/E ratio about 1.5 times the 5 year earnings growth forecast (the “PEG Ratio”).

Here is the forecast from the most recent Standard and Poor’s spreadsheet for the S&P 500 (Standard and Poor’s opinion only).

 

20170506_4

 

Yardeni Research publishes a S&P 500 PEG ratio time series from 1995 forward.

It shows that the high (most expensive based on forecasts) was between 1.65x to 1.70x reached in 2015 and 2016. The low (least expensive based on forecasts) was in 2008 during the last crash. The median is in the vicinity of 1.30x to 1.35x. The current ratio is about 1.4, — just a bit more expensive than the median market in the internet era.

Mean reversion of valuation multiples is a powerful force, and mean reversion of all of the above measures (except for dividend yield), when pressured by outside forces, would cause U.S. stock prices to either decline, or slow down for economics to catch up. The problem is predicting when mean reversion will kick in.

We will keep an eye out for change.

Directly Related S&P 500 Funds: SPY, IVV, VOO, VFINX

Breadth Character of the US Stock Market

Monday, March 27th, 2017
  • Major stocks indexes still in intermediate-term up trends
  • Breadth indicators suggest problems underneath with prospect of near-term corrective move
  • Maintain current reserves in anticipation of better entry point for broad index positions

WHAT ARE BREADTH INDICATORS?:

Stock market breath indicators  measure the degree to which the price of a market-cap weighted index, such as the S&P 500 index, and the broad equal weighted market are changing in harmony — looking for “confirmation” or “divergence”. With confirmation, expect more of the same. With divergence be prepared for the path of the index to bend toward the direction of the path of the breadth indicator.

It works in a way similar  to the physical world as described in Newton’s First Law of Motion, which says that an object in motion continues in motion with the same speed and direction unless acted upon by outside force. The object is the stock index price. The force is the breath indicator.

There are multiple forces acting upon the object (the stock index), and it is the sum of those forces  that determine the speed and direction of the  index. Breadth indicators are among the more  powerful forces, because they reflect the effect of other forces (such as earnings and growth prospects and microeconomic news) on each of the index constituents separately.

Breadth indicators tend to be more effective at signaling impending market tops than market bottoms.

As more and more of the broad market issues move in the opposite the direction of the market-cap weighted stock index, the greater is the probability of reversal in the direction of the stock index.  The breath indicator represents the equal weighted broad market, which normally peaks before the market-cap weighted indexes peak..

Additionally, when breath indicators reach extreme values in the same direction as a market-cap index,  the market-cap  index is thought to be overbought or oversold, and subject to moderation back toward the moving average.

Let’s look at a few breadth indicators that we follow weekly to see what they might be suggesting at this time about the Standard & Poor’s 500.

CURRENT S&P 500 INTERMEDIATE-TERM TREND CONDITION:

First, let us stipulate that the S&P 500 is in an uptrend. Actually most major indexes around the world are currently in up trends (see a recent post documenting trends around the world).

Figure 1 shows our 4-factor  monthly intermediate-term trend indicator in the top panel in black (100 = up trend, 0 = down trend, 50 = weak or transitioning trend).  (see video explaining methodology, uses, and performance in a tactical portfolio since 1901).

FIGURE 1:

(click images to enlarge)

2017-03-27_SPY trend

 

BREADTH INDICATORS CONDITION:

Percentage of S&P 1500 In Correction, Bear or Severe Bear

We  look for divergences between the direction of the combined constituents of the S&P 1500 broad market index with the direction of the S&P 500 index.

In Figure 2, we plot the percentages of constituents  in a 10%  Correction or worse;  in a 20% Bear or worse;  and in a 30% Severe Bear or worse versus the price of the S&P 500.

This measure’s how much bad stuff is happening in the broad market.  The weekly data is a bit noisy, so we also plot the 13 week ( 3 month) average shown as a dashed line over the weekly data.

Leading up to the 2015 correction, these indicators (particularly the 10% Correction or worse indicator) gave an early warning of developing risk of a market reversal.

After the 2015 correction, those indicators continued to deteriorate, event though the &P 500 recovered; once again giving a signal that not all was well, which led to the 2016 correction.

After the 2016 correction,  those indicators improved rapidly  until the period before the 2016 election where concerns were rising. After the election, the indicators once again improved very rapidly, but now those issues in Correction, Bear  or Severe Bear  are rising again, suggesting caution about the possibility of another market reversal.

(click images to enlarge)

FIGURE 2:

2017-03-26_CBSB

Percentage of S&P 1500 Stocks Within 2% of 12-Month High:

In Figure 3, we plot the percentage of S&P 1500  constituents within 2% of their 12 month high, versus the price of the S&P 500.   This measures how much good stuff is happening in the broad market.

That breadth indicator  began to decline months before the 2015 correction and continued to decline even as the market recovered from that correction, portending the early 2016 correction.

The 13 week average turned down before the larger part of the corrective move preceding the 2016 election and rose after the election, but now it is  rising again, suggesting the possibility for a corrective move in the near term.

FIGURE 3:2017-03-26_2pct

S&P 1500 Net Buying Pressure:

Figure 4 presents another breath indicator, which recall “Net Buying Pressure”.

It measures the flow of money into rising and falling prices of the constituents of the S&P 1500 for comparison with the  direction of movement of the S&P 500  index.

The chart below plots  the Net Buying Pressure for 3 months, 6 months, and 12 months.

We multiply the price change in Dollars of each of the 1500  constituents each day, and multiply that change by the volume of shares traded each day. We sum  the negative products, and sum the positive products.     We then divide the sum of the positive products by the sum of the positive and negative products combined. If the ratio is more 50%,  that means there is more positive product than negative product, which we called Net Buying Pressure.   If the ratio is less than 50%,  that means there is less positive product than negative product, which we call Net Selling Pressure.

You can see in the chart that Net Buying Pressure began to decline in advance of correction in 2015 and continued to decline even as the index recovered before going into a second correction 2016. Since then net buying pressure has risen until just recently, when it has begun to decline again. That suggests to us trend in the S& 500  is not well supported by the broad market, and may be ready for a corrective move.

FIGURE 4:

2017-03-26_NetPressure

 

Bottom line for us is the view that the broad market foundation of US stocks is materially weakening, making the major market-cap indexes (dominated by the largest stocks) increasingly, visibly vulnerable to a material corrective price move; which suggests a better time later to commit new capital than now.

 

 

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.

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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.
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FIGURE 3:
Our 4 factor monthly trend indicators ranks each of the three regions as in an up trend.
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FIGURE 4:
This time series of our trend indicator for the US shows the up trend established since March 2016.
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FIGURE 5:
The up trend in non-US Developed Markets was established in November 2016.
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FIGURE 6:
The up trend in Emerging Markets was established at the end of December 2016.
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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).
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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.
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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.
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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.
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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.
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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.

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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.
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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.

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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.
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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.

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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.
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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).
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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.
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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.
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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.
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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.

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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.

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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.
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