The dynamics of the US stock market sectors is still fully consistent with the characteristics of the «healthy» market. The RRG (Relative Rotation Graph) diagram clearly shows that with respect to the S & P-500 index, there are just three sectors in the leading right upper quarter that are the beneficiaries of the growing cycle phase: XLY (Consumer Discretionary), XLI (Industrials) and, of course , XLK (Technology). And inside XLK (here it is not shown) the most powerful papers are representatives of the Semiconductors group, whose leadership role we have already written. On the other hand, in the left lower quarter, that is, the weakest, are the «protective» sectors: XLP (Consumer Staples) and XLV (Healthcare). In my opinion, such an alignment of forces indicates that momentum is still on the market, and it is still premature to talk about some kind of serious medium-term top. Probably, in April there is a chance to see the new historical high on the S & P-500.
An interesting fact that demonstrates one of the advantages of ETF to mutual funds for an investor operating in the US market. Tax implications (peeped by Meb Faber).
If one investor decides to sell, for example, an ETF on the S&P-500 index, he passes through a broker to the secondary market and sells it to the buyer. Accordingly, the tax consequences arise directly from the investor-seller (if there is profit). Thousands of other owners of the same ETF are not affected.
If the investor decides to return his stake in the mutual fund, the fund manager will have to sell part of the fund’s shares in order to free up cash to pay the investor. In this case, in the case of profit, the tax will apply to the entire fund. Accordingly, each shareholder of the fund will feel a negative impact on the profitability of even a long-term “buy and hold” investor, who did not even think of selling anything. This effect will not be very noticeable, since the share of an individual investor in a large fund is microscopic. But, first, why pay extra, even if it is a penny, and secondly, on long horizons «pennies» can turn into a noticeable amount.
This does not mean that mutual funds should not be considered as a tool at all. Simply put, their choice should be approached more responsibly and understand that the alpha of active controls must be high enough to cover the possible negative infrastructure. If there is no such understanding, then working with ETFs can be beneficial to most ordinary investors.
The “wave” continues on the S&P-500 index, which we talked about recently.
This wave of growth has already led the index close to the level of 2600, around which we expect the formation of resistance. It’s too premature to talk about the change of «current». But this does not mean that it will not change later, after another attempt to reduce.
In favor of the fact that the year, in general, will be positive, says the historical pattern. After World War II, there were only two periods when the S&P-500 index closed at minus more than 1 year in a row. Both times it happened during a recession: 1973/74 and 2000/02.
If we consider that the probability of a recession in 2019 still looks very low, the statistics speak in favor of a positive year for the US stock market. Unfortunately, this does not mean «smooth.»
The dynamics of the S&P-500 index on the first trading day of the year is very indicative in the sense that it reflects what is happening in the heads of market participants. In the morning, there is extreme pessimism (“everything is gone”, -1.5% on futures), which is replaced by optimism in the middle of the day (“not so bad”, + 2% from daytime lows), and indecisive closing (“tomorrow is a new day», + 0.1% at the end of the day).
It does not matter at all what kind of news flow caused such a dynamic. Now it is impossible to follow the news in an attempt to find a hint to our actions on the market — the headlines change every hour, swinging the «pendulum of emotions» of players with large amplitudes. And it will probably continue this way all year or at least the first half of the year. That is, you need to get used to living in conditions of high short-term volatility.
The most correct decision for the majority of non-professional investors is to determine their strategic portfolio and look there no more than once a week or a month. It’s not for nothing that they say that the most reliable way to reduce the volatility of your portfolio is to look into it less often. Save your nerves and money.
Traders and speculators, of course, more difficult. This approach does not work with them, they are trying to ride even short-term trends. But we must not forget that, in the marine terms, there is “flow”, but there are “ebbs / flows” and “waves”. So, even if we assume that the economy is still in the growth phase, that is, the “current” is directed in the right direction, then after all the major indices closed confidently below their long-term averages (200-day, 12-month) , came the «ebb». And it’s far from a fact that it has already ended. If you remember, at the end of December there was a series of posts about some extremely oversold indicators: the share of stocks in the index is above 50-day averages, a change in the index over 13 weeks, the sentiment of individual investors. All this is true, and it is precisely because of this set that the “wave” probably arose — the index has fallen down by -20%, and there has been an increase in the last few sessions. But you can not lose vigilance. Looking at the S & P-500 index, our subjective opinion is that while for him serious resistance lies in the zone of 2600-2650. The wave, which appeared after the sale, may well bring the index there, but then it may run out and the initiative will again turn to «ebb.»
Do not forget that no matter how attractive this or that action looked, its dynamics by 2/3 is determined by the dynamics of the whole market. And even if now something looks quite cheap, in the case of a «low tide» in 2-3 months it may become even cheaper (the company itself will not get worse). Therefore, it may be useful for speculators to leave a portion of the «powder» just dry for such a development.
The degree of oversold US stock market increases. The share of stocks in the S&P-500 index, trading above the 50-day average, is one of the lowest in all time.
Now about the technical argument that increases the likelihood of a quick reversal (final or corrective — no one will say that in advance). The graph above shows the weekly chart of the S & P-500 index from 1999 versus the share of index papers that are trading above their 50-day averages.
At the close of the week on Friday, the value of this indicator was 6.2% (that is, 31 out of 500 stocks in the index are trading above the 50-day average). As you can see, over the past 20 years, this is the 4th value from below. The share was lower in 2002, 2008 and 2011. Moreover, it was only in 2008 that the fall in the market did not stop at this, and finally at least the index happened only after 5 months (the index fell by another 20% during this time).
Of course, on the basis of such a small sample it is impossible to draw valid conclusions and build a strategy. By itself, the low value of the indicator can not be a signal for immediate purchase. It’s not about that. But the fact is that such a situation can still help in making a decision. How?
For speculators who are trying to engage in timing, you need to ensure that after such an extremely low value the indicator can quickly show a return to values above 70-80%. This would be a reflection of the fact that at first the index papers tried to go below the 50-day averages (thus, unfolding their medium-term trends), but then suddenly came back abruptly and again above the average. If we see such a drastic change in the “regime” (a quick return from extreme oversold to overbought), this could be the beginning of a new medium-term growth cycle.
For investors, the interpretation is somewhat different. Investors who are trying to make the right balanced portfolios are often concerned about when to start building a portfolio. That is, even realizing that on the long-term horizons, not timing is important, but the composition of the portfolio and its rebalancing, such investors, all the same, try to guess the best moment (that is, in fact, do the same timing). They can be pleased by the fact that extremely low indicator values occur close to pivot points in terms of time. I repeat: time, but not the price level, which in the end may be much lower.
In general, as an observation (not a recommendation!), We can say that while the index is in the long-term uptrend since 2009 (red line), any extreme oversold has more chances to be realized. But how to use it is a matter of subjective preferences and risk appetite. You can act on the principle of «buy and pray,» hoping to successfully catch the falling knife. And you can safely observe some time aside and begin to act only when long-term oversold will be supported by short-term confirmation of a reversal. There will be signs of confirmation of a reversal, we will definitely consider them here.
In addition to the extremely negative sentiment of individual investors, another reason for cautious optimism in the global stock market is the dynamics of the «width of the market.» Recall that this category of indicators includes those that show the degree of participation of shares traded on the stock exchange in a particular market movement.
For example, the graph above compares with the dynamics of the NYSE Composite index the share of securities included in the NYSE index (in%), which are trading above their 50-day averages. The NYSE index is more representative than the S & P-500, as it includes not the 500 largest US companies by capitalization, but 1,900 companies, 1,500 of which are American, and the rest are ADRs for foreign stocks.
The picture is quite clear now: the NYSE index updated at least October minimum, but the share of securities in the index, which are trading above their 50-day averages, has grown and is much higher than the October levels. Recall that the 50-day average is one of the most popular and reliable filters that separate the medium-term trends. That is, this graph visually reflects a simple fact — the “average” market continues to fall, but behind the scenes more and more papers do not confirm this drop and remain in an uptrend. The picture very much resembles the beginning of 2018, when a similar discrepancy between price and «market width» occurred in February-March.
Together with the negative sentiment of the physicists, such an indicator of the “internal health” of the market will make any signal to turn around more meaningful (when and if it appears). By themselves, these signals mean little, because the main thing is price dynamics.
American «physicists» are extremely negative about the prospects of the stock market. Time to buy?
A very interesting picture is drawn on the US stock market in terms of investor sentiment. Every week, AAII (American Association of Individual Investors) conducts a survey among its members on the topic «is your attitude to the market for the next 6 months right now: bullish, bearish or neutral?» On Thursdays, publish the results: https://bit.ly/2EoJjdF
Yesterday’s survey results showed that the percentage of “bulls” was 20.9% — the minimum level since 2016. The percentage of bears was 48.9% — the maximum level since 2013. But for us, the Bulls / Bears ratio looks much more interesting (neutral answers do not participate). It was 0.43 (20.9 / 48.9). Values of this ratio below 0.5 (that is, when bears are more than twice bulls and higher) can generally be counted on the fingers in the entire survey history since 1987. The graph above shows the values of this ratio and the dynamics of the S & P-500 index for clarity. A value of 0.5 is highlighted with a blue dotted line.
What does this tell us, and how can it be used? It says that the American «Johns» and «Jane» are extremely negative-minded, and history shows that the «physicists» are more often mistaken than right at the moments of extremes. And this can be used as a context or “regime”, within which any buy signal has a better chance of success. But the key condition, all the same, is that this buy signal will have to wait.
Why do you need to wait and not buy, for example, as soon as you see such bearish moods? Unfortunately, there are no grails, as well as ideal indicators, which allow catching market minima with a 100% guarantee. For example, in 1990, 2002, and 2003, after the Bulls / Bears ratio for the first time went below 0.5, the market then dropped another 10-12% before turning up. And in 2000 and 2008, the value of 0.5 caused only a pause in the fall, and the real reversal happened when the S&P-500 index was still 40-50% lower.
In fairness, in most cases, such a bear sentiment still led to a quick (and sometimes instantaneous) reversal upwards. So it was in the most recent case, in 2016. When at the beginning of the year the S & P-500 index updated the 2015 lows, it seemed that the uptrend had ended since 2009. But just at that moment, the value of «Bulls / Bears» went below 0.5, and it became a pivot point, and the breakdown of the trend was ignored by the market. Given that now the S&P-500 even remained above the previous lows of the beginning of 2018, formally it still remains in an uptrend, and the chances that extreme sentiment will work look even higher than in 2016. But we would still be in no hurry, because the market, and the whole world is now in a state of such uncertainty, which has not existed for a very long time. Caution does not hurt, and certainly do not need to run headlong and buy «for everything».
While there remains a real risk that the market may fall into a bearish phase for a long time. Therefore, we believe that it would be more correct from the point of view of risk management to wait for confirmation of a reversal upwards on the S & PP-500 index. This confirmation, in our opinion, will be the breakdown of the level of 2800-2816 (this resistance is formed by local maxima in October, November and December). If the market is strong enough to go above this level, then, in combination with such negative sentiment of the American «physicists», this can create an excellent basis for a healthy rally for several months. Well, if it cannot, then it will be necessary to wait for new signals for a turn, and they may already be at lower levels.
Fans of market statistics can be extremely curious to get acquainted with the table above.
It shows the dynamics of the S & P-500 index after the 50-day average crosses the 200-day average (death cross) from top to bottom. Considered all cases since 1923. That is what happened at the closing on Friday.
In general, the index dynamics in such cases is worse than average. For example, if for all periods the average S&P-500 for the year grows by 9.8% from 70% of positive outcomes, then after death cross the result is as follows: the average growth in a year by 5.8% from 65% of positive outcomes.
This is not the end of the world, however. As can be seen, for example, from the last 5 cases, only once in 2008 the index fell a year later. But absolutely with such initial data, you need to be more careful about the risk management of your positions and more confidently take the signals to sell, if they are (they each have their own).
Chart 2: Leading dynamics in stocks of companies that invest heavily in research and development.
Chart 1: List of «breakthrough technologies» according to the PGIM classification.
We wrote earlier about the so-called «big investment topics», which are still in its infancy / development stage and therefore can «shoot» on a long horizon for 20-30 years. Approximately the same way as it happened with Apple, Amazon, Netflix and other pioneer companies that literally create new industries and new demand. Such topics, for obvious reasons, may be of interest to today’s 20- and 30-year-old professionals, who, because of their age, have the opportunity to invest in the future.
Today, there is little in the development of this topic of investment in new technologies that can «undermine» the existing order of things and qualitatively change a particular industry and life, in general. Prudential Global Investment Management (PGIM), a member of the top 10 global asset managers with $ 1.2 trillion, released its small analytical report that might be of interest to us for at least two reasons: https://bit.ly/2RyQlA1
Firstly, PGIM gives its list of breakthrough technologies with the greatest potential (yes, there are blockchains too). He is on the first diagram above this post. It is not necessary to take it entirely and unconditionally, but it is probably useful to get acquainted with the opinion of not the most recent people in the industry.
Secondly, and this is closer directly to investing. It is logical to assume that those companies that in 10 years will become the «new Amazon» should now actively invest in research. Much more active than the rest. PGIM shows that the shares of those companies that are more actively investing in Research & Development (whose R & D costs are higher relative to other incomes than others), on average, outperform the market in dynamics. They divided all the companies in the S&P Global Broad Market Index into 5 parts (quintiles) and estimated their stock returns for the 10 years since 2008. It turned out that the equal weighted portfolio of companies from the top 20% (first quintile) in terms of R&D Intensity noticeably outpaces even the next 20%, not to mention the entire market. More statistics can be found in the second diagram above this post.
Perhaps, if done on the basis of this ETF study, it will be quite logical from the point of view of an investment thesis, and will be claimed by a generation of young investors. For example, a balanced portfolio of top 50 global companies in terms of R&D Intensity. There will obviously be representatives from different industries, and different capitalizations, and different regions. But we didn’t find such an ETF at etfdb.com, and Google didn’t help either. So, if there are people among the readers responsible for launching new products in Management Companies, there is still an opportunity to occupy this niche.
Apparently, the US stock market after a long break for rampant growth, becomes selective again. Correction on it began relatively recently, in early October, but the turn in the priorities of investors came much earlier.
The graph above shows the ratio of two ETFs from Invesco: SPHQ (S & P-500 High Quality) and SPHB (S & P-500 High Beta). It can be seen that since the end of May, «quality» companies are far ahead of the «growth» companies. The term “quality” means those companies whose profits and dividends are more stable historically and therefore easier to predict for the future.
In addition, this leading dynamics of «quality» led to the fact that the ratio drew something like a «double bottom». And although this does not guarantee the mandatory continuation of the dynamics, it makes it more likely. However, with one important reservation for those who like to take everything literally and thinks only in short-term categories. A continuation of the forward dynamics of «quality» is indeed likely, but the goal indicated on the graph may not be achieved immediately, but by the end of 2019. If we talk about the short term, it may well be the opposite. That is, on the horizon of 1-2 months, a certain revenge from the companies of «growth» is not excluded — too quickly and too much they lagged behind the «quality».
The fundamental basis for the fact that “quality” can continue to outpace “growth” in 2019, in my opinion, consists of the following. For the last 3 quarters, the profits of US companies, on average, are growing regularly at a record pace compared with the same period in 2017 (+ 24% in the 1st quarter, + 25% in the 2nd and + 26% in the 3rd). This is achieved thanks to the growth of the economy, but, first of all, thanks to tax initiatives and incentives. And this is already in prices. It is still too early to talk about recession, but it is possible to speak about a slowdown in the US economy in 2019. Companies are experiencing «cost inflation», primarily because of record-breaking wage growth. In turn, this leads to the fact that companies are shrinking margins, and this is a sign of the close end of the cycle (although profits can grow further, but at a much slower pace).
We think that in 2019 this will lead to a certain shift in priorities and investor response to company reporting. While the market was unequivocally bullish, investors «encouraged» companies for good reporting much more than they «punished» for bad ones. Now it can change, and companies will be “punished” more than “rewarded”. In itself, this is neither good nor bad; simply, if we accept this as a hypothesis, then we should expect a higher variation in the dynamics of the shares of companies and higher volatility. Therefore, despite the fact that the medium-term growth of the US economy and the “health” of the business are not yet in doubt, it will not be as effective to buy and buy a “market” as before. Greater importance will be focused on the sectors, and sometimes even on individual companies, whose business is less cyclical and not as susceptible to short-term market changes.
That is why the ratio on the chart above has good chances for continued growth in 2019 (after some recoil in 2018). A graph is simply a visualization of the fact that investor interest will be concentrated in stocks of companies that are able to develop in any conditions, and not only in the most favorable ones. Of course, in the collapse scenario in the US market (which we don’t believe in now), everything will fall in absolute terms, both “quality” and “growth”. But «quality» in this case will not fall as much as «growth», and its relative dynamics in such a scenario will win even more.