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Stocks Will Go up…Until They Don’t

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Stocks Will Go up…Until They Don’t

Investment markets can be confusing. To try to cut through the chatter and investment slang, we present this monthly view to you. We want to give you a 50,000-foot view of market conditions updated as our view evolves. Currently, our Investment Climate Indicator remains at Stormy. Stormy means that bear market rules apply, and we believe we could be a period of wealth destruction.

September and October have reputations as vicious months for stock investors. This was not the case in 2019. This year, the S&P 500 Index gained roughly 2% in each of those months, which brings us to a November that is already looking higher at the start.

For someone who has been cautious on the broad stock market since early 2018, the hype over “new all-time highs” in the S&P 500, Nasdaq Composite, and nearly in the Dow Jones Industrials as November began is yet another confirmation of one of the primary rules of investing. Namely, that all the potential bad news is just potential, until asset prices break down

That has threatened to happen in the S&P 500 and other major indexes. Heck, last year around this time, that index was in the midst of a 20% drop that many investors either forgot about, or don’t remember in the first place. The holiday season will do that to a person, I get it.

So, as Led Zeppelin famously sang, the song remains the same for the “headline” U.S. stock market indicators. Despite the many continued market stress factors noted below, prices can go up anyway.

Retirement party crashers?

The real risk, especially for folks in the waning days of their working careers, is that their retirement party will be greeted by crashers. Or, more specifically, market crashers. That is less of a prediction than a monthly reminder to greet new highs as good news, but not as an excuse to stay complacent.

As I will point out in the data tables below, the surface is cracking more all the time, and for good reason. Furthermore, we are at risk of another cycle that narrows in scope (fewer and fewer stocks leading the market higher), then rolls over. And, the best news of all: the longer the advances go, the more we can tag along and make some money before our “M-O” turns to exploiting the next stock bear market.

A graph for the season…

Don’t get mesmerized by the beautiful autumn colors in the chart below. Here is what you need to know. The stock bull market stalled in late January, 2018. That was over 21 months ago.

Since that time, the S&P 500’s total return in those 21 months has been over 10%. That’s not bad, but is a slowing from before 2018. The average S&P stock (in orange) is up 6.5% total in those 21 months. The other indices shown are either based on stocks smaller than those in the S&P 500, or include stocks outside the U.S. (“International” markets, to U.S. investors).

Those non-S&P 500 indices have produced between +2.0% and -14.5% during the past 21 months. That is at best a stall, and at worst a sign that the S&P 500 is the last domino to fall in this cycle. And, as many on Wall Street has noted lately, there is a lot of “cancelling out” going on within the stock market.

Upon further review…

In other words, a very small number of popular stocks are doing very well (hence, I refer to them as “popular”). The rest of the market is a mix of good and bad that net out to near zero, or worse.

Key Market Stress Points

  • Impeachment: it’s moving along. And the market doesn’t care. The Nixon impeachment process started the same way, so keep that in mind as your TV explodes with coverage the rest of the year.
  • Fed rate decisions: last month I wrote that I think this is fading in importance. This month I say, “look at what Rob said last month.” That is, the Fed’s 3rd rate cut in this cycle only serves to give it less room to get the economy out of a pickle down the road. As a results, it appears that investors and traders are less urgent about reacting to Fed moves, unless and until that pickle presents itself.
  • Geopolitical: China trade news is “good.” USMCA is “good.” Brexit is “delayed. Or, is this just an extended dance to an inevitable conclusion that changes nothing, except for the disruptions already caused to global business supply chains? The manufacturing economy is showing persistent weakness, while the services part is doing OK (debt is great enabler, eh?). That is similar to the stock market situation noted above. It doesn’t matter to investors until it does…and then, look out.
  • Valuation: In another article I wrote during October, I did a study on what happens when the Shiller CAPE price-earning ratio peaks, then declines meaningfully. This started to happen with the past year. The other times it happened, bear markets happened too. But again, the market, narrow as it is, can stay up longer than any of us think.
  • Index mania: S&P 500 index funds are as popular as ever, it seems. That is clearly feeding the narrowing breadth that I have noted a few times here.
  • Credit: the credit bubble remains a big concern. The latest I read is about new type of financial poison called “Online Installment Loans.” Look it up and see if you think it helps or hurts the economy’s foundation going forward.
  • Bond market risks: as noted below, the bond market has had a very nice run this year. However, there is now threat of a sharp reversal. . That’s what my technical/charting work tells me. And with Approximately 50% of bonds in investment grade bond funds are rated BBB, the lowest of the 4 possible rating categories, falling prices/higher rates could be a generational tipping point for bonds. This may also spark more chatter about a long-awaited return of inflation.
  • Sentiment: this is really the one stress point I have written about this year that has already followed through. I have been writing that “TV coverage of the stock market is dominated by companies that don’t make a profit.” In recent months, have seen some pretty amazing drops in some of these stocks. Consider this early-innings for this type of investing, and for growth stocks in general.

The Plan

Bottom-line: don’t get complacent. Look forward. The investment climate is changing. While none of these issues individually will wreck a retirement plan immediately, it does tell you that this “all time highs” thing must be taken in stride, not pointed to as a signal that greed is good. After all, we know where that approach took Gordon Gekko.

I am neither bull nor a bear. I am a realist and a devout risk-manager. Be careful, understand what you own, and respect the laws of gravity.

This is a group of 100 ETFs I track to get a general sense of global market conditions for investors, over the time period shown. It indicates a strong 9 months, but that only allowed the past 12 months to edge out a 2% gain.

Large Value stocks are finally rebounding versus Large Growth. This relationship can be pretty inconsistent in the short-term. However, the cycles of one outperforming the other tend to be years in length. It has been Growth’s game for a while. Perhaps a change is at hand.

Energy stocks are finally nearing the break-even mark for the last 3 years. They could be the last sector to go positive over that time frame. Will that occur just in time for the growth sectors to stop growing? Earnings are indicating that potential.

Healthcare bounced in October. We’ll now see if the bounce is more than just that.

The Merger and Acquisition space is still very strong, thanks to friendly borrowing rates and willing investors. This has made the “deal arbitrage” as reflected in symbol MNA a steady, though not spectacular, performer in a traditionally lower-risk, hedged strategy.

For the past few years, it has generally been the case that the higher dividend yield stocks have noticeably under-performed lower yield stocks. You can see that in the table in the 1-year and 3-year columns above. Some early research work I am doing shows signs that this may be shifting. That would favor the 4-6% yielding types versus the 2-4% yielders. Too early to tell, but I am watching that relationship like a hawk.

It has been a banner year for stocks in “sexy” industries that are tech-oriented. Good news for holders of some of the segments represented above.

I see a positive global effect short-term in these figures. Namely, that what is good news for the U.S., real or perceived, is good for Asia too. That could be the case for the remainder of 2019. 2020, that’s another story.

Not shown here is that the longest maturity Treasury Bond ETF (symbol TLT) fell nearly 6% in 25 days within October. This is the type of risk that may await unsuspecting investors who are giddy about how well their bonds have done this year. Remember, when prices of bonds whip around like stocks, you had better get a grip on what you actually own there.

As noted last month, there are tiny cracks in the lower-quality area of the bond market. But for now, just cracks. Only Joel’s mother from the movie “Risky Business” would notice a crack in that glass egg right now.

I have a hunch that the value of the U.S. Dollar will be a big topic of conversation toward and into 2020. Specifically, there is risk that it gives back some of its strong 2018-2019 gains. There is a mighty ripple effect from that, if it happens. Perhaps everything written above will be a domino off of that situation. We’ll see.

Source for all ETF data: Ycharts.com

Related: The Real Reason Active Managers Underperform The S&P 500 Index

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