On April 1rst, Ned Davis Research (NDR) research printed a report on the extreme pessimism on several US Equity market sentiment fronts. Subsequent to this the markets took off. Now, it should be no shock at all that markets tend to bottom when sentiment is the worst, just like markets tend to top when the froth or sentiment is the highest at market high points. So, true to form, the QQQ posted 13 consecutive up days to close the week. This is something that the market index has achieved only four times in index’s entire 40-year history.
The PROBLEM for most investment recommendation services is that Mr. Market did not tick off all the boxes of a correction prior to this unabated rocket ride higher. The process that is normally expected is as follows:
- Market moves from a point of overvaluation or overextension to the upside into a decline.
- The decline hits it low point and then reverses back up.
- This bounce tends to be short-term in nature and then reverses right back down to “test” the lows that it traded at. This is more of a confirmation action where the market needs to prove itself as either being ready for additional decline, or the decline is completed and then it rises back up.
- The recovery continues and eventually old highs are exceeded, and the market advance (bull market) is back in place.
This time the equity markets did the first two but didn’t give the third. Since the news is so bad on the media front in regard to the Iran conflict and the media’s incessant hatred of President Trump, many investors have not participated in the recovery and have been waiting for number 3 above so that they feel comfortable reengaging in the markets.
The overwhelming group that has led this current advance is once again the technology group. The technology space in general is the only sector that has outperformed the index in the last few weeks. To see the graphic outlier of performance from tech, this is how all sectors have fared:
Even more graphic is the performance of the semiconductor space. Semiconductors- the root of AI processing, have been on an absolute tear! This group has been up over 18 days straight and has gathered almost all semiconductor companies, both large and small and pulled them up. This surely can’t continue, but again, to observe how truly extreme this move has been, please see it in the chart below:
In continuing briefly the short-term retro analysis, upon the markets reaching the record of 13 days straight we got news out of Iran and oil prices that showed that possibly some progress was being made. Just when this sigh of relief was being breathed, we have begun getting the much-needed validation of internal corporate strength in the form of first quarter earnings reports. Practically all earnings seasons are "good" these days considering 70-80% of S&P 500 companies end up beating their consensus earnings estimates each and every quarter. It is almost a running joke at this point how consistently low consensus analyst estimates are, though no one seems to care or even mention it (whatever helps prices keep going higher). Still, this earnings season has so far been strong even compared to the customary lowered bar. With 28% of S&P companies having now reported as of Friday, 84% have beaten consensus earnings estimates while 81% have beaten consensus revenue estimates (source: FactSet Earnings Insight). Both numbers are above the 5- and 10-year averages. Even better, profit margins are on pace to be the highest they have ever been since FactSet began tracking the data in 2009. That has helped produce an average earnings surprise of 12.3% above estimates, which is also above the long-term average.
Positive offsets
Yet, for the sake of debate (or full perspective), let me feature some important offsets we have presented before. Let's start with corporate profits and their cash reserves. Corporate profitability has risen impressively since its low at the end of 2000. Due primarily to technology innovations, lower interest rates, and falling labor costs, after tax corporate profits have more than doubled as a percentage of GDP.
As a side note, there is another fact often overlooked. This is the number of companies that are publicly traded that can be invested in. This number has quietly been falling over time. This means that the concentration in a fewer number of names is even more focused. This is why I tend to focus on those companies that are leaders in the leading sectors. If institutional investors are moving billions of dollars, they need to be confident in the probability of positive outcomes during earnings season and a level of liquidity where they can buy and sell enough of a company or a sector that it can move their performance needle while at the same time does not clobber their performance if they would want to exit a position. Here is the current measure of numbers of public issues across major segregations of the overall US stock market:
So yes, many investors are positioned near record long and that is high risk, but as long as profits keep booming, corporate buying can continue as an offset. Another offset is our crises event studies. As shown way back, as the Iran war was getting underway, crises events usually have a negative initial reaction, but that usually flushes out nervous holders of stocks, leaving stocks in stronger hands, and usually followed by good gains. That table is shown below:
I’ve shown before, numerous times, the way the markets have acted during the most recent military conflicts in recent history, but here it is again. Even as far back as World War II, the US stock market hit its low before we even entered the war and then rose during and coming out of the conflict. Here is the graphic of conflicts going back to the 1960’s:
In closing, it can be concluded that this is truly one of the most hated or mistrusted V-shaped recoveries the US stock markets have ever seen. But here we must try our hardest to ignore the noise (the media) and focus on what the numbers and the markets are telling us. What they are currently saying, which is what they have consistently been saying, is that the economy is in a very healthy position, earnings and revenues of companies are good and growing even faster than expected, and even with oil rocketing over $100 a barrel and surely adding to much hated inflation the country is just fine. The last chart that I am going to leave you with is the old growth vs. value chart. This is the measure of growth companies vs. value companies. In a strong economy with inflation and interest rates in check, growth tends to prevail. As can be seen below, after a brief period of catch up by value companies, during which time the fast growth of technology companies took a much needed breather the growth companies are coming back to lead the pack.
How long will this last? How long before the markets take another breather? Where is the best place to have ones capital invested? These are all questions that on any given day can have a different answer. We will work to do our best at making sure you have more right answers than wrong answers. If you have any questions, please don’t hesitate to reach out. The team is always available to answer any questions you may have.
- Ken South, Tower 68 Financial Advisors, Newport Beach
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