The markets seemed to have found a way to settle on all the tariff and recession banter. Clearly, the tariff negotiations aren’t over, but they have settled down to a point of negotiation. I’m going to start this week’s note with a picture of where we have come from, where we went, and where we are currently. For those of us in the investment management business, the current 5,500 level on the S&P 500 is pretty important as it represents a bounce back of exactly one half of the decline. In management jargon, it is termed a 50% retracement. Here is where we sat at the end of last week:
US equities that had been pretty much locked in worry-worry mode for much of the time since February 18 when the S&P 500 hit its most recent record high. After taking a dive, the index found reason to change direction not just on a lessening of the day-to-day tariff war worry, but also on better-than-expected earnings growth. Stocks last week regained lost ground as Q1 earnings season pressed on with better-than-expected results.
Earnings Exceeding Expectations. With a little better than a third of the firms in the S&P 500 index having reported through Friday, profits in Q1 are up 17.8% from a year earlier on 4.1% revenue growth. Prior to the start of the quarter, Bloomberg’s bottom-up estimates put analysts’ expected earnings growth at 6.8% from a year earlier. What was even more impressive was that the earnings guidance was not dreadful, hence there were some good moves to the upside after the positive earnings surprises. As for the tariff issues. Some major trading partners of the US have come to the negotiation table. It appears that things are on track for the administration’s goals for US trade. Here is what was experienced last week:
Even though the markets have begun some level of stabilization, the “Boo Birds” were still out in force and had a new and meaty factoid to dump on the market. It is titled the “Death Cross.” This is when the 50-day moving average of price crosses below the 200-day moving average.
Death Crosses Suggest Danger…
Except when they don’t! The reliability of a “Death Cross” as a trading signal is questionable. While they can provide warnings of major declines, they also are subject to frequent false alarms. Going back to 1929, Bespoke Investment Group shows that the data is mixed at best. The S&P 500 has tended to be negative most of the time one month later, but the one-year average forward return after the signal is positive 71% of the time. My point isn’t that stocks can’t continue to fall lower – they very much can –but the Death Cross, itself, doesn’t really change anything for me. In the chart below, I have put a red dot on every Death Cross so that the subsequent market action can be seen. Obviously, this chart compresses time and that doesn’t allow us to see the very short-term action immediately following the cross, but it does bring to light that pullbacks such as this are really opportunities for those with intermediate to longer-term time horizons.
Consumer sentiment, a measure of the opinion of consumers, has also recorded negative readings. University of Michigan Sentiment data has never been this negative. Recent survey results seem to show extraordinarily negative sentiment, which dovetails with the record number of bearish weeks above 50% in AAII data. As shown below, 12% of all respondents surveyed believe there is zero chance of a stock market rally in the next year. Bloomberg data shows this is far and away the most negative that people have been in the 22-year history of this indicator.
Besides the consumer, the American Association of Individual Investors (AAII) has also hit a record extreme. For 9 weeks consecutively over 50% of all investors have been negative. Going back to the beginning of this study, this is the worst that has been recorded.
Now that we have taken some time to address the negative measures that have been seen of late, I wanted to take some time to go over the more positive things that I have recognized. These are measures that I believe will help to convince longer-term investors that maybe a bottom has been put in and we are now building a base for future market advancement. I separate these two opinions as we are now seeing a very interesting set of market characteristics that are not often seen. Last week we had three days back-to-back when the S&P 500 was up more than 1.5% each of the three days consecutively. Now, 1.5% doesn’t seem so special, but three days in a row is. It doesn’t stop there though. We call this type of rare strength a buying thrust and it tends to happen early in bullish markets, as strong future returns are common after similar buying thrusts historically. In fact, stocks were higher a year later 10 out of 10 times. Since 1950, a ten-for-ten record is pretty impressive, and an average return of 20.7% would be a nice recovery.
Just as meaty as the “Death Cross” was, so was Friday’s positive “Zweig Breadth Thrust.”
The “Zweig Breadth Thrust” is a measure that was created by Marty Zweig in the mid-1980’s and was referenced in a 1984 article. It did not work prior to WW II, but since then it has been an accurate measure for future market performance 18 out of 18 times. It is a moving average of 10 days of advancing issues over declining issues. When it goes from very low low, to a high, quickly over the 10-day period it is considered a type of “thrust.” Since 1978, this has been the track record. I bring it up because it is really quite an impressive statistic. The forward 1-month, 6-month and 12-month returns have been positive 100% of the time:
Last week I brought up what I feel is a very important economic indicator that is not often discussed. This is the spread between high-yield (riskier) bond yields and US Treasury yields. If the financial markets are in fear of economic problems, high-yield debt will be required to pay a far greater amount of interest than US sovereign debt. As can be seen below, even in the face of the supposed dreaded tariffs, there is decreasing concern about overall economic prosperity. It basically says that the economy is walking away from the recession call that has been espoused along with tariff negativity:
Often the strength of a move off of a low is measured by the percentage of companies that rise on a given day, and then again within a 9-day period. Much like the “Zweig Breadth Thrust” mentioned above, I often look for a number of days in quick succession when over 90% of the companies are up in a day. On April 22nd (last Tuesday), the second of two of such days where over 90% of stocks advanced. When there is this level of institutional buying, it tends to trigger positive forward market action. Going all the way back to 1979, this has only happened three times, and every time the markets advanced 3, 6, and 12 months later:
I have provided a lot of statistical data this week, but I believe that much of it points to a recognition of extremes that have been hit and subsequent expectations for the next action of prices. From an overview perspective, I pay attention to all of these but am careful to make sure that they are occurring in an environment of a stable and growing economy. That the economy is growing with a low level of inflation. US Treasury interest rates are in a fairly tight range and not signaling any undue stress in the global trading of sovereign debt. All of these things seem to be pointing to what I have been thinking is the case. What will happen next is tough to handicap, particularly when it all seems to hinge on the actions of one person. If this week’s earnings reports come out as they have the last two weeks, our market could stabilize and possibly progress higher after some backing and filling (Two Steps Forward One Step Back).
- Ken South, Tower 68 Financial Advisors, Newport Beach
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