THE GOOD, THE BAD AND THE PUZZLING
In its regular review of the markets, TPA notes that there was a lot of strong technical factors such as breakouts to new highs and strong, consistent uptrends. This is very positive. There also exists areas of the market that have been consistently weak for quite some time and show little signs of changing their ways. Finally, TPA identified characteristics of the market that should either give clients pause or at least cause them to dig deeper.
TPA first uses its relative performance ranking in 3 different periods of general upward direction to identify changes in relative performance between broad market categories, sectors and subsectors. Looking at the first chart below of the S&P500, TPA’s periods are since the lows on Christmas Eve 2018, since the low on 5/31/19, and since the start of 2020.
The tables that follow the chart measured performance in each period and then provide the relative performance rank. The table is sorted by the 202 YTD performance.
What is Good
1. BIGTECH has recovered and is very strong. The worry for TPA, during parts of 2019 when BIGTECH was lagging as the S&P500 made new highs, was that eventually this huge part of the market would become a weight too large for the market to bear. This is, obviously, no longer an issue.
2. In line with #1, Large Cap growthcontinues to power ahead and, although perhaps overdone in the short term (discussion to follow), it is good for the market to have Growth lead.
3. TECH overall is consistently strong in all 3 periods. TECH’s strength can also be seen in the subsector analysis.
What is Bad
1. Small cap continues to lag Large cap. This may (1) indicate the market power of large cap stocks, (2) point to investors unwillingness to take on the risk associated with smaller companies or (3) simply reflect the power or indexing and ETFs and the weight of the largest stocks in these instruments.
2. Commodities cannot recover no matter how good the rally and the economy get. The sectors and subsectors (see the highlighted area in the tables below) are consistently weak even as stocks continue to make new highs and the economic numbers continue to be strong.
3. Value indexes also remain the consistent underperformers.
4. As discussed above, BIGTECH is doing great, but chart 2 below of the ratio BIGTECH/S&P500 shows that it has become overbought compared to the market. Previous overbought instances in 2016, 2017, and 2018 have resulted in short term pullbacks (periods of underperforming the market).
RATIO OF BIGTECH/S&P500
5. TPA analyzed subsectors in the table below with large positive or negative changes in performance rank and makes the following observation, that can also be seen in the charts below:
· Many stocks and subsectors have technically strong charts, but they are also trading at historically high valuations. We provide the PE chart of PEP as an example below (chart 3). PEP’s PE is now 25.4, a new 10-year high and well ahead of the 10-year average of 19.86.
· Three sectors have been in long term uptrends, but are technically vulnerable due to long term resistance. See charts 4, 5, and 6 and stock membership tables below.
Ø Electric Manufacturing Services
Ø Casinos and Gaming
What is Puzzling
1. Given the record run stock have had, it is natural to look for signs of an end to the bull market. The predominance of the largest stocks in terms of performance (narrowing of the market) and the inability of economically sensitive areas like Value and Commodities to recover should at least give clients pause.
2. Andrew Sheets, chief cross-asset strategist at Morgan Stanley has postulated that there are signs that we are in or entering the final stages of the bull market.
He wrote, “Historically, in the ‘downturn’ phase of our indicator, long-dated bonds outperform stocks. Defensive and large-cap equities (modestly) outperform cyclicals and small caps. U.S. stocks (modestly) outperform those in the rest of the world. Investment grade credit returns more than high yield. Precious metals outperform other commodities. All have been happening, not just year-to-date, but for the better part of a year,” https://www.marketwatch.com/story/apart-from-the-major-indexes-like-the-sp-500-markets-are-behaving-like-it-is-late-in-the-cycle-says-morgan-stanley-strategist-2020-02-17?mod=home-page
Charts 7 and 8 show that he is right about the last two factors. Investment Grade Bonds have outperformed High Yield Bonds significantly over the past year and Gold has run ahead of Crude and Copper.
3. Finally, China should continue to underperform the U.S. Chart 9 shows the relative performance of major world markets over the past year. China is the big loser, down 3%, while the S&P500 is the winner, +21%. This may tempt investors to look at China’s weakness as a buying opportunity. However, a look at the very long term chart of the ratio of the HangSeng/S&P500 (chart 10) shows that the Hang Seng/S&P500 just broke below long term support from 2001, 2002, and 2003. This leaves the Hang Seng vulnerable over the next year to further underperform the S&P500 by another 20%. That would put the ratio at the levels last seen at the lows of the Asia Crisis of 1997-1998. This discovery cuts 2 ways:
Ø negative - weakness in China is not good for the world as it is a huge part of the world economy
Ø positive – China’s problems continue to make the U.S. a relatively safe investment.