Advanced Optimism and the Need for a Healthy Correction

Has the market become too optimistic?  The fact that analysts are asking this question suggests that fear of piling on has arrived.  By short-term cycle standards, the market appears overdue for a healthy correction, though the current slow and healthy decline intimates a small correction.  While past performance is no assurance of a similar trajectory, the last two tests of the S&P 500 index 200-day moving average resulted in spikes higher off of approximately 1,986 and 2,083.  The current 200-day moving average rests at approximately 2,154.

As of this writing the S&P 500 sits at 2,273 Therefore a test of 2,154 (with a few days below) could easily result in a 5.25% correction. The reasons are not important, though I am happy to move beyond animal spirits to list a number of possible headlines. To illustrate: “Law Makers Cannot Find Agreement on Infrastructure Spending” “Lawmakers Cannot Find Agreement on Corporate Tax Cuts, “Law Makers Cannot Find Agreement on Repatriation Rules”, and “Law Makers Cannot Find Agreement on New Healthcare Rules”. I could go on. Smiley face.

While a tweet or two from President Trump may be capable of muting the dollar’s rise or the market’s decline, according to global strategists at Credit Suisse, the near-term implications of fundamental and technical analysis suggest the market is a bit overly optimistic.  Therefore, the short-term outlook is uncertain. In this case, think of short-term as weeks and months only. According to J. Sweeney, Global Strategist at Credit Suisse:

“Our basic forecast…is for a modest wobble lower in global growth and purchasing managers index data in the months ahead, followed by a rebound in the second half of the year.”

To illustrate the reason for caution among buy side analysts, figure 1 below shows the growing Euphoria among global risk takers.

“Certainly, recent data and surveys have been solid. We see the current strength in global growth as mostly attributable to an ongoing rebound from the commodity-centric slump of 2015.  Already high PMIs (purchasing manager index data) also appear to have received a boost from new policy expectations for the US”.

(Sweeney, Credit Suisse, 1/30/17)

The stock and bond markets appear to be priced in-line with upbeat growth expectations.  However, no one knows if the rewards from potentially lower tax rates, foreign profit repatriation, enhanced consumer confidence and infrastructure spending will be realized in 2017.

Meanwhile:

  • Global credit market risk appetite is approaching Euphoric levels; a negative
  • US Industrial production momentum has fallen back into negative territory
  • The beginning of the Trump presidency adds to uncertainty
  • US consumer demand appears solid, but unremarkable
  • Mortgage and business loan demand are stagnant
  • Few industry groups are technically weak according to Investor’s Business Daily; not a bullish indicator.
  • The Bullish/Bearish Investment Advisors Index is technically bearish
  • The Cyclical Trend index and the Sentiment Trend index are signaling a weaker market.

 

 

Bottom line: The current thinking among Credit Suisse analysts is that Investors are now in danger of extrapolating further upside from recent growth, while a reversion to the mean is more likely. Therefore, short-term caution is in order.

With this in mind, we have structured portfolios to hold a bit more cash, assign a more critical eye to stock values and to mute buy ideas until greater trend clarity unfolds. To put it more simply, we are focused on “value” as a theme.

Value as a style has provided lower volatility during corrective stages in the past, though there are no assurances this strategy will beat other growth or momentum strategies. It’s always possible a “value trap” period of underperformance could ensue if growth or momentum as a style, take off. Late stage economic cycles are known for euphoric risk taking. However, global Euphoria appears to be limited to the bond (credit) markets just now. Moreover, when the credit market begins to breakdown, as is expected to be the case as interest rates rise, the stock market should benefit.

Therefore, while short-term technical signals point to greater volatility, the year ahead point to solid growth. So to quote the Credit Suisse global strategy team:

“Great policy risks mean we should not be too precise on our outlook for later this year.  But for now, we remain upbeat, even while expecting a wobble lower in the months ahead.”

In other words, the stock market should act more like the stock market we all grew to know before quantitative easing; that is, wobbling up and down as a pause from the years of quantitative easing (2008-2016) ensues. Call this flattish period a breather for now. If so, the old adage, never short a dull market, may portend better times ahead.

Meanwhile as the slowly lower pause continues, the outlook for investment is improving as headwinds dissipate despite the underlying immediate growth trends which appear lackluster.  So to leave you with moderately hopeful data:

  • Equipment investment returned to positive growth in Q4
  • Core capital goods shipments have improved in recent months
  • Consumer optimism has increased since the election
  • China and the US have witnessed higher bond yields; an economic positive
  • Auto consumption growth remains robust
  • Capital expenditures for manufacturing in the US appear set to rebound
  • Unemployment remains low
  • The cost of money remains low
  • Technically speaking, all of the major equity indices remain in expansion territory.

As always, thank you for your continued support and trust. Our mutual trust is the qualitative energy and the formidable mindset that drives account performance. I wouldn’t write these words here if I didn’t believe what I just wrote one hundred percent. So again, thanks so much.

 

Sincerely,

Vaughn Woods, CFP, MBA

Vaughn Woods Financial Group

2226 Avenida De La Playa

La Jolla, CA 92037

858-454-6900

www.vaughnwoods.com

Securities offered through Bolton Global Capital, Inc., 579 Main St., Bolton, MA. Member FINRA, SIPC  978-779-5361. Advisory services offered through Bolton Global Asset Management, a SEC registered investment advisor.

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