Weekly S&P 500 ChartStorm - 18 Sep 2016
Those that follow my personal account on Twitter and StockTwits will be familiar with my weekly S&P 500 #ChartStorm in which I pick out 10 charts on the S&P 500 to tweet. Typically I'll pick a couple of themes and hammer them home with the charts, but sometimes it's just a selection of charts that will add to your perspective and help inform your own view - whether its bearish, bullish, or something else!
The purpose of this note is to add some extra context beyond the 140 characters of Twitter. It's worth noting that the aim of the #ChartStorm isn't necessarily to arrive at a certain view but to highlight charts and themes worth paying attention to.
So here's the another S&P 500 #ChartStorm write-up
1. 50-day moving average breadth: This chart tracks % of S&P500 companies trading above their 50 day moving average and serves as a decent overbought/oversold oscillator. While we always look for breadth divergences, we also look for extremes in breath to provide a guide for extremes in price/sentiment. The latest readings show the indicator clearly in the oversold zone - as bad as it got during Brexit, but not quite as bad as the August/January corrections. So this is one piece of evidence for the oversold case.
Bottom line: 50 day moving average breadth is pointing to oversold conditions for the S&P500.
2. VIX futures cuve: This chart shows an indicator based on the VIX futures curve (ratio of VXV i.e. medium term VIX vs VIX i.e. spot VIX). The indicator typically drops during a correction or selloff as spot VIX spikes tend to be more extreme than the rest of the curve. While the indicator rebounded on Friday (a good sign), it hit over sold levels at the worst point, so this is a second piece for the oversold case.
Bottom line: The VIX futures curve indicator went oversold.
3. The CNN Money Fear & Greed Index: This indicator crunches together 7 different components to give a reflection of the mood of the market (Greed vs Fear). In the case of this sentiment metric it went slightly worse than during Brexit, but is still comfortably above the Aug/Jan correction levels. This is an important point because in an uptrending market sentiment indicators don't need to fall as much to provide a contrarian buy signal. So arguably this is a third piece for the oversold case.
Bottom line: The Fear & Greed index flipped over to fear mode, which is an important signal for contrarians.
4. IPO activity vs the market: This chart shows the monthly number of IPOs vs the S&P500 over the past 55 years and seems to display a clear pattern that whenever IPO activity slows down the market is usually either undergoing a correction or bear market or is actually at a bottom. This is an important observation because recently the trend has been for a slump in IPO activity - the type of pattern of activity that you would see around a market bottom. So on this chart alone you would say that the twin corrections of August and January was the worst of it and a major market bottom is in.
Bottom line: There has been a slump in IPO activity, which is usually consistent with a major market bottom.
5. Forward and trailing PE ratios: This graph tracks 2 PE ratios (trailing 12 month and forward earnings) and shows that PE ratios are generally higher than usual, in fact you have to go back to the dot com mania to find similar levels of valuation. The optimist would say that they're only around levels that preceded the last part of the bubble (i.e. around 1997/98) while the pessimist would say that they're too expensive and point to poor future returns.
Bottom line: PE ratios are elevated vs history, and the last time they were this high was around the later stages of the dot com market mania.
6. Price to sales ratio: A similar but different valuation metric, the price to sales ratio shows a market that is looking much much more overvalued than the PE ratio would suggest. One reason it's so high is the structurally higher level of profit margins (i.e. you would expect a higher price to sales ratio if profit margins were higher), so this chart says more about the change in composition of the market and a shift towards services and software vs manufacturing and hardware. Having said all that, it is still quite a high number, and warrants noting.
Bottom line: The price to sales ratio for the S&P500 is at a historical extreme high.
7. S&P500 PE ratio vs 1 year forward returns: This chart attempts to determine whether there is a relationship between high PE ratios and short-term performance (1 year forward returns). As you can see there is little to no relationship, so we can conclude that in the short term valuations provide no real useful information...
Bottom line: There is little to no relationship between PE ratios and short-term returns.
8. S&P 500 PE ratio vs medium/longer term returns: Where it changes, as this graph shows, is for medium-longer term holding period returns. PE ratios actually historically provided a good guide for future medium to longer term returns. So while PE ratios have no useful information for the short-term, over the longer term they provide a decent guide to returns. The pattern is higher PE ratios tend to point to lower or negative longer term returns, and lower PE ratios point to higher longer term returns.
Bottom line: PE ratios historically provided a good guide on medium to longer term returns.
9. Small businesses citing political climate as a reason not to expand: This chart is basically a measure of small business perceptions of political risk, and reflects the degree to which it's impacting on their decision making. With such a polarizing and divisive presidential campaign it's understandable that there is a certain air of angst out there. It is clearly impacting negatively on confidence and will likely also put a dampener on real activity. So it's worth pondering whether the selloff that we just saw was a result of political risk. If it is the case, then it's probably fair to expect more political risk driven volatility episodes as November 8 approaches.
Bottom line: Political risk is having a rising impact on confidence.
10. Economic policy uncertainty vs the VIX: History shows us that higher levels of economic policy uncertainty are consistent with higher levels of the CBOE Volatility Index (VIX), and not only higher levels but more frequent spikes in the VIX. This makes sense for a number of reasons (higher policy uncertainty usually means something to do with Fed policy, tax hikes, regulation changes, government shutdowns etc...). For the US it's likely that policy uncertainty will remain elevated in the near term, so VIX spikes are something to remain on watch for.
Bottom line: Higher policy uncertainty is consistent with a more volatile market.
So where does all this leave us?
There's probably 3 main themes that came out of this week's charts:
The first 3 charts showed 3 different types of indicators which showed a market that is looking oversold (50 day moving average breadth, VIX futures cuver, and the fear & greed index). The usual caveat applies, i.e. oversold markets can get more oversold. The other chart that slips into this theme is the IPO chart which put in a pattern consistent with a major market bottom. So for the bulls there is some hope with this theme.
2. High valuations
The bears will quickly counter with the valuations theme in which we looked at elevated forward and trailing PE ratios and an extremely high price to sales ratio. The charts show that in the short-run valuations don't provide much useful information, but they provide very important information about what to expect over the longer-run. But for now, the same caveat applies as the previous theme, i.e. expensive markets can get more expensive.
3. Political risk
The final theme is political risk. There has been a clear rise in uncertainty around the policy outlook and the political climate. This has had a clear and understandable negative impact on confidence, and is likely to flow through to softer real activity in the short-term. It also seems to be impacting on the stock market, and it's worth pondering if the recent selloff is politically driven. Either way, political risk is here to stay for the next couple of months at least, and will surely drive more volatile market conditions.
This week's ChartStorm highlighted a number of indicators which suggest the market is short-term oversold. At the same time a checkup on valuation indicators show a reasonably expensive market, which at the margin is bad news for those operating on a longer time frame. In the shorter run, political risk is rearing its head and will likely drive ongoing market volatility through the next couple of months at least. So overall, a mildly short-term bearish bias could be justified by the oversold conditions, you would just need to close your eyes to the high valuations and rising political risk.
See also: Weekly S&P500 #ChartStorm - 10 Sep 2016