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Weekly S&P500 #ChartStorm - 4 May 2020

Those who follow my personal account on Twitter 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 to explore 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 and color. 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. But inevitably if you keep an eye on the charts they tend to help tell the story, as you will see below.

So here's another S&P 500 #ChartStorm write-up!!

1. Happy new month! For the S&P 500, March’s steep drop (-12.5%) was followed by a sharp April rally (+12.7%) as volatility persists. The monthly chart shows a pattern of increased volatility since 2018. Price has weaved back and forth between the 10-month moving average indicating indecision. Similar trading action was seen during the 2014-2016 period which was characterized as a soft global recession while the US avoided negative growth but still saw lackluster stock market returns.

Many market watchers are waiting to see if this snapback rally, among the most explosive in market history, will find significant resistance. Widely noted last week, the 61.8% Fibonacci retracement from the February peak to the March 23 trough was tagged, followed by a 3.6% drop on Thursday and Friday.

Bottom line: Keep a longer-term perspective. May will provide clues as to the next significant move.

S&P500 monthly chart and 10 month moving average

2. March & April asset class returns: US large caps (S&P 500) were among the best performers in March (least bad, perhaps better said), but then rallied relatively well in April too. It’s the same old story from the 2010s – US large cap growth (mega cap tech) has continued to lead. Perhaps huge cash hoards on the balance sheets of the biggest of the big companies helps during this volatility.

US MLPs, namely those related to the energy sector, saw perhaps the most pronounced inflection during the downturn. It’s particularly fascinating when you glance down at the worst April performer - commodities! Was it the final washout for the beaten-down energy sector? We’ll wait & see, but May could be the market tell to see if April was just a big head fake.

Bottom line: The S&P 500’s leadership during March & April masked some steeper declines across small cap stocks and foreign equities. The latter issues fell about 10% during the two months while the US large caps were nearly flat.

monthly asset class performance charts

3. Mind the gaps: This chart from the prolific @MacroCharts underscoring the 1-month net gap direction on SPY. Recall the slew of opening bell “limit-down” instances in March – add them all up, and the month featured the biggest net gap down on record. April had the biggest net gap up. Welcome back volatility! It makes Q4 2018 look like child’s play.

2007-2009 gets a lot of play as the primary comparison, but take a look at the time around the 2000 peak. That topping & bottoming process was more drawn-out in nature, and the market experienced many volatile months. Huge net gap-up months were seen closer to the market top than bottom though.

Bottom line: The market of stocks has to prove itself. Technicians will look for confirmation that the final low is in, but it is too early to make that call.

S&P500 ETF chart - market gaps indicator

4. Hedge fund positioning: @hedgopia brings us this look at the CFTC Commitment of Traders report. The CoT report can give traders clues as to where the smart-money is positioned. Hedge funds’ net shorts are at the highest level since October 2015, prior to the early 2016 market bottom. Go back to the European debt crisis and US downgrade period of Q3-Q4 2011 – the CoT report showed sharper net shorts then, however.

Interestingly, shorts were higher at two key times: 1) October 2011 which was a stock market bottom and 2) September 2007, near a market peak. So net positions of hedge funds are a tricky thing to analyze at market inflections. Indeed, it can even be a sign of a transition from the "buy the dip" vs "sell the rip" mentality.

Bottom line: Hedge funds used April as a ‘sell the rip’ opportunity. How long that defensive sentiment will last is the question.

hedge fund positioning in S&P500 futures chart

5. Equity risk premium & COVID: It’s time to go to school with Professor Damodaran. Are we being paid to take risk in the stock market? Is it better than the alternative? Those are the questions we hope to address when analyzing the equity risk premium.

Damodaran attempts to adjust the ERP with impacts from COVID. Not surprisingly, the ERP is lower when assuming a 30% drop in 2020 earnings and just a 75% recovery by 2025. COVID essentially takes away more than a 0.5% annual return via a lower ERP from the look-back ERP numbers versus the expected earnings-yield picture.

Bottom line: We all know earnings will collapse near-term, but it is interesting to see how that potentially affects equity market returns. As the market goes up without a corresponding surge in earnings, a tighter premium means less reward vs. risk. The good news for longer-term investors? Even the lower-case earnings projection features a higher ERP vs 4.8% figure from February.

equity risk premium adjusted for covid chart

6. US zombie companies: The next chart comes from the innovative @benbreitholtz. April 2020 was a strong month for companies with lousy fundamentals. A ‘zombie’ firm is defined as a firm with more interest expense than earnings (before interest & taxes). It’s a business that is kept alive by debt financing.

April 2020’s more than 12% climb in the S&P 500 was helped along by these types of stocks. The Fed played had a big hand in it as Powell came out in support of both investment-grade and even some junk bonds, helping to prop-up these debt-laden businesses. October 2011, April 2009 and November 2002 are noted in the dot plots as similar months with massive equity market gains driven by zombies.

Bottom line: a 7% outperformance from the zombies has marked stock market troughs, unfortunately n=3.

chart of zombie companies vs S&P500 returns

7. A concentrated market – or is it? @benmarrow keeps us honest with this look at S&P 500 concentration. Among the more ubiquitous charts & narratives shared on finance twitter this year, and for the last few years, is some variant of just how big the top market caps are. What few realize is that the US stock market was actually more focused on a handful of big market cap issues during the 1960s and 1970s.

There’s a lot to dig into here. Economists and business analysts like to bust out the Herfindahl-Hirschman Index (HHI) to get a gauge on market concentration. The HHI is found by squaring the market share of all firms then adding up the products; the higher the sum, the more concentrated the market.

2020’s mega cap gains yield an HHI similar to that of the 2000 peak, but way below the level seen during the 60s and 70s. AT&T and several massive industrial stocks dominated during that time. Regulators actually went on to break-up AT&T in 1984. The Gini Coefficient measures economic inequality. It increased sharply this year but is still materially below the 2000 peak and the mid-20th century highs.

We are all more familiar with the bottom two looks. Last week, Michael Batnick provided us the tongue-in-cheek pie chart-crime, and the visual on the bottom right puts that pie chart data into historical perspective. Remarkably, it took the bottom ~440 market cap issues in the early 1960s to match that of the top 5 biggest caps. Today, we are near 350.

Bottom line: the market is concentrated, but history says it could still go a lot higher.

US equity market concentration metrics graphs

8. Bear market bounce? @RyanDetrick shared this table of historical dead cat bounces. Cue the Tom Jones as it’s not unusual to be face-ripped by bear markets. The ‘normal’ bear market is 30-40% and exhibits rallies of 10-20%. It’s interesting to see that the prior two bears experience rallies of about 25% within the broader down-trend. 2020’s 31% rise would be one for the books if it were just a bull-trap, but we did see similar type moves during the 1930s too.

Bottom line: History is a tool in the toolbox. A piece of evidence we must weigh. We look at technical and fundamentals at Topdown, and we must always keep in mind that this bear market will likely look different than the past several. It is helpful to monitor a range of outcomes based on history, not a deterministic analog. High volatility means high emotions (fear & greed) during the huge rallies and crashes, and being sucked into emotional investing can be your biggest risk.

9. An even Greater Depression? @MichaeBatnick brings us this look at where the Dow would go if it followed the path of the early 1930s. US stocks collapsed nearly 90% in less than three years from the September 1929 peak. If it happened today, the DJIA would fall to just above the 3,000 mark by late 2022. Ouch. That would also bring the price-weighted index to levels from before the 90s tech rally.

I can think of many more reasons why this wouldn't happen than why it would (I tried to think of some scenarios, and came up with a few, but I would say some of them require more imagination than others!). Anyway, given the fact that the pandemic is fundamentally a temporary one-off shock, and given the massive, globally coordinated monetary and fiscal policy stimulus, I would put less stock in this chart and more in the next one...

Bottom line: Pre-mortem analysis can be useful when managing risk, so how would handle this hypothetical, yet possible, outcome? Always keep an open mind and try to be prepared.

great depression market analog chart on current times

10. Crab Markets: Here's a good reminder that it's not just bull markets and bear markets, sometimes you get crab markets. In other words, yes we have a lot of evidence of markets that trend strongly and persistently up and some examples of markets that trend down, but there's a third type of market regime: a sideways, grinding along type of pattern (a "crab market" as a bit of a tongue in cheek term).

@cullenroche shows us what happened from 1917 to 1924 in the chart below. What’s also interesting about this timeframe is that the Spanish flu gripped the world from January 1918 to December 2020; hard to tell from this chart, isn’t it? US stocks meandered for years following WW 1 and the Spanish Flu pandemic, a basing pattern, before the well-known bull craze of the back-half of the 20s.

Aside from that, there are many many examples of long term crab markets across countries, and across time - remember the 1960's and 70's (me neither, but it was another period of ranging markets).

Bottom line: The stock market has uptrends, downtrends… and sometimes no trend.

crab market chart - long term ranging

So where does all this leave us?

1. A range of outcomes to ponder We tried to convey that anything can happen from here. There are plenty of signs that we may still be in a bear market. A 31% rally off a 35% drawdown is huge, no doubt about it, but was it the bottom? Beyond that debate, it is more important to be prepared for what happens next from the perspectives of: history, current technicals, and market fundamentals.

2. Indecision Massive gaps in March and April, and a recent snapback from some of the worst performers, leaves us waiting for what May has in store. Meanwhile, US mega cap tech growth stocks have generally kept outperforming, driving further concentration gains among the 5 top market cap stocks. Will May 2020 be like November 2008 – a leg lower? Or similar to April 2009 – a confirmation of a market bottom?

3. Concentration & leadership The age-old leadership battle. Some say improving market breadth is ideal, while others want to see the leaders keep leading. Bear markets bring about interesting changes to the structure of market trends – which industries fall from grace and what new ones re-invent themselves? How does that evolution impact the drivers of returns? The balance of the year will feature new winners and losers. Stay tuned, but keep a long-term perspective.

Summary Tying it all together, while it's easy to get sucked into the short-term and the noise flow, if nothing else, this week has helped bring in some perspective or at least serve as a reminder of the value of taking a look at some of the longer term charts and historical data. Short-term there's all sorts of reasons why the market might make a further pullback, and equally possible drivers higher. But longer term I think there is value in thinking beyond the binary market polarization of bull vs bear market; we could easily be in for a crab market.

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