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Weekly S&P 500 #ChartStorm - 18 May 2020


Those that 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. Markets in Lockdown. A trading range ensued following the sharp rally off the March 23 low. Large cap US stocks are about flat over the past month while the 10-year treasury yield has hovered between 60 and 80 basis points for the last month as well. This choppiness has occurred in the face of some of the worst economic data points on record. The 200-day moving average remains above the current S&P 500 level and the 50-day moving average should begin to flatten.

Thursday and Friday last week were interesting in that both days featured 1% or worse intraday declines only to see the bulls fight back and bring the index positive – that has not happened on back to back days since early 2009 according to Bespoke Investments. We’ll see if it portends more positive price action in the coming days and weeks. 2940 remains resistance on the upside while support is not as easily found – the bears thought they were on to something last Thursday morning when US stocks broke beneath the low from May 4. In the end though, the loss for the week was somewhat minor at just 2.1%.

Bottom line: Lockdowns and quarantines can frustrate individuals and trading ranges can frustrate the bulls and bears. We’ve talked about a ‘crab’ market for the last few weeks, and that price action has largely played out. Perhaps now more than (versus the last several months) it will be important to monitor the technicals for the next significant move in equities. For fixed income, many would have expected yields to creep back up, but that of course has not happened. The last month across most of the bond market factors has been rather quiet after the Fed’s bazooka moves in March and early April.

2. “Bear Market Rally”. @MacroCharts brings us this look at news stories of “Bear Market Rallies” since 1990. There have been relatively few such stories when contrasting 2020 to 2002 and 2009. Even early 2016 and late 2018 featured more such headlines. How should investors interpret that?

Perhaps not many see this recovery off the March 23 low as a bear market rally. Do people really believe that was THE bottom? Hard to say. Something to keep in mind though is the backdrop of not only the economic situation but also the human-interest narratives that are so prevalent at the moment due to COVID-19. Maybe the news media is not as interested in the stock market performance now versus the more economically-driven bear markets of the recent past.

There are many interesting takes on this chart, but from a sentiment point of view, it’s possible in fact few believe we will ‘retest the lows’. That would be another good phrase to search, by the way. It seems like it is commonplace on finance twitter to read about the S&P retesting.

Bottom line: Expect this chart to see a spike if there is follow through on intraday losses rather than recoveries (like intraday rebounds seen on Thursday & Friday last week). Cracking fresh multi-week lows and falling back below the 50-day moving average would certainly spark a new wave of ‘bear market rally’ narratives.

3. Lotto tickets & free trades. @sentimentrader shows us this interesting feature of the current market – heavy activity among small traders buying calls and selling puts to open. Both buying calls to open and selling puts to open are bullish trades, so it has perhaps worked out well for such traders in the last 8 weeks. Maybe with no sports betting available and the recent advent of free trading for everybody has led to massive small options trades. Also consider people may be sitting at home with not much else to do other than to fire up their laptop or smartphone, and start clicking and speculating away. Doesn’t seem like a great trading strategy to us, but let’s move on.

Trying to glean more from this chart, there was no trend from 2010 through 2016, but then it gradually began to incline starting in 2017. 2017, of course, witnessed a massive bullish move in stocks, so it made sense that traders may have been prone to near-term bullishness. But that timing also aligns with when trading costs really began to come down.

Bottom line: Maybe chalk up this chart in the buy the dipper’s corner. Congrats to those who successfully sold puts at the market low. But beware should market volatility rear its head once again.

4. Money market melt-up. While small traders feel prone to speculate, the bigger money has been flowing to cash – money market funds, more specifically. So there is more dry powder available as many turned more defensive in the last 3 months. 2000-2002 and 2008-2009 featured similar sharp moves upward in cash positions, which of course corresponded to troughs in the equity markets.

There are few attractive spots to invest – bond rates are at all-time lows and the stock market is still volatile with questionable valuations right now. The near-term part of the yield curve is of course near 0%, so all of this cash is losing ground to inflation which, though taking a huge fall in April, is probably still going to run in the 1.2.-2.0% range for the next year (with upside risk post-pandemic). It is reasonable to expect this massive amount of … wait for it … ‘cash on the sidelines’.. to help buffer against major moves lower in stocks. Or maybe it all goes into gold and bitcoin; that’s always possible, right? (tongue-in-cheek).

Bottom line: Investors are positioned somewhat defensively according to the sharp move higher in cash. Cash is a position, but history suggests major spikes in cash holdings are usually signals of equity market lows rather than tops. We take this as a signal that investors are waiting to get back in and will be buyers at some point down the road. That thesis would be supportive for equity markets.

5. Consumer discomfort. @RenMacLLC produced this chart of the S&P500 against the Bloomberg US Weekly Consumer Comfort Index with year-over-year percent change at the bottom. Surprising to nobody, the comfort index took a nosedive in the last several weeks as COVID-19-induced shutdowns led to the worst near-term drop in economic activity in history. How should we interpret this chart?

Obviously when y/y declines reach beyond the 10th percentile (meaning conditions are awful), we can take that as bullish contrarian indicator. But what is interesting is in the data up top in the graphic. The first bearish signals have taken place in advance of equity market bottoms. For 2020, we just recently had a negative signal. So more equity market declines to come? Hard to say of course, but to suggest that the comfort index will turn up in a big way soon seems quite unlikely and to see a positive y/y move happen is impossible until at early 2021.

Bottom line: 2020 is unique. Wait for it … ‘it’s different this’ time. But it really is. Each time is different. Just look at the economic data - the inflection from good to bad is nothing like what we saw in 2000-2002 and 2007-2009. It’s not to say that was can’t draw parallels to those periods, but an analyst just has to be very careful when doing so. It’s interesting to see 1987 on the very far left side of this chart – no signal was given then (perhaps because the index did not have a full year of data yet). The current y/y change is near -0.4, about in-line with the worst of the Great Financial Crisis. It’s conceivable to see y/y changes continue to run negative through early next year.

6. Broken indicator. The forward P/E ratio is one of the most common market valuation tools. The problem is the denominator. Earnings are of course very difficult to estimate in the next-year, we all know this. But the problem goes beyond that. Earnings are focused on the very near-term. The forward P/E takes quarterly corporate earnings estimates over the next year and then compares that to the current price of the equity index. When it comes to market & economic cycles, 1 year is just not long enough.

This is where longer-term, more smoothed indicators are more useful. At Topdown Charts, we prefer the PE10 over the forward P/E ratio as a means to determine market valuations. As discussed last week, The PE10 takes price divided by the average of trailing (historical) earnings of the last 10 years. The reason for doing this is it provides a more stable anchor for making judgments about the level of valuations. That's why it is sometimes referred to as the cyclically adjusted or normalized earnings PE ratio.

Bottom line: The forward P/E is something everybody knows about. It’s taught in lower-level finance classes in college and is tossed around the web non-stop. The problem is it has serious limitations as a good market valuation tool - particularly in the current environment.

7. Don’t stand on this PEG. If the Forward P/E is questionable in its usefulness, the PEG ratio is worse than useless. But it helps writers find entertaining narratives (so there’s that). Before I comment further – just take a look at the chart. Late 2000, early 2001, early 2009, early 2016 – these were buying opportunities, not expensive markets to be avoided. Sure there have been times when the PEG nailed it, but ‘let's face it, even a broken clock is right twice a day’.

The PEG ratio is the forward price-to-earnings ratio of the stock market divided by the long-run expected growth rate. We already discussed how the numerator here is not ideal. And growth estimates are always wonky when equity market volatility strikes.

Bottom line: The PEG indicator, while handy for coming up with clickbait, is useless for actual investment decision making.

8. PEG Problems. Let’s dive deeper into the PEG ratio denominator – the long-term average earnings growth estimate. This figure comes from the Institutional Brokers Estimate System consensus earnings expectations. Maybe surprisingly, the estimate can vary wildly despite being described as ‘long-term’. It peaked at the 2000 market top just shy of 20% while the Great Recession brought about a reality check and a lower expected growth rate. The 2017 Tax Cuts and Jobs Act shot the outlook way too high at almost 18%. And now here we are back near the lows. Of course a lower denominator means a higher quotient (a higher quotient means a more expensive market, according to the PEG).

Bottom line: I think we’ve beaten this horse to death. We have a questionable numerator (forward P/E ratio) and an unreliable numerator (long-term average earnings growth estimate). So the output is going to be lousy. Make better use of your market valuation analysis, and look to the PE10.

9. Earnings simulation. We laid out a few ‘what ifs’ last week. Here’s another – this time on the topic of earnings. What if earnings follow the path of 2009? First off, it would be about 2 years until we made a new high in corporate EPS. The point here though is that both the consensus forward earnings outlook and the trailing 12-month earnings figure are very volatile.

The black line is what we prefer – the 10-year average. It’s just better for helping to identify intermediate and long-term market valuations. An underlying assumption of the PE10 is that earnings tend to be trend-reverting – a huge upward move (like from the Tax Cuts) is probably transitory. At the same time, early 2009 and the current period probably feature corporate profits that are unusually weak. So it’s better to smooth out it out.

Bottom line: Market valuations are not suggesting a tremendous value right now, but certain areas of the global equity markets certainly feature opportunities when analyzing current price to the long-term average earnings multiple.

10. Working hours. Our final chart of the week comes from @LawrenceLepard. Average working hours to buy the S&P 500. If you are looking for a bearish narrative on large cap US stocks, this one’s for you. Technology, the fruits of globalization, lower taxes, declining interest rates and increases in productivity help explain away some of the surge starting in the early 1980s.

This chart also drives home the point that it is dangerous to assume all charts and data sets are mean-reverting. Not saying this chart will keep moving up, but always consider the chance that trend will prevail over mean-reversion – much like the phrase ‘the market can stay irrational longer than you can remain solvent’. So it is more of a gimmick chart, but certainly a conversation starter.

Bottom line: US large cap stocks have of course outperformed most other major equity sub-asset classes in the last 10 years. The result is the S&P 500, near 2900, is hardly ‘cheap’. Other areas of the global markets do offer solid long-term value though.

So where does all this leave us?

1. Consolidation.

The equity markets have done a whole lot of nothing in the last month while economic headlines have been beyond awful. There have been a few trading days during which the bulls were ready to drive stocks to fresh highs, only to see sellers step in around the 2940 level. And there have been other times when it appeared the bears were ready to roar and send stocks south only to see solid intraday bullish reversals. And the bond market has perhaps been even more sideways since mid-April. Maybe market participants are waiting for a ‘second wave’ of catalysts beyond just COVID-19 headlines. There is an election coming up soon, in case you forgot.

2. Dry powder.

Money market fund balances have moved up despite equity markets recovering a big chunk of the February-March losses. While day traders have been buying options like the betting addicts they may be, the bigger money is waiting it out before putting their money back to work in stocks. Cash is a position, after-all. It’s possible that has helped cushion the blow when we do witness those days where it feels like stocks are ready to move lower once again.

3. Looking long-term.

Be careful and thoughtful analyzing equity market valuations. The common measures like the P/E ratio and PEG ratio have proved to be unreliable indicators, yet everybody talks about them and they are taught in every finance classroom (or Zoom meeting) across the country. “This too shall pass” is a prevalent phrase right now, and it applies to corporate earnings too. Just as severe jumps in earnings outlooks are usually transitory, so too are sharp declines.

Summary Tying it all together, not a whole lot has changed from last week, but there are always fascinating features of the market that emerge from under the surface. Volatility has come off in a big way; the VIX went under 30 for a time last week – and realized volatility, above 80% early April, is now just above the 30% level. We tried to focus on the future and longer-term signals this week though. While it is an understatement to say conditions are discomforting for consumers, as state stay-at-home orders ease, people will gradually return to normal life and businesses will slowly reopen. For markets a return to normal will likely also emerge, but for now the new normal is more ranging...

See also: Weekly S&P500 #ChartStorm - 11 May 2020

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