20 Nov 2017
Elevated Optimism and Complacency Could Lead to Pullbacks in the U.S. Ongoing Bull Market
The long-running bull market continues and has shown few signs of faltering. Even modest pullbacks have failed to gain any momentum and the uptrend has been largely intact throughout the course of 2017. There are signs that the potential for a “melt up” is heightened. Investor sentiment is well into the extreme optimism zone based on the Ned Davis Research Crowd Sentiment Index. Strategas Research reports that the S&P 500 has posted a 15% year-to-date gain through October, 17 times since 1950, including this year. While past performance is no indication of future results, the average return in those years for November and December was 2.7% and 4.9% respectively, above the historical average for those months of 1.5% and 3.2%. Additional support for the ongoing bull market could come from the holiday shopping season, which is shaping up to be a good one. For starters, there are 32 days between Thanksgiving and Christmas—the second most possible—and consumer confidence is quite high heading into the most important period of consumerism each year.
We don’t want investors to be complacent however, as pullbacks are always possible and exogenous events are inherently unpredictable. Stretched valuations, combined with signs that investors may be complacent and/or overly optimistic, mean that the risk of pullback is elevated.
Economy and earning support ongoing bull
That solid backdrop has been bolstered by third quarter earnings season. According to FactSet, with 81% of the S&P 500 having reported, 74% have beaten earnings estimates, while 66% have beaten revenue estimates—both above their longer-term averages. However, the earnings season has also contributed to our belief that we are entering the latter innings of this bull market, as those companies that have even modestly disappointed have largely seen their stock prices face harsher declines than usual. EvercoreISI reports that S&P 500 companies that have missed estimates on both the revenue and earnings sides have seen their shares underperform over the ensuing three days by 3.47%, over 75 basis points more underperformance than the historical average.
Solid earnings are made possible by a strong economy, which appears to be more and more the case in the United States. Although some data continues to be skewed by the natural disasters, especially in the housing and auto areas, the majority of releases continue to point to solid growth. Personal spending rose a healthy 1.0% in September according to the Commerce Department, which was the largest increase since 2009; while the Chicago PMI supported other regional manufacturing surveys by rising to 66.2, its best level since March 2011. These solid regional surveys help feed into the Institute of Supply Management (ISM) survey that showed the manufacturing index remains in strong growth territory at 58.7, while the forward-looking new orders component posted a robust 63.4 reading. The significantly larger services side of the economy also looks healthy, with the Non-Manufacturing ISM rising to a boom level of 60.1, while the orders component remained strong at 62.8.
The labor market is becoming increasingly tight, which is filtering through to wage growth. Although average hourly earnings growth remains relatively tepid, the Atlanta Fed’s Wage Tracker—which measures median wage growth—shows significantly stronger growth of 3.6% on an annualized basis. In addition, the leading indicator of unemployment claims readings has recovered from its brief move higher during the hurricanes and is back at historical lows.
The latest employment report from the Department of Labor for October showed 261,000 jobs were added, rebounding from the hurricane-induced weakness seen in September; while the unemployment rate fell to the lowest level since 2000 at 4.1%.
New Fed head and major tax announcement fail to move markets
Two potentially historic announcements came recently, but failed to move markets to any great degree. President Trump nominated current Fed governor Jerome “Jay” Powell to replace Janet Yellen as Chairman of the Federal Reserve when her term ends early next year. The move was largely expected and greeted relatively favorably by the market as he is, like Yellen, a relatively dovish consensus builder; and therefore will represent continuity as the Fed continues its monetary policy normalization process. Given the aforementioned strong economic data and the pickup in some measures of wage growth, we believe the Fed will hike rates for the third time this year next month.
Earnings season, both in the United States and globally, has been solid, while economic growth has accelerated across much of the globe—all supportive of an ongoing global bull market. Elevated optimism and complacency could lead to pullbacks, but we believe it would be in the context of an ongoing bull market.
This material is issued by Charles Schwab, Hong Kong, Ltd. The information provided here is for general informational purposes only and has not been reviewed by the Securities and Futures Commission in Hong Kong.