5 Dec 2016
The secular bull market should live on to see its eighth birthday
Since the pre-election low on November 4, the S&P 500 is up 4.7%, while the Russell 2000 (small caps) is up a whopping 13.8% as of November 21—rallies which have confounded many investors given the pre-election consensus that stocks would fall on the uncertainty associated with a Trump victory. We did not move into the bearish camp pre-election; but did expect to see a bit more volatility than what has ensued so far.
Bears morphing into bulls
Investors sentiment has certainly shifted swiftly back to optimism. Two sentiment indexes on which I keep a close eye are from the American Association of Individual Investors (AAII) and SentimenTrader (ST). The former shows a significant spike in bullishness—back to the highest level in nearly two years.
Strategas Research Partners recently conducted a snap survey of institutional investor sentiment; with more than 650 of their clients responding. The question was simple: Does the outcome of the election make you more bullish or less bullish on stocks? More than 83% responded that they’re more bullish. And in keeping with the strong outperformance of the financial sector (on which Schwab has an overweight recommendation), nearly 57% believe financials will be the “biggest beneficiary as a result of the election.” On the other hand, over 40% believe utilities (on which Schwab has an underweight recommendation) will be the “biggest loser.” The utilities’ dour sentiment no doubt reflects the significant back-up in longer-term Treasury yields.
We’ve witnessed one of the largest sector rotations in the modern market era—in this case from more defensive sectors to those seen as potential beneficiaries of the perceived pro-growth policies of a Trump administration. But performance has been somewhat narrow as financials and industrials are the only two sectors outperforming the S&P 500 by more than one percentage point.
Another behavioral measure of investor sentiment is fund flows. More than $30 billion flowed into U.S. equity funds in the week up to November 16—a record weekly haul, according to data from EPFR. And correlations have been coming down—a potential support for the beleaguered active style vs. passive style of investing.
Has the market gone too far too fast? Perhaps in the short-term, but animal spirits—assuming they’ve awoken—can fuel rallies for an extended period. There is much about this rally so far to behold—and much which is also unique. According to data from Bespoke Investment Group (BIG), performance since the election has been inversely correlated to market cap.
Stocks with the most attractive valuations have rallied the most, which is unique relative to what is normally seen in big rallies. I think it reflects an environment with improving economic growth prospects. When economic growth is harder to come by, stocks with better growth prospects tend to outperform. But when growth is less dear and more amply distributed among companies, investors tend to shift their focus to finding companies trading at reasonable valuations.
Finally, with the dollar up sharply, stocks of companies with the lowest exposure to international markets are up about three times the performance of stocks of companies with the highest exposure to international markets.
Recent economic releases have also provided support for the rally, suggesting that some of the lift in the economy was already happening, and isn’t just a hope for next year under a Trump administration. Of the 20 reports released in the week of 14 November, nine were better than expected—including retail sales, housing starts/permits and unemployment claims. Four were in line with expectations and seven were weaker—including industrial production and capacity utilization. Reflecting the better economic data and higher inflation, the Federal Open Market Committee (FOMC) is likely to raise rates at its December meeting.
Secular bull should live to see its eighth birthday
The net is that my view has not changed that we remain in a secular bull market, which is set to celebrate its eighth birthday this coming March. But we may be pulling some of next year’s performance into the final weeks of this year. I continue to expect some bouts of volatility as we move from speculating about Trump’s policies to actually facing their reality next year; especially if protectionism moves up the priority ranking of policies. As mentioned, animal spirits have been suppressed for some time, and appear to be lighting up. This is the strongest support for both the economy and stock market looking ahead. But there are risks, including the aforementioned spikes in optimistic sentiment (a contrarian indicator) and the U.S. dollar (which is causing a tightening of financial conditions). Stay long, but stay strong in terms of your discipline around diversification and rebalancing.
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