Week 20 Sitrep

The month of May is usually a time to focus on U.S. corporate earnings growth for the 1st quarter and whether the market will slow over the summer months. Investors over the last week seemed to care less about current stock market conditions, corporate earnings reports, or the record unemployment over the last six weeks. Rather, the mood was set by media headlines that more states are considering allowing businesses to return to work. As a result, the major U.S. stock indexes enjoyed another robust week of returns with the S&P 500 Index up more than 3.5%.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 5/11/20

 

Most investors believe that the markets are broadly improving but there are large disparities between the various indexes. As of Monday, May 11th, the Dow Jones Industrial Average is down 15.13% for the year while the S&P 500 Index is down 9.21%. However, the NASDAQ Index is up 2.64%. Those differences are largely due to the exposure of certain sectors and stocks to the different indexes.1 For example, the S&P 500 is broadly represented by technology, health care and consumer stocks where the largest companies represent a larger share of the index. The NASDAQ has a larger representation of technology, telecommunication services and discretionary stocks. 2020 has been a more difficult year if you own nothing but index funds!

Source: J.P. Morgan Asset Management, Weekly Market Recap, 5/11/20

 

The NASDAQ Index is now trading within 5% of its all-time high values, which is roughly the same level that it was on February 24, 2020 and has only had 16 days trading above its current level.2 There are many stocks in the NASDAQ Index that have been unaffected, or have even benefited from, the effects of the COVID-19 virus and subsequent economic shutdown. Companies such as Amazon, Netflix and Zoom have been complemented by various health care names to keep the NASDAQ ahead of other indexes. Areas that have been negatively impacted by the economic shutdown are more prevalent in the S&P 500 and include industrials, financials, and retail.

Source: Bespoke Investment Group, The Bespoke Report, 5/8/20

 

The drastic differences between market sectors has left the S&P 500 Index trading in a familiar range. Many analysts have noted the recent market performance has created an overbought environment for many stocks. Bespoke Investment Group notes that 154 stocks in the S&P 500 are now trading more than one standard deviation above their 50-day moving average. The technology, consumer discretionary, communication services and materials sectors are all in overbought status as well.3 Given the negative earnings setup and expected economic setup over the next month, the index might be stuck in this trading range a bit longer.

Source: Bespoke Investment Group, The Bespoke Report, 5/8/20

 

As stated earlier, many investors question if the worst is behind us for the broad stock market indexes. The stock market returns in April were out of the ordinary but individual investor confidence remains subdued. We continue to witness major divergences across the stock market that cause concern about a market recovery. Analysts report that many of the stock market gains have come from a small group of stocks and that evidence of market breadth is weak. A favorite tool to determine market health is the Advance/Decline (A/D) line which measures the number of stocks advancing compared the number of stocks declining. 2019 was marked by rising index values and a rising A/D line. Recently, the A/D line is lagging significantly behind the index price increases.4 Alternatively, the number of S&P 500 sectors trading above their 50-day moving average is encouraging. However, the 50-day moving averages are not increasing as we would hope in a market recovery.

Source: Bespoke Investment Group, The Bespoke Report, 5/8/20

 

Corporate earnings season is winding down for U.S. companies and results have been in-line with expectations. The areas of the market hardest hit by the economic shutdown have experienced the worst results. Factset Insight reports that first quarter earnings are down 13.6% from the same period last year.5 The outsized losses from consumer discretionary, financial, and energy sectors are too large for other sectors to overcome. The net result will mark the largest year-over-year decline in earnings since 2009.

Source: Factset Insight, John Butters, 5/1/20

 

We have discussed the importance of comparing earnings results to current prices to ascertain a relative valuation for the markets. The most commonly used measure for valuation is the price/earnings ratio. Economic recessions typically lead to elevated P/E ratios initially as earnings decline. The key question is whether stock prices will decline enough to bring P/E ratios back to relatively attractive valuations. The long term average P/E for the S&P 500 is 15 and the most recent measure of P/E stands above 20.6 The current market would be considered expensive in terms of anticipated economic growth for the next few quarters. There is always a chance that P/E ratios could decline as earnings recover faster than prices rise – that might be wishful thinking given the current economic outlook.

Source: Factset Insight, John Butters, Earnings Insight, 5/8/20

 

Our market indicators remain steadily in bullish mode. The long-term indicator has held in a tight range of 55-60 despite the market increases. The intermediate indicator is still negative and will not be eligible for reversal until July 1st. We have added a fourth indicator at the bottom of the chart that is called the Balance of Strength Signal (BOSS). The BOSS indicator measures the demand for cash as an investment class relative to all other investments. The indicator is positive when the demand for cash is falling relative to the demand for other investment classes such as large growth companies. A change in sentiment for demand will be reflected with a negative indicator reading. The BOSS indicator recently turned positive on March 26th.

 

Interest rates remain bound with the 10-year U.S. Treasury Bond trading between 0.60-0.70%. Analysts are divided on interest rate forecasts based on the promised growth in money supply from the Federal Reserve. Some will say that interest rates will rise as the need for additional borrowing by the government will necessitate higher rates.7 In the short term, economic contractions historically lead to lower inflation and lower rates. Our investment committee believes that rates will remain low until economic growth begins to rise again.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 5/11/20

 

Factset Insight recently compiled economic projections for all the major world economies. The chart below reflects a summation of the U.S., China, and Eurozone countries. The economic declines are not unexpected, but we are interested to see that forecasts for the Eurozone continue to reflect regional weakness in demand. Those readings are consistent with additional research we use and are the basis for limiting our investments in the European equity markets. We continue to emphasize that economic forecasts are extremely uncertain currently as we await the reopening of economies around the world. The third quarter forecasts are prone to significant revisions if businesses continue to be held back on government orders. These revisions present additional investment risk in client portfolios and will be accommodated as data is released.

Source: Factset Insight, John Butters, Earnings Insight, 5/8/20

If you’d like to schedule a time to discuss your portfolio or the markets in detail, please feel free to call our office at (281) 616-5935 or send an e-mail to cameron.malott@engravewealth.com. We welcome the opportunity to sit down with you and learn more about your situation so we can help you optimize your portfolio to meet your financial goals for years to come.

Engrave Wealth Partners Investment Committee

Bill Day, CFP®, CIMA

Taylor Parker, CFP®

Greg Parker


Footnotes:
1. Bespoke Investment Group, The Bespoke Report, 5/8/20
2. Bespoke Investment Group, The Bespoke Report, 5/8/20
3. Bespoke Investment Group, The Bespoke Report, 5/8/20
4. Saut Strategy, Andrew Adams, Trading Flash, May 12, 2020
5. Factset Insight, John Butters, 5/8/20
6. Factset Insight, John Butters, 5/8/20
7. Zerohedge.com, Tyler Durden, Another Leg Lower is Coming…, 5/11/20

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