Feeling Conflicted
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In portfolio analysis, there are many things to pay attention to. I believe that the first and most important thing is to see where money is being treated best. This means taking a very high-level approach at examining US Stocks, Foreign Stocks, Bonds, a currency other than the US Dollar, Commodities, and Cash. From there, given that we reside and tend to be most focused on the US Economy, there tends to be a greater than average amount of concentration given to the US Equity market. When looking at the US Equity market, it can be divided into Growth companies and Value companies, then further boiled down to large, medium, and small companies. And lastly, which sectors are doing the best, and which companies are the leaders in these sectors.
Taking one last moment to quantify the activity outside our borders, I think it is important to measure the monetary action in greater Europe. Both the European Central Bank and Bank of England plan to continue to reduce rates. This is super important because they aren’t lowering rates because they are paying attention to inflation. They are lowering rates because their economies are in the hurt locker!
All of these points make sense longer term, but in the short run, which is cultivated and exasperated by the media beliefs are challenged. Given that right now we have no limit to the number of interesting things going on that can challenge an analysis, sticking to one’s disciplines becomes even more difficult. At the end of the day, the noise should always be superseded by “it’s the economy stupid.” This is an old saying that basically says that anyone can believe whatever they want to believe, but in the end, if the economy is expanding- at a digestible rate, and corporate earnings are progressing, beating expectations, and forecasting continued expansion, equity prices in general should continue to advance. This is where we are currently.
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Markets take these into consideration and prices vacillate higher and lower on a continuum or average price basis. At high points short-term oriented types take money off the table, and at lower points those that don’t want to miss the next move start adding to positions.
This brings me to the point of this week’s note. Currently we are at a point of indecision, but, still within an uptrend. When this happens the price of the market, as measured by following the S&P 500 index, will remain locked in a tight range until something that sways investors to either put more money in or take money out. This was the picture that I put in the letter last week where I put a big box around the current range that the market has been in since October. Below, I have gone back to 2020 and found other times where these boxes can be drawn. Does it mean anything? Strangely enough, no! What it does mean is that at some point Mr. Market jumps out of the box. Will it be higher or lower? Again, this depends on what combination of facts exist that are strong enough to make the broad flow of money move in or move out.
So, this brings me to the question of the day, what is it that makes the market feel conflicted, and what are some of the things that I use to examine the conflict and make shorter-term decisions while always remaining focused on “it’s the economy stupid.” I subscribe to a service called Ned Davis Research. This team is a valuable information source as I find their research agnostic to the ups and downs of the market yet very good on consistently following different measures that I feel are important to consider. But before I do this, I wanted to put up the short-term picture of the S&P as it is in what is called a triangle formation. This is where it is moving sideways and compressing (like a spring) into a tighter and tighter range. Normally, things will break out of this triangle in the direction of where the price has been moving longer-term prior to the triangle. But, this is not always the case, hence the art vs. the science on interpretation.
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Back to the studies of market behavior. Even though there are many studies, we do not hang our hat on any one indicator. For sentiment, that means looking at polls of individual and institutional investors, flows into mutual funds, ETFs, and stocks, and positioning ranging from strategic asset allocation to options volume.
The weight of the evidence for sentiment was optimistic after the election. A two-year bull market during ’23-’24 discouraged many bears (negative market people), and Trump’s victory appeared to have pulled a group that had been investing with their political leanings (which we do not recommend, regardless of party) off the sidelines. The Trading Sentiment Composite spent much of November and December in its extreme optimism zone. Uncertainty around inflation and Fed policy, the viability of the AI theme, and President Trump’s flurry of executive orders have knocked the Trading Sentiment Composite back into its neutral zone. To see what the money is actually doing, and to follow up on Big vs. Small, Growth vs. Value and others, this is a clear picture of what we are currently seeing from a cross reference:
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What’s the chatter now?
While we rely on the weight of the evidence, and the direction of economic growth, it is helpful to occasionally dig into the details. The rest of today’s report highlights investor surveys. They paint a picture of growing complacency, with a couple of glaring exceptions (both positive and negative).
First, the bad news for the bulls (those positive on the equity market). The National Association of Active Investment Managers (NAAIM) surveys member firms for their equity positioning. This is a measure of the institutional (big money) side of the investment market. While off a little from its post-election high, it has spent most of the last five months in its optimistic zone, where it sits today. I believe this is due to the fact that interest rates do not make bonds attractive- due to a fear of continued inflation / stagflation, international markets are in a dreadful position as evidenced by the no contest votes out of Germany, France and Canada. And commodities, other than gold (a flight to something other than the US Dollar) seem to be fairly tame at present.
Similarly, the Investors Intelligence weekly survey is showing a modest drop from the multi-month highs of December but still remains in its extreme optimism zone. The "Investor Intelligence Weekly Survey" is a survey conducted by Investors Intelligence (an outside polling organization) that gauges the sentiment of financial advisors regarding the stock market, essentially measuring how many advisors are currently bullish (expecting market rise) versus bearish (expecting market decline), providing insight into overall market sentiment based on professional opinions;?it's often considered a contrarian indicator, meaning extreme bullishness might signal a potential market downturn and vice versa.?Each week the service Investors Intelligence?surveys some 140 financial newsletter writers to determine whether they are leaning bullish or bearish in their opinions to subscribers. One might think that more bullish opinions are better, but in reality, within an upward progression, we want to have periods where the bulls are getting tired and recharging their batteries so to speak.
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In looking at the various newsletters that are sold both in print form and online, there is a company called Hulbert that takes most all of them into account to create its own measure of market sentiment. The Hulbert Newsletter focuses on short-term market gyrations, so it makes sense that the survey has been more volatile. It hit a record high in early December, fell to neutral, but has returned to its extreme optimism zone. This study tends to mirror the general moves of the overall market as it is rather short-term in nature.
The US Conference Board does its own studies as well. In its monthly survey, the Conference Board asks if respondents think stock prices will increase, decrease, or stay the same over the next 12 months. Only 23.5% expect a decrease, barely high enough to keep the indicator out of its bearish zone. The Conference Board monthly survey is called the "Consumer Confidence Index" (CCI), which measures consumer sentiment about the current economic conditions and their outlook for the future, essentially gauging how optimistic consumers feel about the economy based on a survey conducted by The Conference Board, a non-profit research organization. Even though people are uneasy by the number of moves of the new administration. If they are measured by the action of their wallets, they are still quite positive. Here is what the media is blathering about currently. The tariffs are a pretty meaty subject that they can sink their teeth into so this is what we are getting:
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The American Association of Individual Investors (AAII) asks its members if they are bullish, bearish, or neutral over the next six months. The ratio of bulls over bulls plus bears (removing neutral respondents) has been more cautious than many other surveys in recent years. See the measures in the charts above. Its spike after the election was much smaller, and it has since returned to the extreme pessimism zone. It has been in this pessimism zone again because of the agitation being felt due to extreme differences in the way the current administration is making changes.
As can be seen in the probability table above and the market action in the other chart above that shows what happens when bulls are negative and have flipped positive, the probabilities of a continuation of the last two years of market action seems to be pretty good.
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Political pessimism remains with Trump’s first approval rating. While not an investment survey, the presidential approval rating has tended to act like other sentiment polls in that it has been a contrarian indicator for stocks. The exception has been when approval ratings have been so low they reflect major recessions or crises. Both Trump and Biden have been disliked by so many Americans that their low approval ratings have been bullish for the stock market from a contrarian perspective. Trump’s first approval rating was only seven points higher than Biden’s last one. Many of those who were excited about Trump’s return to the White House have been offset by those concerned about tariffs or other policies.
In closing, what does this all mean for you, your money, and your future? It isn’t unusual for the stock market to consolidate sideways for a time. However, these types of multi-month periods within such a tight range don’t happen that often. And they don’t always necessarily lead to a top either. As shown in the first picture at the top of this report, since the 2020 COVID low, I can spot three other similar multi-month sideways ranges of similar size and duration to the current one. While the one in late 2021—early 2022 did ultimately create some sort of top and resulted in a larger decline afterward, the ones in 2020 and last year resolved higher. So as frustrating as these times are, all we can really do is watch for a change in trajectory. This is what has happened just this last week. Looks like the bulls seem to be winning once again.
I will continue to be vigilant at measuring the major global markets against each other and making changes when we feel it is appropriate. At the same time taking into consideration YOUR personal situation, YOUR tax situation, YOUR time horizons, and YOUR feeling about risk and return.
Every day there are things that are “different this time.” To me, I feel the biggest elephant in the room is the amount of money that was helicopter dropped on the economy following the Great Financial Crisis and the Pandemic. In looking at the graph below, I highlight what is bothering me the most, the servicing of the debt on the entire US economy. I don’t really know how this is going to play out eventually, but this could be a major component in setting the course of the US economy for decades to come.
-?Ken South, Tower 68 Financial Advisors, Newport Beach
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