Market Narrative Makes for Record Gap between Hope and Reality

Market Narrative Makes for Record Gap between Hope and Reality

There is just no escaping the reality that markets are driven by narratives and people are highly trainable – just ask Dr. Ivan Pavlov. For years investors have been trained to believe that markets cannot go down because central bankers will step in and do something that will prop them back up. This has essentially become a self-fulfilling prophecy. The most recent narrative has been the Trump reflation and economic acceleration trade in which narrative versus reality has reached a whole new level of wackiness.

As reported in the Financial Times recently, Morgan Stanley has found a record gap between the hard and soft US economic data, which is the difference between sentiment and reality.


The difference between quantifiable data and reports based on sentiment has never been so wide, prompting a sharp divergence in expectations for first-quarter US economic growth, according to an analysis by Morgan Stanley.

Source: Morgan Stanley flags ‘record gap’ between hard and soft US economic data

The prevailing narrative, as we head into earnings season, is that businesses are full of optimism and animal spirits are taking hold of the economy with robust growth right around the corner.

Apparently, those animal spirits aren’t looking to borrow to pay for that accelerating growth. It is possible that some businesses are holding off on borrowing until we learn what changes might be made to the tax code, but such a profound decline in borrowing does not support the assertion that businesses are gearing up for accelerating growth. This does support our Asset-Lite Business Models investing theme, as in such uncertain times, businesses look to limit long-term investments and focus just on those areas they can deliver value with minimal investment risk.

Investors have learned since the financial crisis that betting on the market going down is a fool’s errand as central bankers have stepped in every time to prop asset prices back up. We learned, oh did we learn. The markets now trade within a very tight band, with median volatility in 2017 lower than 95% of all trading days going back nearly 30 years and yet there is this. Note that the red line denotes the level on April 3rd, 2017. Only two other times in the past 5 years has uncertainty been this high yet the VIX is lower than 95% of all trading days over the past 30 years? I’d say those bears have learned to ignore the bell of weakening fundamental data.


Those watching the fundamentals and thinking that meant something had their shorts handed to them as the bulls smugly wagged their knowing fingers. The market will not go down, it will not go down I say… until the day the market sees what is behind that magic curtain.

Perhaps this might start to lift that curtain just a tad.

HT to Variant Perceptions

This chart shows that in recent years US equity price increases have been driven by rising PE ratios rather than improving business fundamentals, much more so than in years past where PE ratio shifts, in contrast, were often a drag on returns. What we found particularly interesting is the relationship between increases in government spending and PE ratios. The Trump Trade expects an increase in fiscal stimulus. That means increased government spending which has historically been associated with falling PE ratios – something to keep in mind as we watch the battles in D.C.

Looks to us like bonds are also thinking this accelerating growth/reflation story may not be quite right.

10 Year Treasury Rate Chart

10 Year Treasury Rate data by YCharts

Your Tematica team will be watching carefully as this narrative gets tested further and will keep you posted when meaningful events occur, so stay tuned!

S&P 500 hits record $20T market cap as warning signs mount

S&P 500 hits record $20T market cap as warning signs mount

This morning the S&P 500 reached $20 trillion in market cap for the first time in history even though investors have been flocking out of active management funds and into passive ones, such as exchange traded funds (ETFs), at an accelerating rate. This is typically the behavior we see nearing market tops.

As markets move deeper into expensive territory, meaning higher P/E ratios, many active professional investors start to put on protection and/or increase their cash balances as they see less upside potential relative to downside risk. If the markets continue to press higher, those managers will then obviously underperform. Often this is when we see investors’ confidence rise as passive outperforms active and with that, we see accelerating fund flows into passive over active management. We saw such moves in 1999-2000 and 2006-2007, typically marking an impending market top.

Investment managers that have stood the long-term test of time, such as Jeremy Grantham of GMO, are watching clients walk out the door as we see the reemergence of “This time is different” theory with increasing belief that high P/E ratios this time mean something different. We saw similar moves away from those tried-and-true managers in 2000 and 2007. Today’s market is not one that would be wise to short as confidence remains high, but watch out for the catalyst that reverses the assumptions upon which all that investor faith is resting.

Investors pulled a net $340.1 billion from U.S.-based actively managed funds last year, according to Morningstar, while pouring a record $504.8 billion into U.S.-based passively managed funds.



Vanguard crossed the $4 trillion mark in January after collecting an estimated $49 billion in net new cash from investors during the month. Of those January flows, about $45 billion went into index funds while the balance went to actively managed funds.


In 2016, index funds accounted for about 85% of the total net new cash Vanguard attracted.


These flows have led to the size of passively managed assets in the U.S. to grow significantly faster than active, which have nearly flatlined in recent years.


This confidence in more rules-based approach has come at a time when equity valuations are more stressed than at any other time in the past decade. As P/E ratios get stretched, upside potential continues to shrink while downside risk grows.

Meanwhile trailing 12-month net margins look to be rolling over – yet another warning sign.


And despite investor enthusiasm, corporate guidance hasn’t been all sunshine and roses. The disconnect between investor enthusiasm as evidenced by P/E ratios above what we’ve seen in over a decade and corporate guidance is another warning sign.

But that hasn’t stopped analysts from reflecting investor enthusiasm. This chart pretty much speaks for itself – that is a lot of perfection expectation!


While investment newsletter writers fan the flames of enthusiasm, which has also typically been a signal of an impending market top.

The share of newsletter writers who are optimistic on the stock market climbed to 62.7% this week, the highest level since 2004, according to Investors Intelligence, which surveys more than 100 newsletter writers each week for its Sentiment Index.

A reading above 55% suggests a trading top is forming, while topping 60% means “it is time to start taking defensive measures,” according to Investors Intelligence.  The measure has been above 55% for 11 straight weeks, and above 60% for four of them.


Remember Bob Farrell’s Rule No.9. “When all the experts and forecasts agree, something else is going to happen. This is not magic. When everyone who wants to buy has bought, there are no more buyers. At this point, the market must turn lower and vice versa.”

On a more positive note, so far EPS growth for the December quarter is around +5 percent for the S&P 500 versus the +3 percent bottoms up consensus estimate at the beginning of that quarter. So there is some cause for optimism, but the level of success that the markets are pricing in is exceptional. Since the market’s bullish moves have been based upon expectations around President Trump’s reduction in regulation and taxes, it is noteworthy that he recently acknowledged that the repeal and replacement of the Affordable Care Act, a major talking point during the election, could be pushed back into 2018. We suspect that isn’t the only change that won’t be implemented as quickly as the market expected.

Sources: Vanguard Reaches $4 Trillion for First Time – WSJ and Newsletter Writers Are the Most Bullish Since 2004 – WSJ


Investors are strongly…. neutral but then there's TINA & JOLTS

Investors are strongly…. neutral but then there's TINA & JOLTS

As the S&P 500 repeats its attempt to break through the 2015 highs and get out of the trading range it has been in for over two years, investors are strongly…neutral, (once again) at least according to the American Association of Individual Investors survey.

US Investor Sentiment, % Neutral Chart

US Investor Sentiment, % Neutral data by YCharts

In fact to find a time when investors have been more neutral than the recent highs you’d have to go back to 1988!

Since the stock market peaked over a year ago, earnings for the S&P 500 have declined 8%. In fact the current level of per share operating earnings are around the same level it was in the second quarter of 2011; five years later and earnings at the same place but the S&P 500 is 50% higher.

Investors are neutral, the market is seriously overbought, but many have already left the dance floor with investors having pulled over $100 billion from equity funds so far this year.

Looking at other measures of market sentiment,  in the past two months the net speculative position on the S&P 500 on the CME has swung from a net short of 17,474 to a net long of 12,028 contracts. That’s a big change in attitude! We’ve seen the opposite with bonds as the 10 year US Treasury has gone from 2,706 net long positions to 159,930 net shorts and is the most bearish in over a year.

What’s driving this?

Yesterday we talked about FOMO, so today, meet TINA aka There Is No Other Alternative. With an aging population across most of the developed and more affluent world, retirees and soon-to-be retirees are desperate for somewhere to put their savings.  About 25% of OECD debt has negative interest rates, which means investors are paying for the privilege of lending out their money. Just today UK Gilt yields (10 year at 1.263%) and German Bunds (10 year at 0.049%) have hit record lows and with the European Central Bank no longer confining itself to just purchasing sovereign debt, yields are likely to keep going down until something breaks. The Swiss government just announced plans to issue a 13 year bond with a zero coupon – good times!

But then there is the JOLTS report, which after Friday’s dismal non-farm payroll mega-miss, delivered some much welcome hope in the form of the fifth consecutive month of rising job openings. So it’s all good, nothing to worry about, moving on… or is it?

The problem is that job openings don’t drive economic growth, hirings do. While job openings have been increasing, actual hirings have been shrinking: down -198k after -220k in March for a combined 418k, which is the fourth steepest decline on record and was broad based, meaning across all sectors rather than concentrated in just energy for example. The hiring rate for February was 3.8%, dropping to 3.7% in march and down to 3.5% in April for the lowest level since last August. We are also seeing voluntary quits, a reflection of how confident people are with their ability to find a new job, has called in three out of the past four months.

Right now we are seeing a divergence in signals from the data with core capital good, (non-defense capital goods ex-aircraft) shipments and orders falling. The most recent reports show a decline in shipments of 7.7% on an annualized basis with 4.8% year-over-year decline. Orders dropped 8.8% on an annualized basis with a 4.4% year-over-year drop, so both are accelerating to the downside. Here’s the big question.

If companies are cutting their capital expenditures, which is a reflection of their future growth expectations, why would they continue hiring?

First Quarter Earnings Recap

First Quarter Earnings Recap

Just over 2,500 companies reported for the March quarter with 60% of companies posting better-than-expected earnings results, which is 2% below the average quarterly beat rate since 1999 and is well below the beat rate from the last quarter. This is now the fourth consecutive quarterly year-over-year  declines in earnings since Q4 2008 through Q3 2009.

2016-05 EPS beat

Top-line revenue beat rate was 53.8%, which is the strongest beat rate in the past five quarters, but is still well below what we’ve typically seen in years past. The drop in revenue came in -1.5%, which is actually worse than the -1.0% drop projected however at the end of March.

2016-05 Revenue beat

Looking at the movement of the S&P 500 index versus the earnings for companies in the S&P 500, we can see that the market’s movements have been based on multiple expansion, which simply means that with earnings falling, the amount investors are willing to pay for each dollar of earnings has been increasing for the market to even stay at roughly the same levels.

2016-05 SPX v EPS

The good news though, (drum roll please) is that guidance is finally positive! Ok, so that may be a wee little stub of green in the chart at right, but it is still an improvement as more companies raised guidance than lowered this reporting season – finally!

2016-05 Guidance

Bottom Line: Looking back at prior periods of earnings recessions, we see that from 1986-1987 the S&P 500 experienced six consecutive quarters of negative earnings without the country experiencing a national recession. From late January 1986 through to the market’s peak in August 1987, the S&P 500 gained 65%. By mid-October it had of course lost about 1/3, but nevertheless, an earnings recession clearly doesn’t guarantee a crashing stock market. However, this time we find ourselves searching for any reasonable catalyst to propel valuations higher. The reality is that today monetary policy has become relatively ineffective for getting the economy moving along with more vigor – negative rates in Japan have done little and arguably have cause greater weakness. The problems are primarily structural in nature, which means that to the degree they can be addressed, it will be political, and in the middle of a highly contentious and polarized election cycle, uncertainty rules. This is likely to be a market that ebbs more than flows, so patience and risk management need to be front and center.

Elle On RT's Boom Bust Talking June Rate Hike

On May 4th I spoke with Ameera David on RT’s Boom Bust about the likelihood that the Fed will hike rates in June. We discussed the ongoing earnings recession facing companies, the continued decline in top line revenue and how that will affect the recent uptick we’ve seen in wage pressures. We also talked about the impact of the Brexit vote on any hike in June and what we can learn about the global economy by looking at what’s happening in China.

Bear Markets Ahead?

Bear Markets Ahead?

The third quarter ended with all the major indices in the red for 2015, with small cap stocks as well as the industrials delivering the weakest performances… so the big question is are bear markets ahead?

2015-09-30 Mkt Indices

Every sector also ended the quarter in the red for the year, with the one exception of Consumer Discretionary, which barely eked out a wee little positive return, (technical term there) while the Energy sector and Materials took a major pounding.

2015-09-30 Sectors

So let’s take a bigger step back and see where the markets are from a longer-term perspective. The chart below shows the inflation-adjusted S&P 500 index in constant August 2015 dollars. We believe it is rather telling to see that prior to the current bull run, the S&P 500 peaked in 2000.  The 2007 peak did not quite reach as high as the 2000 peak and had a lower trough.  The most recent bull run reached just slightly higher than the 2000 peak, but has broken its longer-term upward trend and now appears to be on a downtrend.


The big question is are we now in an interim dip, that will provide a great buying opportunity along a continued upward trend, or are we facing the beginnings of a beat market? Hate to say it, but the data is giving me a serious craving for some honey!

  • The typical bear pattern is first a loss of breadth, which we’ve experienced for about 18 months. Check…
  • Next comes loss of leadership. We’ve seen Walt Disney (DIS), which has been on a tear since late 2011 break significantly out of its long-term trend. Sectors like biotech, as illustrated by iShares NASDAQ Biotechnology ETF (IBB) and media, such as Global X Social Media Index ETF (SOCL) have also experienced major directional shifts. Check, check.
  • During the first stage of a bear market, we often see rallies that simply cannot hold. We experienced a painful plunge down to a bottom on August 24th with the following rally unable to bring us back up to the previous highs, followed by another collapse on September 16th. Check, check, check!
  • Finally, after having the markets trade in the tightest trading band in history for the first half of the year, we now have triple digit drops in the Dow Jones Industrial average becoming more frequent. Check, check, check, check!


That’s the market movement, but what about fundamentals? Over the last six months, only about 37% of publicly traded companies have increased their revenue forecasts, which is the smallest percentage since 2009 and almost as bad as during the 2001 bust. Median sales growth estimates for the next 12 months are about 4% versus the longer-term norm of 7%. Meanwhile earnings revisions are back down at historically low levels not seen since the financial crisis.


With weaker earnings moving forward, a continued bull market will need investors that are comfortable with expanding P/E ratios, but that would require that investors be risk-seeking and there isn’t much evidence of that when we look at how much money has been pulled out of emerging market stocks and bonds.  Only time will tell if that bear is coming out of hibernation to stay a while, but for now, I’m getting increasingly defensive as I perceive the potential risks for most equities as being disproportionately nail-biting versus rewards.

Earnings Season

Revenue growth for US companies hasn’t been terribly inspiring, yet earnings have been respectable. So far this earnings season, as of Friday, 90% of the companies in the S&P 500 have reported actual results for Q2.

  • 74% have reported earnings above estimates, which is above the 5-year average
  • 50% have reported sales above estimates, which is below the 5-year average

That sound pretty good right? Earnings per share is above the long-term average so we should be happy right?  That’s a lot of headlines you’ll read, but it misses an important part of the bigger picture.

Earnings growth for the quarter, across all companies in the S&P 500 that have reported so far, is currently running at -0.7%.  That means that while 74% of companies are beating on earning growth estimates, those estimates were for a decline in earnings!  Well that paints a slightly different picture now doesn’t it?

On top of that, revenue growth for the second quarter is currently running at a drop of -3.4%. Yup, revenues are falling.  This is also the first time we’ve seen two consecutive quarters of year-over-year revenue declines since Q2 and Q3 2009.  If we look at forward guidance, analysts are expecting earnings to continue to fall year-over-year through the next quarter while revenue is expected to continue to fall through the end of the year. Now you see why we’ve been concerned.

Sales and earnings have been falling while stock prices are rising.

Those earnings have also been the result of considerable cost cutting and financial engineering.   The cost cutting is a bit like going on a diet, always a good idea to trim and tone where things have gotten flabby, but it isn’t something that can be done indefinitely.  At some point you simply aren’t getting enough nutrition, or in the case of a company, investing sufficiently in the future, and you start to harm longer-term health/growth.

As for financial engineering with things like stock buybacks, that is the corporate equivalent of Spanx and a push-up bra; looks good out in public, but back home the fundamentals really haven’t changed.

Market and Earnings Season Update

Market and Earnings Season Update

Over 700 companies have reported earnings so far this season. As of Friday 4/25, 61.1% of all U.S. companies had beaten consensus earnings estimates, which is just slightly below the 62% from last quarter and is consistent with the rate we’ve seen during the current bull market.









When earnings season began, top line revenue estimates were relatively weak, but have improved over the last five days. Currently 55% of the companies reporting have beaten estimates, up from 50% last week.










The two prior charts show that so far, things are looking decent during this reporting cycle, but nothing to get giddy about. The big change this quarter, and it is decidedly something to get giddy about, is guidance. The past 10 quarters companies have given the markets pretty grim forward outlooks, with a negative guidance spread, meaning more companies lowering guidance than raising, in each of the last 10 earnings seasons. This season we finally see a positive ratio.










Last earnings season investors bought aggressively during the season, despite the negative outlooks. This season the opposite appears to be occurring with the average company falling 0.39% on its reporting day. Companies that beat estimates are not rewarded all that much, rising an average of 0.13% while those that miss are falling 0.52%.


Last week the market was a condensed version of what we’ve been experiencing for much of the year, a great deal of whipsaw back and forth action that hurts sentiment more than actual portfolios. The market closed Friday 4/25 at nearly the same place it was on the close of Thursday the week prior, (markets were closed on April 18th in observance of Good Friday). The much maligned Nasdaq is now about 6% off its recent cycle high while the S&P500 is 1.4% below its recent April 2nd high of 1890.9. If we go a bit deeper we find that while corporate earnings reports are painting a sunnier picture, stock prices have been struggling. Last weekend Barron’s pointed out that the average stock in the S&P500 has fallen 12.5% from its peak. The average consumer discretionary is down 16%, despite some positive March retail sales data. Internet stocks are down 18% on average with biotech, the darling of 2013, down 25%. The average large-cap has lost just under 9% with small cap falling nearly 16%. We’ve been warning for months that stocks have been richly priced, so while the fundamentals appear to be improving, prices are moving in the opposite direction, falling off their heady highs. For those who read these posts regularly, this will come as no surprise.


That being said, the majority of country stock markets are still above their 50-day moving average, including the U.S. which is just keeping its neck above water at 0.3% above this key support level. If we take a broader six month look, the S&P500 and the Dow 30 have been fairly consistently moving above their 50-day moving averages, so while it’s been painful, the longer-term uptrend remains in place. Small caps are a different story, with both the Nasdaq 100 and Russell 200 below their 50-day moving averages, where they have been for over a month. Nasdaq internet stocks are well below their 50-day moving average and still losing ground.


Bottom Line: After last year’s blow away market that greatly outpaced growth in underlying earnings, we are unsurprised to see some consolidation in prices. So far we see the longer-term upward trends holding firm for the more value-oriented firms that we tend to prefer. We’ve seen the usual reversal of last year’s highest fliers become this year’s dogs, in yet another example of why it doesn’t pay to chase returns.


GDP Growth not Exactly Glowing

GDP Growth not Exactly Glowing

GDP growth for Q4 2013, as expected, was recently revised downward from an initial estimate of 3.2% to 2.4% versus Q3 2013 growth which is estimated to have been 4.1%. GDP growth for the full year of 2013 is estimated to be about 1.9% falling from 2.8% in 2012. Even with the downgrade, growth for the second half of 2013 is now estimated to be 3.3% versus 1.8% in the first half, showing a decided improvement.

The primary drivers of consumption growth were Services, and a jump in spending on housing and utilities (from negative 0.31% to positive 0.14%), as well as Food Services and Accommodations which rose from 0.02% to 0.43% annualized. How much longer consumers can keep this behavior up with shrinking purchasing power remains to be seen.

The bad news emerges from Fixed Investment, which fell from 0.89% to just 0.14% annualized, as investment across the board dipped but mostly in non-residential structures (down negative 0.03% from 0.35%) and a fall in residential fixed investment from 0.31% to negative 0.32%.

Net trade contributed a surprising 1.33% to GDP growth, the most since the 2.39% increase in Q2 2009. How much longer can the US continue boosting its GDP on the back of the shale boom, and declining imports, also remains to be seen. Just like the inventory build-up from the later part of last year that now has to be soaked up, so too a reversal of net trade boost could become a drag on growth, unfortunately at a time when the consumer could also pull back.


Households continue to muddle along, with median household income just over $51,000, which is about where it was 20 years ago. Real disposable personal income recently fell by 2.7% from a year ago, which is the biggest one year decline since the semi-depression of 1974. While the official unemployment rate has fallen to 6.6%, the labor force participation rate, which is the portion of the population either employed or looking for work, is at 63%, a level we have not seen since 1978. If the participation rate was at pre-crisis levels, the unemployment rate would be closer to 13%.

Bottom Line: Enjoy the 2013 Q4 GDP surge as it may not last into 2014. Sustained growth in the economy and the housing sector in particular will remain constrained until household income levels improve on a consistent and stable basis.

Additionally, the low level of economic growth serves as a headwind to stock prices as revenue growth is more difficult in a slow moving economy. Low revenue growth leads to more difficult earnings growth, with the majority of earnings growth for much of the S&P500 over the past few years coming primarily from cost cutting, which has a limit. Future stock price appreciation will be heavily dependent on rising PE ratios, which are already at elevated levels relative to historic norms.

February MarketWatch

February MarketWatch

This month’s MarketWatch is a bit more positive than last month’s.  From Dec 31st, 2013 to the lows for the year to date on Feb 3, the S&P 500 pulled back 5.8%, while the Dow Jones 30 gave back 7.3% in the same time frame.  Both indexes rebounded in February, with the S&P 500 now about flat for the year as of Feb 24, while the Dow has rallied back to being down about 2.2%. Only the NASDAQ is in positive territory, up 2.28% year-to-date. In contrast, natural gas is up 37% year-to-date, gold up 9.8% and silver up 11.5%. By February 3rd, the volatility index (VIX) closed up as much as 51% from the first day of trading for the year, but has since fallen back to close on February 24th at the same level as it closed on the first of the year.

On February 25th, we learned that the previously robust Conference Board Consumer Confidence index dropped by the most in 4 months, missing expectations by the most since October. The Chart below, hat tip to ZeroHedge, shows the trend from 1995. Some good news within the Consumer Confidence readings were seen in the Jobs Plentiful Index, which rose to 13.9%, its highest reading since June 2008, and the Jobs Hard to Get Index fell to 32.5%, its lowest reading since September 2008. Both readings indicate continued gradual improvement of the US employment picture.

Investor sentiment continues to rise, up now 53% from the 10-year low in November 2012 and up 28% from December 2013.  Corporate earnings continue to be a source of concern however, with 82% of the S&P500 companies that have shared forward guidance issuing negative outlooks.  This past earnings season was a repeat of what we’ve come to expect in recent years, as bottom line performance generally meets expectations, but top line revenue continues to be relatively weak, often missing expectations.  The bottom line is being met more through cost cutting that through increasing sales.  Since cost-cutting measures are a more limited source of bottom line growth that increasing sales, this warrants attention.

Last year the utility sector was the 2nd worst performing sector, up 10.7% versus the sector leader, consumer discretionary, which was up 37.4%.  So far this year the defensives that underperformed last year are in the lead this year with utilities leading the pack, up 6.9% while last year’s leader, consumer discretionary down 2.5%.

Meanwhile fears of a hard landing for China are resurfacing, with the Shanghai Composite falling nearly 10% in the past week and down another 2% overnight as of February 25th. In addition, China’s yuan dropped the most in over a year and the Shanghai Composite declined the most in five months on speculation that the People’s Bank of China will act to end the yuan’s steady appreciation. Given the pressure that emerging markets have been under, this is one area where conservative managers such as Mr. Brooker and the First Eagle funds are searching for stocks that are cheap enough to buy.

Bottom Line: Market volatility has returned as the Fed slows QEInfinity and economic news continues to surprise to the downside, coupled with increased fears over China and emerging markets, keeping markets mostly sideways so far this year.