Boeing’s 737-Max issues highlight index construction issues

Boeing’s 737-Max issues highlight index construction issues

The latest flight tragedy involving Boeing’s (BA) 737-8 Max plane has reignited air travel safety concerns that could pressure Boeing’s business in the near-term. Demand for its aircraft has been and is expected to continue to be powered by international air travel, particularly out of Asia, which fits very well with our Rise of the New Middle-class investing theme. This means the recent drop in BA shares could present an opportunity for investors but depending on what we learn in the coming days we could see the shares trend lower. The issue plaguing the company and its shares is the crash of two 737-8 MAX planes in a relatively short time causing several countries and regions to ground those planes as the causes of the most recent crash are sought.

This has raised several questions for Boeing – How long will those planes be grounded? What does it mean for future 737 family orders and production levels that drive revenue, profits and earnings? The 737 family is an important one for Boeing, as it accounted for 80% of its aircraft backlog entering 2019 and 58% of its January order book. In the past Boeing has quickly dealt with situations such as these, and it has already announced an extensive change to the flight-control system in the 737 MAX aircraft.

Still, we are in a period of uncertainty for the shares, and uncertainty has never been a friend for the stock market or individual stocks. Now to see what comes next.

On a different note, the Boeing issue highlights a key difference in how the major market indices are constructed. These tend to be bench marks by which we and others judge their performance, but there are several differences and intricacies between them. For example, we know the Dow Jones Industrial Average is limited to just 30 stocks, while the S&P 500 is roughly 500 stocks spread across 11 sectors, yielding a more broad based view of the market. For that reason, the S&P 500 tends to be the benchmark of choice for most investors even though the media still tends to focus on the Down.

No matter how many constituents an index has, who the constituents are, and their weightings make all the difference. As we know, the Nasdaq Composite Index tends to be weighted toward technology stocks, while the Russell 2000 is focused on stocks with smaller market capitalizations. Inside the Dow, the weighting of BA shares is just under 10%, which makes it the largest holding inside the index. The next closest constituent is UnitedHealth Group (UNH) at 6.52%. This means moves higher or lower in Boeing shares can have a pronounced impact on the overall index. We’ve clearly seen that over the last few days as Boeing’s shares have fallen more than 10%  the Dow’s performance has been markedly different than the rest of the market indices as the Dow has less than 1% while the S&P 500 has risen nearly 2.5%

In examining the S&P 500, we see the reason for that different performance. While nearly 10% of the Dow is represented by Boeing shares, exposure inside the S&P 500 is far more limited at 0.9%. Even though that is more than 1/500thof the S&P it is far, far lower than the weighting contained inside the Dow. The point of this is that to truly understand the movements in the major market indices one needs to understand how these market indices are constructed.

One of the key parts of that understanding is knowing what the holdings and their weightings. This same understanding should also be applied to ETFs as well, especially ones that are based on passive indices. While two ETFs may appear to have a similar strategy and practically the same constituents, the weighting mechanisms between an equal weighted, market cap weighted or a capped market weight approach can produce different returns as well as generate different risk parameters.

As far as the constituents themselves, it goes without saying an investor should be more familiar with the constituents. In the case of Boeing, there are a number of ETFs that hold the shares, but one with sizable exposure is the ETFMG Drone Economy Strategy ETF (IFLY). That ETF, which looks to invest in drones, holds 4.96% of its assets in BA shares, it’s second largest holding. That ETF, which looks to invest in drones, holds 4.96% of its assets in BA shares, even though its revenues from drones and other autonomous systems are so small they aren’t even broken out by the company in SEC filings. We can debate the rationale behind Boeing being the second largest holding, but until the current situation at Boeing is resolved, odds are those shares will have a meaningful impact on both the Dow and IFLY shares.

Weekly Issue: A Number of Our Thematic Leaders Well Positioned for the Holidays

Weekly Issue: A Number of Our Thematic Leaders Well Positioned for the Holidays

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Bulls Buck Bob Farrell Rule #5

Bulls Buck Bob Farrell Rule #5

An article in the WSJ today reminded me of Bob Farrell’s rule #5:

 The public buys the most at the top and the least at the bottom.

Eight years into the bull market with more than a tripling of the major indices and the retail investor has decided to jump in with both feet, plowing nearly $80 billion into U.S.-based equity funds since the election with $6.7 billion of that coming in last week alone. Sentiment is so high that the Investor Intelligence survey shows the bulls at 63.1 percent, the highest reading since January 1987! The bears at a hibernating 16.5 percent, l four leaving us with four bulls for every bear. Can you heard the herd of hooves?

In the WSJ article we learn of just how bullish retirees have become.

One of Ms. Gugle’s clients has increased his stock allocation to around 80% from 70% in recent months after cutting back on bonds amid concerns about low returns.The client, George Bohmfalk, a 69-year-old retired neurosurgeon in Charlotte, says he has faith that remaining loyal to a low-cost passively managed portfolio is more productive than trying to pick winners and losers. But he’s concerned about what the Trump administration may do, and he worries about U.S. stocks’ lofty valuations.

So what kind of returns can these folks expect? When forward-looking P/E ratios are in today’s range, between 18x and 20x, the coming year on average generates around 1.1 percent with a whopping 4.5 percent over the next five years, ouch. While P/E ratios don’t serve as an accurate signal for a market top, they do suggest a cap to returns.

I know, I know, I keep blowing the bubble bugle but bulls hear me out.

  1. Margin debt is now at $513 billion, which is the highest level ever recorded. That’s a sure toppy sign and when we get some pullbacks, all that leverage makes wee little moves a lot more painful.
  2. We are seeing declining breadth, with more new 52-week lows than highs in the past four sessions, the longest streak since November 4th – another toppy indicator.
  3. The small-cap Russell 2000, which is often a leading indicator, is now flat for the year and 4 percent below its highs.
  4. The S&P 500 has gone 57 days without a 1 percent intra-day swing, something we have not seen in at least 35 years and recalls to mind the mantra of Raoul Pal of Global Macro Investor and Real Vision, “Suppressed volatility leads to heightened volatility.”
  5. Survey data is veritably giddy with excitement over an expected economic acceleration while actual economic growth is barely treading water at just over 1 percent annual rate, a classic end-of-cycle divergence.
  6. We’ve only seen households’ exposure to the stock market at or above the current 21.1 percent level fives times in the past 16 years. Bob Farrell’s number five is screaming out on this one.
  7. U.S. high-yield corporate bond (aka junk) yields approached cycle lows recently but are now starting to widen in a more risk-off trend and as the saying goes, bonds lead stocks. Pay attention!

Source: Individuals Tiptoe Further Into Long-Running Stock Rally – WSJ

But those economic indicators are so HOT!

But those economic indicators are so HOT!

Economic data has been coming in more positive lately, which has led some to get a wee snarky with yours truly over my finger-wagging warnings that the market is exceptionally pricey.  Ok then, game on!

The chart below is the Economic Research Institute’s Weekly Leading Index, which according to ECRI, “has a moderate lead over cyclical turns in U.S. economic activity. Historical data begins in 1967.” It is widely considered one of the better leading indicators for the economy.

Marker #1

January 28, 2000, the index hit a top of 128.9.  From that date to the end of September 2001:

  • S&P 500 lost 23.6 percent
  • NASDAQ lost 61.9 percent
  • Russell 2000 lost 21.1 percent
  • Dow Jones Industrials lost 17.7 percent

Marker #2

October 19, 2001, the index hit a low of 112.6. From that date to when the index topped out again on June 8, 2007:

  • S&P 500 gained 40.5 percent
  • NASDAQ gained 54.0 percent (Note that it had not yet recovered prior losses)
  • Russell 2000 gained 9.2 percent
  • Dow Jones Industrials gained 45.9 percent

Marker #3

On June 8, 2007, the index hit a peak of 143.7. From that date to March 6, when the index bottomed out:

  • S&P 500 lost 55.1 percent
  • NASDAQ lost 50.7 percent
  • Russell 2000 lost 58.9 percent
  • Dow Jones Industrials lost 51.2 percent

Marker #4

March 6, 2009, the index hit a low of 105.7. From that date to when the index topped out again on April 30, 2010:

  • S&P 500 gained 73.7 percent
  • NASDAQ gained 90.2 percent
  • Russell 2000 gained 104.1 percent
  • Dow Jones Industrials gained 66.1 percent

Marker #5

On April 30, 2010, the index hit a peak of 135.2. From that date to October 7, 2011, when the index bottomed out:

  • S&P 500 lost 2.6 percent
  • NASDAQ was flat
  • Russell 2000 lost 8.4 percent
  • Dow Jones Industrials was flat

In the weeks and months before each time this leading indicator peaked, along with many other similar ones, the headlines were all about how the economy was moving along so well, champagne and caviar all around and frequently the stock markets were accelerating as well. Only in hindsight could one have seen that we were heading for a major turn and the markets were going to experience a painful pullback.  On the flip side, where the indicator has bottomed out, that was time to get seriously bullish.

Bottom Line: A rising leading indicator is not necessarily a bullish sign for stocks. Stock market returns are in the end, about valuation. Buy cheap and sell expensive. Today stocks are priced at Louis Vuitton levels. Can they go higher? Absolutely, they likely will as we often see an acceleration to the upside just before a major turn. But know that downside risks are rising and upside potential shrinking with every step into more expensive territory.

Market Recap May 27th

Market Recap May 27th

Markets Meh DogSince the start of the month, the U.S. equity markets, to use a technical term, have been pretty much mehhh. By Friday’s close the S&P 500 (large cap) was up +0.85%, the Russell 2000 (small cap stocks) was up +0.84% for the month. Tech stocks finally started to show a little hutzpah with the Nasdaq up +2.41%. While Yellen and company at the Fed have been giving lots of lip service to raising rates at the June meeting of the Federal Open Markets Committee (FOMC), longer dated treasuries, as measured by the iShares Barclays 20+ Year Treasury Bond ETF (TLT) rose +1.6% since the start of May.
Even year-to-date stock indices have been mostly meh with oil, gold and bonds giving us a lot more to cheer about:

  • S&P 500 +2.7% (thanks to a 2.3% gain last week)
  • Nasdaq -1.5%
  • Russell 2000 +1.3%
  • Dow Jones Industrials +2.6%
  • Gold +14.0%
  • iShares Barclays 20+ Year Treasury Bond (TLT) +7.7%
  • Brent Crude Oil Spot +30.5%

This chart of the S&P 500 shows how the major market index continues to oscillate within a fairly narrow band and is right back where it was about 18 months ago.

2016-05 SPX

Taking a look at the broader market, the Dow Jones Transports remain in a steady downtrend (green line).

2016-05 Trans

The Russell 2000 (small cap stocks) had been in a steady downtrend for much of the past year, but recently broke above that trend line in April, which is often a positive sign.

2016-05 Russell 2000

Oil (Brent Crude) is now well above the 50-day and 200-day moving averages and has been on a bull run for 103 calendar days with a gain of 89%, which is the ninth biggest gain in any oil bull market since 1983 and is nearly 27% stronger than the average and over 50% stronger than the median. All that has been accomplished over a period that is just half as long as the average bull market and nearly 40 days shorter than the median bull run. That’s a hell of a gain in an exceptionally short period of time, so a pullback here wouldn’t be surprising. Inventory levels still remain over 50% above their historical average for this time of year and oil rigs are now down to their lowest level since October 2009. We’ll be watching closely to see how crude responds if/as the dollar strengthens with the Fed taunting the markets about a rate hike.

2016-05 Brent

Strong Economy, Really?

Strong Economy, Really?

Last week I pointed out that the data coming in wasn’t exactly painting a picture of an increasingly robust economy that would warrant the Fed tightening rates.

Last Thursday we learned that initial jobless claims rose again the last week of February to 320,000, significantly above expectations of 295,000. We also learned that US Factory orders fell 0.2% versus an expected increase of 0.2%. Friday we received impressive headline jobs data, but it didn’t exactly jive with much of the rest of what we are seeing in the economy and upon a closer look, the fall in the unemployment rate was driven more by people leaving the workforce than by new jobs, and those newly filled jobs were skewed towards lower paying industries.

Today we learned that retail sales fell for the third consecutive month in February as a mix of bad weather and consumer caution outweighed an improving labor market and cheap gasoline prices.  Sales at retailers and restaurants decreased 0.6% last month to a seasonally adjusted $437 billion, the Commerce Department said Thursday. Retail sales fell 0.8% in January and 0.9% in December.  We also learned that business inventories growth was flat in January versus expectations for 0.1% increase… but what is even more concerning is the sales to inventory ratio, which is back to where it was back in the depths of the financial crisis!

Inventory to Sales

So much for the economy getting back on track.

In fact, Tuesday the Wall Street Journal ran an article entitled “Recession’s Impact Lingers for Many States,” which pointed out that 30 states are still below their peak, pre-recession tax revenue receipts. The states that are actually above their last peak include North Dakota and Texas, which are likely to suffer going forward with the impact of plummeting oil prices. We’ve also seen US GDP expectations for Q1 tanking, (today’s retail numbers reinforcing this) with many forecasting in the 1.5% range, which given the increasingly soft data coming in, seems wise. Prior forecasts were north of 2% at the beginning of the year.

Additionally, inflation expectations remain firmly muted with yields indicating that investors expect US consumer prices to rise in the neighborhood of 1.7% a year for the next 10 years, dropping from 1.9% just last week – more of that dropping price thing. In addition, consumer credit growth is moderating, auto sales appear to be topping out and the Case-Shiller 20 city price index shows home price inflation has slowed to 4.5% year-over-year from 13.4% last year. So far, nothing screams out a need for tightening, particularly in light of the defacto tightening resulting from the rising dollar. In fact, if the Fed did tighten in June, it would be the first time in the past 30 years that it has done so with a rising dollar. We do see tightening also occurring on the fiscal side where the federal deficit is shrinking significantly.

The Euro has now dropped below $1.05 for the first time in about 12 years and is down around 33% from its highs against the dollar, last seen in April 2008 and down around 12% since the beginning of the year.


Tale of QE


As the ECB gets cranking on its 10-year sovereign debt purchases, yields have once again hit record lows yesterday in Germany, Belgium, the Netherlands, Italy, Ireland and Spain. The 10-year US Treasury rate at 2.2% is over 9.5x the 10-year bund, a phenomenon never before seen. With the US one of the few places to get any kind of yield on sovereign debt, it is unlikely that dollar strengthening will cease. So not only do foreign investors get better yields in the US, the dollar is most likely strengthening against your currency, jacking up returns even more.


Diverging monetary policies are continuing to affect domestic equity markets as we see the US materially underperforming Europe and Japan in 2015, which is a complete reversal from 2014. Monetary policy clearly continues to dominate equity markets post-financial crisis. We believe this is likely to continue further into 2015, making international market indices more attractive. Investors can access these market easily through ETFs such as the relatively new Recon Capital DAX Germany (DAX), iShares MSCI France Index (EWQ) or MAXIS Nikkei 225 Index ETF (NKY).