CAMS Weekly Views from the Corner – Week Ending November 27, 2016
With the holiday shortened week of trading behind us let’s step back and look at the big picture – post election – through the lens of the markets and what they are “seeing” for our future, economically speaking. Collective wisdom of markets can radiate off a message of future experiences yet seen. These future expected outcomes do not always come to fruition hence the importance of quantifying the on-going message and monitoring closely how it is unfolding.
As a market participant and observer I am struck at how strong, if not overwhelming the message is from the markets at large. That message is simply expectations of stronger economic growth and higher inflation. Interestingly, it is not just economic growth in general that is being offered but rather how the growth is expected to occur if you will. Through the lens of expected economic policy objectives of the new Administration, it seems the markets are fully buying into the economic vision of said Administration.
Within the S&P 500, on the sector front our SPX9 system is now identifying four key risk oriented sectors as leaders. The quality of leadership is crucial when deciphering the market message of expected economic backdrops. With the Industrials, Financials, Technology, and now Consumer Discretionary adding to the list, we see solid, risk-oriented sector leadership within the stock market.
Within these sectors we are also seeing strong sub-industry leadership which also points to the same market message – stronger economic growth. As a small, representative sample we see Steel, Aluminum, and Copper stocks moving strongly higher. Heavy Construction, Industrial Supplies and Industrial Machinery have rocketed higher. In the case of Heavy Construction it was dormant-to-negative for the previous three years and has come to life quickly. In addition, Banks, Transportation areas, and Retailers generally have moved noticeably higher.
Micro and small sized companies have led the way in an astounding fashion suggesting a belief in a strengthening domestic economy. The bond market has also played a role with a spike upward in interest rates as they seemingly now see, and expect more of the budding inflation that has been quietly building. Simultaneous to all of the above, in the currency markets the U.S. Dollar has also spiked upward speaking to expected domestic strength and higher interest rates on the back of that strength.
A Little Political History & Market Reaction
Dialing up some political history and simultaneous market reactions we have seen the 1980 results usher in the Reagan Administration where tax cuts and deregulation were a couple of similar themes. There also was a stock market reaction of strength with the bond market pushing interest rates higher while the Dollar also moved noticeably higher. The notable stock market advance, post-election, ran through late November of 1980 and began to stall to the point of turning lower in the ensuing months. The late November high point was not seen again until the fall of 1982 – a full two years later.
Specific stock market similarities do exist and yet there is a significant disconnect between our current era and that of 1980. Valuation levels then-to-now are a distance apart. For the collective S&P 500 companies in the fall of 1980, the price paid relative to earnings was extremely low. The price-to-earnings ratio (p/e) for the S&P 500 was registering in the vicinity of 8 times earnings while our current measure is three times as much equaling 25 times earnings. With this, we are quite expensive relative to the 1980 time as well as through distant history.
Taking the total value of the stock market and comparing it to the size of the economy via the GDP measure, we see in 1980 stocks in total were valued in the low 30% range of GDP while currently our total stock market value is in the 140% range of GDP. More simply, this means the total value of the stock market in 1980 was 1/3 the size of the economy compared to our current day’s total value of the stock market equaling 140%, or 1.4 times the size of the economy. Either valuation measure speaks to how expensive our current market is compared to a previous era that ultimately ushered in a new long-term bull market which lasted nearly 20 years.
Off to the races stock market performance is by no means a slam dunk with high valuation levels, high debt levels, and rising interest rates. Market reactions have certainly been strong but it is imperative to keep in mind no market(s) ever goes up (or down) in a straight line. This strength is impressive but extrapolating it out into the future in a straight upward line is unrealistic.
As stated in previous Weekly Views, earnings growth for the collective S&P 500 companies is crucial going forward. We have been on a multi-quarter earnings recession whereby the S&P 500 collective earnings have posted negative growth. At this stage, to support the post-election expectations of strong economy and strong stock market, we need to see earnings growth kick into gear. The next round of earnings will begin in early January along with the Inauguration and the beginning of said economic policies. The next 60-90 days will be loaded with economic and market impacting news – stay tuned.
I wish you well…
Ken Reinhart
Director, Market Research & Portfolio Analysis
Portfolio Manager, CAMS Spectrum Portfolio
Footnote:
H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP). This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”. A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.
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