Positive Returns 97% Of The Time
Based on current readings of their “sell side indicator”, Bank of America/Merrill Lynch (BOAML) recently wrote in a research note to clients:
“Historically, when our indicator has been this low or lower, total returns over the subsequent 12 months have been positive 97% of the time, with median 12-month returns of +25%,”
Recommended Stock Allocations Remain Low
The BOAML indicator is based on the recommended stock allocations inside portfolios. A typical benchmark equity allocation is 60%-65% of a portfolio. Presently, the recommended allocation is significantly below that range, coming in at 51%. If the recommendations moved back to the historical mean, as they typically do, money would continue to flow out of bonds and into stocks. More information about the BOAML signal can be found on Yahoo Finance.
A Separate Rare Signal Also Leans Bullish
Has any other longer-term signal appeared recently that aligns with the possibility of double-digit stock gains over the next 12 months? Yes, this week’s stock market video covers a monthly S&P 500 momentum and trend signal that has occurred less than 10 times over the past 23 years. The signal was triggered at the end of November. Even more importantly, the signal was also triggered recently in numerous risk-on ETFs, such as small-caps (IWM), mid-caps (MDY), energy (XLE), copper (JJC), materials (XLB), and the total stock market (VTI), which may be due in part to allocation shifts based on President-elect Trump’s platform. Bearish signals have been triggered in defensive assets such as bonds (TLT), utilities (XLU), consumer staples (XLP), and healthcare (XLV), which may be due in part to post-election shifts regarding growth, earnings, taxes, deficits, and inflation.
If you do not feel the signals outlined in the video are helpful, there is an easy solution…you can choose to ignore them and continue to make decisions based on your own criteria.
How Can These Signals Help Us?
Since there is no such thing as a perfect signal or indicator, the material covered in the video above and the BOAML indicator help us in two ways: (1) to better understand the probabilities of good things happening relative to bad things happening, and (2) to remain open to all outcomes, even better than expected outcomes given the market’s trendless and whipsaw pattern over the past 2-3 years.
The Weight Of The Evidence
Have any other signals occurred recently that align with the signals presented above? Yes, in recent months we have covered another rare trend signal, an extremely low volatility reading, and breakouts from long-term consolidation patterns.
Since the future is unknown and markets can do anything at any time, as always, we will remain open to all outcomes, including bearish outcomes. The data we have in hand aligns with a favorable risk-on environment; if the data deteriorates, we will make the necessary defensive adjustments.
These Signals Are Based On Facts
As noted in the tweet below, recent events (Brexit, U.S. election) remind us to take any forecast or opinion with a necessary grain of open-minded salt. The BOAML indicator and the broad array of recent monthly bullish MACD signals are based on facts, rather than opinions or forecasts. BOAML has historical data they can compare to present facts in hand. The MACD crosses presented in the video above are observable facts that can also be compared to historical facts, which is quite a bit different than an opinion or forecast of something that may or may not happen. If the facts change, the historical interpretation of the facts will change as well. Time will tell.
You can access them here (@CiovaccoCapital). You do not need to know anything about Twitter to view our comments or use the links to view charts.
Today’s post can be found on SeeItMarket.
Dollar Breaks Out
With the Fed flip-flopping on interest rates, the U.S. dollar traded inside a two-year consolidation box, which is indicative of indecisive investor behavior. The dollar was recently able to break to the upside with market participants expecting a Fed rate hike in December.
Impact On Multinationals And Consumers
There are valid concerns tied to a rising U.S. dollar. A strong dollar makes American goods more expensive overseas, which can negatively impact earnings for multinational companies. However, the flip side of that coin is U.S. consumers will pay less for imported goods, allowing them to have more disposable income.
What Can We Learn From History?
This week’s video explores the question:
Is it in the realm of historical possibility for stocks to perform well in periods marked by rising interest rates and a strong U.S. dollar?
Higher Rates Can Impact Capital Flows
Bonds have recently sold off on expectations for stronger growth, higher inflation, and higher interest rates. The selloff in bonds and the post-election push higher in stocks have allowed the stock/bond ratio to break out of a long-term consolidation box (see chart below). The impact of capital flows between stocks and bonds was covered by The Fat Pitch:
In July, fund managers’ had their highest exposure to bonds in 3-1/2 years. In other words, they expected yields to keep falling. Instead, yields reversed higher and have since risen so sharply that several smart money managers now say that a new secular uptrend in yields is taking place. That is a big call, given that the foregoing secular downtrend has lasted more than 35 years.
Over the past 18 months, investors’ money has been flowing consistently out of equity funds. Where has that money gone? Mostly to bond funds. Money usually follows performance, so it’s a good guess that fund flows might soon begin to favor equities. If past is prologue, then equities should gain and bond yields should continue to rise. Whether that will constitute the start to a new secular uptrend for yields it is far too early to say.
Financials Have Responded
Since bank earnings are impacted by interest rate spreads, higher interest rates tend to be positive for the financial sector. President-elect Trump’s platform also calls for toning down regulations from the post-financial crisis Dodd-Frank legislation. Financial stocks have responded by breaking out from a multiple-year base relative to the S&P 500.
Time Will Tell
As long as the markets are moving based on the higher growth, higher inflation, and higher rates theme, economically-sensitive areas of the market, such as small caps (IWM), mid caps (MDY), metals (JJC), and consumer discretionary (XLY), will most likely continue to outperform more-defensive oriented areas, such as bonds (TLT), gold (GLD), and utilities (XLU). Stocks have come a long way in a short period. Even under longer-term bullish conditions, some “give back” is to be expected.
Market’s Message Prior To The Election
While there is no question the stock market’s short-term profile was showing signs of strain before voters headed to the polls, an analysis performed six trading days before the election noted the stock market’s long-term outlook remained constructive:
The slope of the 200-day looks quite a bit better than it did before the 2016 New Year’s plunge, telling us the present day long-term outlook is quite a bit better than it was on January 1, 2016.
Market Expectations Shift After Election
In the first three trading days after the election, the market seemed to align with the basic narrative from A Wealth Of Common Sense:
The recession/crash scenario is certainly one to consider. But here’s one scenario not many people will be talking about — it’s possible that within the next couple of years we could see a melt-up in the markets.
No one really knows what Trump’s policies will be (possibly not even him yet) but he has stated numerous times that he plans on doing massive infrastructure spending. He’s always promised tax cuts and isn’t afraid of large budget deficits. If anything like this were to happen, we could see much higher corporate profits and higher inflation.
If this were to occur I think it’s possible that we could see a massive shift in investor allocation preferences which could potentially take the stock market into bubble territory.
Impressive Election Follow-Through?
A November 11 analysis highlighted numerous asset classes and sectors, including base metals, transportation, banks, and smaller-capitalization stocks, that could benefit from Trump’s anticipated policies. Did the market continue to respond to the Trump platform after the November 11 analysis? The answer is yes; the chart below, via stockcharts.com, shows the performance since November 11 for metals (XME), regional banks (KRE), transportation (IYT), mid-caps (MDY), and small caps (IWM).
How Does The Big Picture Look Now?
This week’s stock market video compares and contrasts asset class behavior before and after the election in the context of the pre-and-post election fundamental drivers. The analysis also walks through the evolution of the market’s risk-reward profile between February 2016 and the present day, allowing us to put the market’s current profile in some historical risk-reward perspective.
Fed Rate Hike Baked In
Given the market has placed roughly a 94% probability on the Fed raising rates in December, it is unlikely a rate hike is going to catch many market participants by surprise. From Bloomberg:
“Analysts spent early November warning a Trump victory in the U.S. presidential election would make the Federal Reserve less likely to raise interest rates. What happened instead is that it made a December increase a near certainty.”
“Traders assign about a 94 percent probability, the highest level this year, to a Fed boost at its final meeting for the year on Dec. 13-14, futures contracts indicate. Trump’s spending plans, and Republican control of Congress, are causing the market to revise higher its outlook for the pace of Fed rate increases.”