Weekly Wrap: Momentum Is Going Up Up Up, Albeit With A Lot Less Conviction

You’ve heard this one before, right? Equity markets are making new highs while volatility continues to be exceedingly low. Here are a few thoughts as we exit the summer and head into the final months of the year.

  • The yield curve continues to flatten and yet few seem to care. This is nothing new as the same thing happened in 2000 and 2007. What’s old is once again new… again.
  • Market breadth is weakening. As I mentioned on this week’s Cocktail Investing podcast, only 2 of the 11 S&P 500 sectors are currently at new highs (Consumer Discretionary and Healthcare). Back in January, 7 sectors were at new highs. We also see fewer stocks making new highs than back in January.
  • Volume is also quite low at this time of year, so I would argue there isn’t a ton of conviction due to seasonality behind the recent new highs.
  • The Shiller PE ratio has risen to 32.2x. It has only been this high 3% of the time in the past 127 years. This metric has a terrible track record for timing, but has been quite good for forward overall market returns. If history is any guide, and it usually is, just buying the major indices and hoping for the best is likely going to disappoint at best. Specific security selection matters more now than at any time during this bull run, and we here at Tematica continue to favor our thematic approach. 
  • People keep talking about the forward PE being reasonable at 17x and 16x for all of 2019. Hold on a minute. That is dependent on 10% EPS growth in 2019, which seems unlikely because…
  • Corporate profits as a percent of GDP remain well above historical norms. In the first quarter, S&P 500 operating earnings rose 25% year-over-year versus 5.4% nominal GDP growth. Normally these two are within a few percentage points of each other – not 20% apart!
  • The S&P 500 dividend yield is now less than the 3-month Treasury. Recall that from 2010 to mid-2016 the dividend yield was on average, roughly 2% more. TINA (There Is No Alternative) has left the building.
  • The spread between the 10-year and the 2-year Treasury bond is below 0.2. Historically when this drops to zero, a recession isn’t too far away.
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