The Greed Is Palpable

The S&P 500 was up 0.28% and the VIX was down 3.02% to 10.93 on Tuesday. The S&P 500 and Wilshire 5000 are less than 1% away from their record highs. Just as the market is getting close to its record high, it is also showing signs of excessive greed. As you can see from the chart below, the S&P 500’s 14 day RSI is at 65.15 which is nearing 70 which is considered overbought. The CNN Fear and Greed index is at 73 out of 100 which is 2 points away from the extreme greed category. There haven’t been many economic reports this week, so the economy can’t stop this run. The biggest economic report of the week is the July CPI report on Friday. Earnings season is finishing up strong.

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The energy sector was the biggest winner as it was up 0.72%; the biggest loser was consumer discretionary which was down 0.57%. The financials have been on an amazing run; they are a key reason why the market is very close to breaking its record high. The XLF financials ETF is up 5.3% since July 13th. The most notable mover on Tuesday was Tesla. It was up 10.99% because the Saudi Arabia wealth fund announced it has invested $2 billion in the company and Elon Musk announced his intentions to take the company private at $420 per share.

10 Year Nears 3% Again

The 10-year yield increased from 2.9395% to 2.9730% in its latest attempt to get to the 3% threshold. There is a record short position in the 10-year bond, yet it still can’t stay above 3%. That’s remarkable given the strength in the economy and the increase in inflation. My point is that if the yield hasn’t gone up in that environment, it can only fall since growth is about to slow. The bearish argument on the 10-year is that the market has the yield set at a fundamentally wrong price which needs to be reevaluated. It’s tough to argue that growth will be higher than Q2 and inflation will get much higher. We’ll see on Friday if inflation can increase further. The 2-year yield went from 2.6452% to 2.6697%, meaning the latest 10-year 2-year differential is about 30 basis points.

U.S. Outperformance

As you know, the American stock market has been on a tear this year as the S&P 500 is up 6.91% year to date. That’s near average, but when you consider the weakness abroad, it’s great. Recently, the market has also been outperforming other global markets, as you can see from the chart below. The U.S. stock market is up over 5% since mid-May while Europe, Japan, and Asia ex-Japan are all down. Asia is being brought down by China. The Shanghai index is down 21.92% since January 24th. SinceMay 15thh, it is down 12.93%. The Chinese economy probably would be weakening without the tariffs, but they certainly aren’t helping the economy. The Caixin general services PMI fell to 52.8 which is still a positive territory but is at the lowest level since December 2015.

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Earnings Growth

The tax cut and fiscal stimulus have extended this economic expansion by a few quarters. Some think it would have ended this year without the support from the government. 2016 was very close to a recession, which means it extended this expansion as well. There needed to be a few extenuating circumstances for the economy to have its longest expansion in over 100 years. The biggest reason American stocks are outperforming other countries is the stimulus. As you can see from the chart below, the earnings growth in Q2 is 24.77% and the earnings growth in Q3 expected to be 23.08%. Sales growth in Q2 is 10.94% with 427 firms reporting earnings, which is much higher than the 9.08% growth in Q1 at this point in the quarter.

Since stocks respond to changes in earnings estimates, you can see why they are up recently. The estimates for Q3, Q4, and Q1 earnings growth are all up in the past week as you can see from the chart below. Q1 2019 improved the most out of the future quarters as expected earnings growth went from 7.32% to 8.28%. That would end up being an amazing 2-year stack of earnings growth. My principle concern is that analysts are making estimates from the top of the cycle, but once the fiscal stimulus wears off and the Fed continues to raise rates, 2019 earnings growth will be less than anticipated.

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Wage Growth Slows

In this section, I will finish the discussion about the July employment report. Manufacturing added 37,000 jobs which beat estimates for 15,000 jobs. This sector continues to beat estimates, yet economists continue to underappreciate it. Some say the economy is in a new phase where manufacturing jobs make a comeback.

Month over month average weekly earnings growth was up 0.3% which met estimates and was faster than last month’s growth of 0.1%. Year over year average weekly earnings growth was 2.7% which met estimates and was the same as last month. The fact that average hourly earnings growth was stable means this was a Goldilocks report where wage growth wasn’t too hot or too cold. The average workweek was 34.5 hours which was down from 34.6 last month. This means the average weekly wage growth was down too. The average weekly wage growth went from 3.3% to 3%, meaning it fell from the near cycle peak growth rate it was at in June.

Conclusion

The stock market is overbought, but deservedly so since earnings season has been amazing. After earnings season comes bigger buybacks which could help the S&P 500 have double-digit returns this year. I’m neutral on stocks because I think most of the upside for the year is in. Looking at the market broadly, I think almost all the gains in this bull market have been realized.