The secular bull market that began on March 9, 2009 in the wake of the Financial Crisis just passed its ninth anniversary last Friday, and as if to celebrate, stocks rallied big on the strong reports of jobs growth, total employment, and labor participation, while wage inflation remained modest. All in all, it was a lot of great news, but instead of selling off – as stocks have done in the past in a “good news means bad news” reaction, assuming the Fed would feel emboldened to raise rates more aggressively – stocks rallied strongly. This is a market of investors looking for reasons to buy rather than to sell, i.e., the bulls are still in charge.
Strong global fundamentals are firmly in place for the foreseeable future, while corporate earnings expectations continue to rise, inflation fears appear to have diminished, and the overall climate remains favorable for equities. After the February selloff was complete, extreme valuations had been reduced, and support levels had been tested, investors were ready to embrace good news – albeit with some renewed caution in the wake of the recent surge in volatility. As we all learned, volatility is not dead. VIX is an oscillator that always eventually mean-reverts. This will surely result in some deleveraging as well as perhaps some P/E compression from the run-up in valuations we saw in anticipation of the fiscal stimulus package.
In this periodic update, I provide a market commentary, offer my technical analysis of the S&P 500, review Sabrient’s latest fundamentals-based SectorCast rankings of the ten US business sectors, and serve up some actionable ETF trading ideas. In summary, our sector rankings still look bullish, while the sector rotation model regained its bullish bias during the recovery from the market correction and volatility surge. Read on….
Let me share an analogy. If you are in sales, you know that there are essentially two types of prospects – those looking for a reason to say “yes” and those looking for a reason to say “no.” As a salesperson, you want to spend the bulk of your time focusing on the former because, let’s face it, if they are looking for reasons to say “no” they will certainly find something. Well, the same can be said for the stock market. You want to invest when most investors are looking for reasons to buy. If investors are looking for reasons to sell, they will certainly find them by interpreting any kind of news (good or bad) in the worst possible way.
Indeed, after an unprecedented period of low volatility, stocks went almost vertical in January, largely in anticipation of great things to come from the new tax bill and ongoing deregulation. But it became so overbought that investors were looking for reasons to sell, so of course they found a few, which under normal conditions might have led the market to merely consolidate in place for a week or two. There were: overblown fears of inflation and rapidly rising interest rates; an unfounded assumption that a dovish Fed and its long-standing “Fed Put” were no longer in place to support the market; and panic that structural problems in the market had been revealed by the collapse of inverse-VIX products. But the reality was that investors simply knew that stocks had gotten ahead of themselves, so they were just looking for reasons to protect profits and (for some) put on short positions. The aftermath was ugly and scary as investors were looking for reasons to sell.
As if on cue, the doomsayers came right out of hibernation to declare that the “next big correction” was upon us – and perhaps the end of the secular bull – with some comparing current market conditions to 1987, e.g., weak dollar, rising inflation, bonds selling off, big deficits, rising volatility, elevated valuations, and a new Fed chairperson. Moreover, asset classes have been highly correlated such that there is nowhere to hide, so to speak, when investors broadly hit the sell button. And as Goldman Sachs just pointed out, even the standard safe havens, like bonds and gold, have failed to provide positive beta to either rising VIX or rising 10-year yields.
But it wasn’t the end of the bull market – far from it. It turned out to be a mere technical correction from extremely overbought conditions, as support levels were successfully tested, and investors took advantage of more favorable valuations for a buying opportunity. Investors remain encouraged by a broadly positive market climate. Synchronized global economic expansion continues, as all 45 countries tracked by the OECD are in their fifth straight quarter of synchronous growth, boosting foreign demand for US exports. US economic reports continue to impress. Corporations are reporting strong (and improving) cash flow and earnings, as well as high cash balances. Unemployment remains near 1960 lows. Inflation is modest, with Tuesday’s February CPI report coming in below expectations at only 0.2%. The Fed remains accommodative (only somewhat “less dovish”). There is still over $2 trillion in excess bank reserves. Interest rates remain low. The yield curve is upsloping. There is continual progress in loosening the regulatory noose. And of course, the biggest tax overhaul in a generation is just starting to gain traction – incentivizing capital investment, expansion, onshoring of offshore operations, and hiring, as well as higher dividends, continued share buybacks, and additional M&A.
The February jobs report (BLS nonfarm payrolls) showed a gain of 313,000, clobbering expectations of 205,000, while the BLS household survey showed that total employment (including agricultural workers, self-employed, and small business startups) spiked strongly by 785,000. The unemployment rate remained steady at 4.1% for the fifth straight month as the labor participation rate rose. Wage inflation is only nominal and less than expected. US Industrial Production hit an all-time high of 107.24 in January. The Conference Board’s Consumer Confidence Index for February came in at 130.8, the highest reading since it hit 132.6 back in November 2000, while the NFIB Small Business Optimism Index rose yet again to 107.6. 4Q17 earnings season has been stellar with the vast majority of S&P 500 companies reporting both top and bottom-line beats. The BEA’s second estimate of real GDP in 4Q17 sits at 2.5%, and for 1Q18, the Atlanta Fed’s GDPNow model just came in Wednesday morning with an updated forecast of 1.9% (notably down from 5.4% on February 1), while the New York Fed’s Nowcast model projects 2.8% for 1Q18 and 3.0% for 2Q18. Fears of runaway inflation have suddenly subsided.