Saturday, December 03, 2016

Small Cap Stocks No Longer Cheap Relative To Large Caps

Subsequent to the election, the equity 'risk on' trade has been most evident in small company stocks with the S&P 600 Small Cap Index returning 13.0% since 11/4 versus a return of 5.4% for the S&P 500 Index.

In fact, small cap stocks have been outperforming large caps since the market pullback in February of this year. Benefiting the return of small cap stocks is the fact, based on their respective P/Es, they were cheaper than large caps on a relative basis as can be seen in the below chart. However, this spike in return over the last four weeks has put the relative valuation of small caps below the average relative value going back to 2004.

Given small caps burst of outperformance over the last four weeks, a period of near term underperformance would not be surprising and would actually be healthy. One factor likely at play though is the anticipation that small cap earnings will begin to accelerate as occurring in the large cap space. The third quarter will market the end of the earnings recession with S&P 500 Q3 2016 earnings expected to be up 4.2% versus Q3 2015. Looking ahead, Thomson Reuters I/B/E/S is estimating earnings growth rates for the S&P 500 Index for Q4 2016 through Q3 2017 at 6.2%, 14.0%, 11.9%, and 9.8% respectively. This improvement in the earnings picture may serve as a floor against an extended equity market pullback.

Saturday, November 26, 2016

Will The FANGs Lag During A Period Of Faster Economic Growth?

In the lead up to and after the November election a significant change in stock leadership has been underway. The better performing sectors are those that will benefit from faster economic growth and a steeper yield curve (like the banks.) Seemingly left behind, or at least underperforming, are the technology stocks as can be seen in the below sector performance chart.

One area of technology that generated out sized returns in 2015 was related to internet and social media companies. The favored group of stocks called the FANGs (Facebook (FB), (AMZN), Netflix (NFLX) and Google/Alphabet (GOOGL) were a beneficiary. The below chart shows the significance of the 2015 FANG returns.

Given the strength of the FANGs return in the couple of years leading up to the end of 2015, the fact they have kept pace with the market in 2016 is somewhat a sign of investors continued interest this group of stocks.

Back to the change in stock leadership that is underway this month, the FANGs have not been immune to weakness relative to the broader market. The rotation that has occurred since the election is seeing flows into value/cyclically oriented stocks versus growth stocks that tend to trade at a higher price earnings ratio or valuation multiple. Each of the four FANG stocks are underperforming in November and is this indicative of the beginning of a longer term trend?

One measure an investor can use in evaluating stocks is to compare a stocks P/E to its expected earnings growth rate, the PEG Ratio. P/E is a company's price per share divided by earnings per share. The lower a company's PEG ratio the cheaper the stock relative to the company's earnings growth.
  • P/E = Price Per Share/Earnings Per Share
  • PEG Ratio = (P/E)/Earnings Per Share Growth Rate
The importance of comparing PEGs across different stocks or sectors is the PEG enables an investor to uncover stocks that may trade at relatively high P/Es because the company's earnings are expected to grow at a faster rate than maybe a lower P/E stock. As can be seen in the below chart, the FANGs' PEG ratio is lower than that of the broader S&P 500 Index and the technology sector itself.

Based on the PEG alone, and in spite of the high PE multiple, the market is expecting faster earnings for this basket; thus, rewarding the stocks with a higher P/E. Working against higher valuation stocks at the moment though is the market's anticipation that economic growth will quicken in the coming year or so. This is leading to investors rotating into more economically sensitive stocks that tend to trade at lower valuations or PEs in anticipation of faster earnings growth.

Friday, November 25, 2016

Black Friday For E-Commerce

E-commerce retailers are likely to continue their dominance and be the primary beneficiaries on Black Friday. As the below chart shows, e-commerce sales continue to garner a larger percentage of overall retail sales with traditional brick and mortar retailers stuck in a no growth environment. Further detail on third quarter e-commerce sales can be reviewed in the U.S. Census Bureau's recent e-commerce sales report.

Thursday, November 24, 2016

Individual Investor Sentiment May Be Too Bullish

The American Association of Individual Investors released their Sentiment Survey today and bullish sentiment is reported at 49.9%. This is slightly above the +1 standard deviation level of 48.4%. As can be seen in the below chart, the bullish sentiment level has spiked higher subsequent to the U.S. presidential election from a few weeks ago. Although not shown on the chart, the bull/bear spread widened to +20.1 and is the widest level since November of last year.

Data Source: AAII

Individual investor sentiment measures are contrarian ones and at their extremes frequently coincide with market reversals or pullbacks. Given the strength of the market averages since the election, an equity market pullback or consolidation would not be surprising and actually healthy for a next move higher.

Wednesday, November 23, 2016

An Equity Market Finding Little Upside Resistance

Today the Dow Jones Industrial Average Index closed at another record high of 19,083.18, crossing another 1,000 point interval on Tuesday. It has taken nearly two years for the index to breach this 1,000 point interval after breaking 18,000 in December 2014. The market advance following the election is beginning to sound like a broken record as commentators announce the market's close at a "new all time high" at the end of each trading day.

Emotionally, it feels as though the market is due for a pullback, and for investors in cash, a pullback is being hoped for. A pullback will come just as night follows day; however, the market being a weighing machine as it is, a better investment environment continues to get more priced in based on potential policy changes in Washington.

Turning to the broader S&P 500 Index, the S&P is up 5.6% since the beginning of election week and up 20.4% since the February 11 taper tantrum low. Setting emotions aside and looking at the market technicals, the money flow index and the stochastic indicator appear to indicate the market is near overbought.

Saturday, November 19, 2016

Equity Market Beginning To Resemble Bull Market Of The 1950's And 1980's

In the early days following the presidential election, the equity market seems to be anticipating better economic growth in the years ahead. Knowing the economy is not the market though, investors believe a better economy will translate into stronger corporate profits as well. When the new administration takes office in 2017, Trump's campaign comments indicate the economy is in need of more government spending, specifically on infrastructure and the military. Additionally, a Trump administration has promised tax reform, and specifically tax cuts.

History does not necessarily repeat itself perfectly; however, it does tend to rhyme. The below chart overlays the S&P 500 Index from September, 2013 compared to the bull markets of the 1950's and 1980's. Trump's anticipated policies do have similarities to policies pursued in the 1950's and 1980's and those two decades were periods of a strong bull market.

The decade of the 1950's followed World War II and pent up demand saw the Gross National Product in the U.S. more than double from 1945 to 1960. Government spending in the 1950's was targeted at construction of the interstate highway system, building of schools and an increase in military spending. A Trump administration is indicating a stimulus program would focus on infrastructure and the military.

The decade of the 1980's was know as the Reagan Revolution. A focus of President Reagan's policies was reducing the tax burden on Americans, lowering government regulation and shrinking government itself. During Reagan's years in office, he cut the top tax rate from 70% to 28%. President Elect Donald Trump also projects to implement similar policies as Reagan, i.e., reduce regulation, shrink the government and lower taxes.

The 1950's and 1980's were good decades for equity investors. President Elect Donald Trump is projecting he will pursue policies that look similar to those implemented by presidential administrations of the 50's and 80's. If Trump's policies have a similar impact as those in the 50's and 80's, the coming years could be rewarding for equity investors.

Wednesday, November 16, 2016

Powerful Sector Rotation May Need A Breather

The market action following last week's election has seen powerful rotation among stock market sectors and industries. In my last post I highlighted this movement along with stocks and industries that are benefiting from this rotation and industries that are not benefiting. I noted a potential caution due to the fact the targeted sectors seems to be a consensus trade by investors and the moves may be occurring too quickly. One area benefiting from the rotation is the financial sector at the expense of the technology sector as seen in the below chart.

Sunday, November 13, 2016

Investors Adjusting Investments As A Result Of The Election Outcome

This post is more of a chartfest to feature information I ran across over the weekend from various sources but related to investment topics relevant to potential policy changes under a President-Elect Trump administration. Investors know the equity market reacted favorably to the election outcome last week; however, some market segments did far better than others. Although the night is long, the futures market tonight is indicating a positive open for Monday. The Dow and S&P futures are higher by about .40% to .50% (this is 95 points on the Dow.)

Thursday, November 10, 2016

Toss Aside Your Political Leanings, The Equity Market Is

Tossing aside ones political leanings, the stock and bond market are telegraphing positive results from a Trump presidency as it relates to the economy. I briefly touched on the bond market in yesterday's post and below is another chart of the 10-year Treasury yield-the yield continues to move higher.

Wednesday, November 09, 2016

The Market The Day After The Election: Emotion Versus Fundamentals

In Monday's post I highlighted the importance of separating ones politics from their portfolio. The market's reaction to yesterday's election outcome is a perfect example why this is important. As election results trickled in last night and it became apparent Donald Trump would be the 45th President of the United States, equity futures sold off sharply. The day after election sell offs are not unique. The market sold off 2.4% after the 2012 election and sold off 5.3% after the 2008 election.

The Dow futures were down over 860 points at one point early this morning. In spite of this initial negative reaction, today the Dow Jones Industrial Average closed up 256 points at 18,589 after reaching an intraday all time high of 18,650. At the end of the day, stocks will trade on fundamentals and whether or not one is a Trump supporter, his policy proposals could be very bullish for the economy and stocks. Today's market action is a reflection of this potential positive. Additionally, stock prices follow earnings and it looks highly likely third quarter S&P 500 earnings growth will be positive for the first time since Q1 2015. Q3 2016 earnings growth is tracking to be up 3.9% and 7.5% ex-energy.

The bond market sold off rather sharply in a potential sign investors anticipate a faster pace of economic growth. The 10-year Treasury yield closed at 2.07% and is the highest yield since reaching 2.1% in January of this year.

The market will certainly not move higher in a straight line. Also, the Fed rate decision in December may also create some equity market volatility. However, the election outcome in and of itself may not be bad for the economy and thus could be good for stocks. Separating emotion from fundamentals remains an important characteristic for investors.