Join the conversation and feel free to submit a question to our experts.Submit a question
Stay up to date and have the STA Weekly Report and 401k Plan Manager emailed to you.Subscribe
Read STA's Featured ArticlesRead More
It May Be America First, But Emerging Markets Have Doubled the Performance of the S&P 500 This Year
Chart of The Week “Emerging Markets vs. Domestic Markets”
401k Plan Manager
Weekly Technical Comment
Weekly Snapshot of Global Asset Class Performance
Featured Articles & Interviews
It May Be America First, But Emerging Markets Have Doubled the Performance of the S&P 500 This Year
Once again, Washington gridlock (Affordable Care Act repeal) seemed to work well for the stock market. The Dow rose 0.32% last week while the small cap Russell 2000 jumped 2.37%. We saw 2.8 stocks advance for every one that fell and we also saw three times as many new highs as new lows.
For the first quarter of 2017, the S&P 500 did jump 5.5%. The quarter overall was huge for the reflation trade, but all the gains took hold in January and February. Something happened in March which was the proverbial stalling-out or what is referred to as the “Trump Fade” replacing what was the “Trump Trade”. Suddenly, the Financials, Energy, and Industrials, the poster children of the Trump fiscal stimulus plan, all lagged.
We remind folks about excessive valuations and bullishness. Margin debt, borrowed money to buy stocks, has reached record levels and sales of Exchange Traded Funds have also jumped to unprecedented levels. These are more often associated with a topping market than one which is bottoming. The Federal Reserve raised the Fed Funds rate on 15 March. This was the third hike, and true to form it followed the old saw of three steps and a stumble. Our research shows the market tends to slip in the 12 weeks following the third rate hike. Indeed, the Dow is down 1.4% since the hike.
The market has been riding a wave of optimism about the economy. Chief Executive magazine shows the highest level of CEO confidence in almost 11 years. Furthermore, the Conference Board Consumer Confidence reading hit its highest level since the end of 2000. Lastly, Homebuilder Confidence, as reported by NAHB, has reached the highest level since June of 2005. Many expect good things and hope the new administration will get the economy growing more rapidly. Alas, many dreams wind up on the rocks due to Washington. If it cannot get its act together, expect stock prices to reverse some or all the 13.8% gain the Dow has enjoyed since the election.
So, the real action is overseas where monetary policies are more accommodative, currencies more competitive, and earnings trends and revisions more compelling. It might be America first, but as far as market action is concerned we have the likes of the German DAX and Hong Kong’s Hang Seng that have doubled the performance of the S&P 500 this year and others like Singapore, Korea and India that have tripled the U.S. performance.
The emerging market space has generated a 12% net positive return so far this year and yet all I get asked day in, day out, is where the S&P 500 is headed this year. Even with that, Euro area stocks in this eight-year bull market have lagged the U.S. by 150 percentage points; Asia ex-Japan by more than 100 percentage points and Japan by 80 percentage points. You get the point, right?
Let’s broaden our horizons folks, and focus on markets where you can buy stocks at 12x forward price-to-earnings (P/E) instead of 18x. These recent relative gains have come from years of lagging performance so this may have room to run.
The market remains in a period of heightened risk due to higher valuations, but they aren’t particularly helpful in determining shorter term moves. For now, we would recommend investors remain moderately invested in stocks.
With the first calendar quarter now behind us, we continue to see an equity market that believes in the possibility, albeit moderated, that a pro-business presidential administration will save the day and keep stock markets moving higher. Year to date, the S&P 500 has moved higher by 5.7% while Emerging market equities as measured by the MSCI Emerging Market Index have returned 12.43%. In other words, in just the first three months of 2017, domestic and emerging market equities have turned in what would be considered solid performance over an entire year. During the last several months we have touted the merits of adding exposure to emerging market equities based on not only an improving macroeconomic backdrop, but also improving technicals, and valuations that on a relative basis look more favorable than domestic stocks. This brings us to our chart of the week, which shows the valuation gap that still exists between the MSCI Emerging Market Index and the S&P 500, despite outperformance by Emerging Market Equities this year.
As the chart shows, since the beginning of 2012, there has typically been a valuation difference (or spread) between the S&P 500 and the MSCI Emerging Markets Index. On average the spread has been just above 4% and is represented by the dotted red horizontal line in the chart. Although, the spread tends to bounce around quite a bit, we currently see the spread at 26%, indicating a more favorable valuation level for emerging market stocks vs. domestic market peers.
In addition to valuations looking more attractive in Emerging Markets, we also see more constructive technical indicators serving as a secondary confirmation of improving markets abroad. The chart that follows shows the longer-term 50- and 100-week exponential moving averages (EMA), indicators that we often use. The EMA is like the standard moving average that is often used by investors, but instead of equally weighting prices, it weighs recent prices more heavily.
What the chart shows is that the MSCI Emerging Markets Index 50-week EMA has spent the better part of 6 months converging toward its 100-week EMA. More important however, is that this past week the 50-week crossed above the 100-week EMA and could signal the beginning of a longer-term bullish period for emerging market equities.
Back in 2010, we witnessed the S&P 500 experience a similar cross and marked the beginning of the multi-year bull market for domestic equities (chart below).
While these technical indicators can yield false positives, it is worth noting that what we have seen this week provides yet another data point that supports adding some emerging market exposure to a well-diversified portfolio.
The 200-day moving average is an important level, and it is what separates uptrends from downtrends. To sustain a bull market, more stocks must be above their 200-day average than below it. And that is currently the case.
The red line plots the percent of NYSE stocks above their 200-day moving averages. The index peaked last August at 80% before dropping to 55% just before the November election. It then rose to 75% in February. So far, the March pullback has been very mild with its current reading at 70%. From spring 2015 to the start of 2016, the index dropped from 65% to below 20% before bottoming. That’s what happens during a serious market correction. At the moment, there are no signs of that happening. The % line appears to be consolidating within an overall uptrend. It also looks like it’s turning back up again.
The blue line at the bottom of the chart below shows the percent of NYSE stocks above their 50-day average. That more volatile line fell from 80% to 45% during the first quarter which is a relatively mild setback. And it appears to be climbing again as well. Also, constructive for stocks.
Oil Service Stocks Bounce Off Major Support
Energy has been the market’s weakest sector during the first quarter. But it was this week’s strongest sector. The VanEck Oil Services ETF (OIH) had the stronger week (+3.7%) versus 1.9% for the Energy Sector SPDR (XLE). It also has a stronger looking chart. The chart below shows the Oil Services ETF starting to find support at its 200-day average and a rising support line drawn under its January/September lows. The direction of crude is of course the major factor influencing oil shares. Crude jumped 5.5% last week for its best showing of the year. It also climbed back above its 200-day line which helped boost energy shares.
The chart shows WTIC Light Crude Oil climbing back above its 200-day average after bouncing off a rising trendline drawn under its August/November lows. And from an oversold RSI reading at 30 (top of chart). Needless to say, weak energy stocks are a drag on the S&P 500. Any sign of new buying in that sector would be good for them and the market as a whole.
Sector Relative Rotation Model
The Sector Relative Rotation Model shows what sectors of the S&P 500 are strengthening and what sectors are weakening relative to the index. In other words, what is driving returns versus detracting from them.
The chart below (updated through April 3, 2017) indicates relative strength (relative to the S&P 500 Index). Technology and Consumer Discretion are leading relative to the S&P 500. Energy is currently lagging. Financials, Materials, Industrials, and Small Cap Stocks indicate weakening, with Healthcare, Utilities, Consumer Staples, and REIT stocks indicating improvement in the model. Keep in mind while this model is helpful to analyze sector strength in the S&P 500, it is one tool and should be used with a comprehensive investment discipline.
Note: There are four quadrants on the chart:
• Leading (Green) – strong relative strength and strong momentum
• Weakening (Yellow) – strong relative strength but weakening momentum
• Lagging (Red) – weak relative strength and weak momentum
• Improving (Blue) – weak relative strength but improving moment
If you have any questions, please feel free to email me at email@example.com.
STA Investment Committee
Luke Patterson, CEO & Chief Investment Officer
Michael Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA Wealth Management, LLC. Please remember to contact STA Wealth Management, LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. STA Wealth Management, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA Wealth Management, LLC’s current written disclosure statement discussing our advisory services and fees continues to remain available upon request.
and for exploring our website. Whether you are looking for someone to partner with you in protecting and growing your assets, or you are an experienced financial advisor interested in joining the STA team, we want to hear from you. Please reach out to us using the information below, or by completing the online form, and we’ll be in touch as quickly as possible!
281.822.8800 (Houston area)
800 Town & Country Boulevard, Suite 410
Houston, TX 77024
For directions to our offices, click here.