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STA Weekly Market Report – Market Resilience

INSIDE THIS EDITION:

Market Resilience
Chart of The Week: “Global Trade and the new U.S.-China Trade Pact”
401k Plan Manager **Recently Updated!
Weekly Technical Comment
Featured Articles & Interviews

Upcoming Event
2017 M&A Insight
“Seizing Opportunities in Today’s Markets”
You are cordially invited to attend an exclusive presentation
June 7, 2017
4:30 pm – 7:00 pm

Hilton Americas
1600 Lamar Street
Houston, TX 77010
Complimentary Valet

This year’s panel and Q&A will address:
Current trends in the market and future outlook
Proposed legislation and its potential transaction impact, including tax reform
Acquisition financing
Capital raise/mezzanine financing opportunities
Maximizing value through planning and preparation
Growth strategy alternatives
Pre-transaction planning, including wealth management strategies

Attendees will have an opportunity to ask their questions during the Q&A portion, as well as talk with panel members during the cocktail reception.
RSVP Required, Register today @ BIT.LY/2017MAINSIGHT
For more information, contact Francesca Rainosek at info.texas@doeren.com or at 713.789.7077

Market Resilience

The stock market had a setback this week with the large cap S&P 500 down almost 0.3% and the smaller stocks of the Russell 2000 falling almost 1.0%. Declining stocks outpaced advancing stocks. The decline was led by losses of over 1% in the Basic Materials and Finance sectors while Technology and Energy managed to advance.

The U.S. stock market keeps grinding higher, but how robust is the brigade leading the advance?  The Standard and Poor’s 500 index closed at its 16th record high of 2017 last week.

One concern for the markets and market-weighted Exchange Traded Funds (ETFs) is how top heavy it has become. Our research suggests there are slightly more than 6,600 common stocks today. Amazingly, just five companies (Google, Amazon, Apple, Microsoft and Facebook) make up over 10.5% of the market cap for all our common stocks. This suggests the next market correction, whenever it occurs, will likely be amplified for these larger stocks and the ETFs which follow them.

Another measure that seems to be struggling is the percentage of stocks trading above their 50-day average which peaked late last year at 80%, and has since shrunk to about 50%. The index is climbing, but half its stocks are struggling to keep up. That isn’t something bulls want to see as the rally continues.

Unfortunately, the markets’ problems are not just relegated to the largest stocks. Valuations are expensive almost everywhere. If we break the market down in equal numbers to groups of five (quintiles) we note at the peak of the “dot com” bubble in February 2000 the cheapest quintile had an average P/E of 7.2. As of the end of April this number is now 9.0 indicating even the cheapest stocks in the market are, by this measure, 25% more expensive than the Tech bubble’s top.

Another troubling sign comes from the surprises from “soft data” reports which are mostly surveys on how different groups feel. Much of the rally in stocks since the election has come from “Hope”. Hope Washington would create a pro-business atmosphere based on lower taxation and regulation. This hope caused many surveys to be more optimistic than had been anticipated and stocks ran up on these animal spirits. Unfortunately, the slow pace in Washington has turned the tide from optimism to disappointment. This reversal may create headwinds for stock investors.

However, there have been some bright spots. One was this week’s Retail Sales data. After a disappointing 1st quarter in personal consumption, many pundits wondered what the start of the new quarter might bring. In April Retail Sales advanced 0.4%. While this may have been below some of Wall Street’s expectations the underlying data is encouraging. Spending on big ticket items like vehicles, furniture, electronics and building materials leaped 0.8%.

From a strategic standpoint we have concerns including expensive valuations and the disquieting turn away from hope. This is not a time to be overly aggressive in stocks and we would recommend investors focus on having moderate levels of equities with a focus on bargain securities.

Chart of the Week: Global Trade and the new U.S.-China Trade Pact

Last Friday, the Trump administration announced a trade deal with China to boost exports and narrow trade deficits while helping job growth in the U.S. The plan could make it easier for a variety of American exports including beef, electronic payment services, and natural gas to enter the world’s second-largest economy. As a first step under a 100-day plan the new arrangement aims to address trade imbalances between China and the U.S. After this latest round of trade negotiations, we had the stock market react positively as it was taken as a signal that a trade war may not be as large a threat as once thought. In the chart of week that follows we highlight U.S. – China trade statistics and policies. More specifically, it shows that China and U.S. are the world’s No.1 and No. 2 merchandise and service traders with both countries topping $3.5 trillion in total trade during 2016.

Economies by size of merchandise trade

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Source: World Trade Organization

That all makes sense as China is the largest trading partner of the U.S. and vice versa. In fact, during 2016, U.S.-China bilateral trades accounted for more than 15% of total trade volume of each country, reflecting strong economic ties and the mutually dependent relationship that exists between the U.S. and China.

The charts that follow provide some additional data on both the U.S. and China.

Top trading partners of U.S. and China

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Source: Bloomberg.

Global trade with China has steadily expanded over recent years. In the U.S., goods exports to China have increased 115.7% while service exports to China increased 406% since 2006. For the same period, U.S. goods and service imports from China have risen 60.8% and 58.8%, respectively. Despite export growth outpacing import growth, the U.S. trade deficit with China has remained proportionally constant. In 2015 it hit a record high before a 5.5% decrease in 2016.

Historical trends of U.S. – China trade

*Click to Enlarge

Source: U.S. Commerce Department; Wall Street Journal.

The trade imbalance between the U.S. and China varies greatly by sector. Service trade for the U.S. outweighs China’s, with a surplus of $37 billion in 2016. The surplus in the service sector, however, is dwarfed by strong demand from the U.S. for Chinese consumer and capital goods. In fact, in these areas the U.S. runs a deficit of $215 billion and $125 billion, respectively. Agriculture is one exception with the U.S. exporting $16.7 billion more in agricultural products than it imported from China, benefiting U.S. farming.

Trade balance by sector

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Source: U.S. Commerce Department, Wall Street Journal.

The question of whether trade deficits matter, is a good one. We can answer it with a resounding yes.

Trade deficits with China and many other countries, including Mexico, Germany, Japan, and Canada, have been the largest drag for U.S. economic growth since financial crisis. Recall that growth in real GDP depends on only four factors: consumption, government spending, private business investment and net exports. Intriguingly, the contribution from private investment has also been weakened in recent years, partially attributed to a sluggish growth outlook and offshoring production due to high taxes and burdensome regulations at home.

Contributions to Real GDP have changed since 2007

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Source: www.advisorperspectives.com

The rise of trade protectionism and anti-globalization sentiment has created headwinds for global trade. Per the WTO’s latest trade statistics, the value of merchandise trade and trade in commercial services declined in 2015 following rapid expansion in 2005-2008 and modest growth in 2012- 2014.

World merchandise trade and trade in commercial services, 2005-2015

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Source: World Trade Organization

Global trade remains in focus and will have a significant impact on the direction of the market. The U.S. has withdrawn from the TPP (Trans-Pacific Partnership) trade deal and agreed to renegotiate NAFTA (North American Free Trade Agreement) with Canada and Mexico. On the other side of the Atlantic Ocean, the UK must work on a new trade deal of their own with the European Union as part of the “Brexit” process. In the Pacific, China just held a two-day summit over the weekend to promote the “One Belt, One Road” initiative launched in 2013. The project involves billions of dollars of infrastructure investment in countries among a vast and ancient network of trade routes linking China’s merchants with those of Central Asia, the Middle East, Africa and Europe.

*Click to Enlarge

Source: Economist

Although talk has been about trade protectionism, it appears that global trade is unlikely to erode aggressively. Instead, it appears that certain sectors stand to benefit as new global trade agreements are reached and as the latest U.S.– China pact certainly highlights

Weekly Technical Comment

U.S. Stocks Are Global Underachievers

We have been writing about foreign stocks doing better than those in the U.S. this year.  The chart below, however, is designed to show how weak U.S. stocks have been relative to foreign markets. The solid line is a relative strength ratio of the S&P 500 divided by the Vanguard All-World ex-US ETF (VEU). [The VEU includes foreign developed and emerging markets]. The chart shows the ratio falling below its 2016 lows to the weakest level since 2015. That doesn’t mean that U.S. stocks have fallen. They’re just underperforming foreign stocks “on a relative basis”. In fact, the S&P 500 has gained 7% since the start of the year. Foreign stocks, however, have doubled that performance (14%). To break things down even more, emerging markets are up 19% this year versus 13% for foreign developed markets. Europe is leading developed markets higher with a 2017 gain of 16%. Eurozone stocks are even stronger (18%). Asia is leading emerging markets higher (21%). Stronger foreign currencies are giving an additional tailwind to foreign stock ETFs.

*Click to Enlarge

Long-Term Trend May Be Shifting Away From U.S.

The next chart shows that the U.S. has lost market leadership before, and may be doing so again. The blue line is a relative strength ratio of the MSCI World (ex USA) Index divided by the S&P 500 going back to 1995. After leading the world higher during the 1990s, the U.S. underperformed between 1999 and 2008 (a falling ratio). The U.S. started outperforming in 2008 and did so until last year (rising ratio). The red line tracks the 14-month RSI line for the ratio. The downturn in the ratio in 1998 from overbought territory gave an early signal that U.S. leadership was ending. The rising RSI line broke a ten year down trendline in 2008, which coincided with a bottom in the US/ foreign stock ratio (up arrows). The U.S. did better than the rest of world from 2008 through 2016. Which brings us to the present. After spending 2016 in overbought territory, the 14-month RSI line has fallen to the lowest level in four years, and has broken its rising nine-year support line in the process (see circle). That suggests that the decade of U.S. leadership that started in 2008 has probably come to an end.

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MSCI Eurozone ETF Hits Ten-Year High

The monthly bars in the chart shows the MSCI Eurozone iShares (EZU) breaking through its 2014 high to reach the highest level in ten years. The EZU is doing slightly better than Europe in general because it includes only countries that use the Euro. Since the EZU is quoted in dollars, it’s getting an additional lift from a 6% gain in the Euro versus the dollar this year. A 1% jump in the Euro to a six-month high today is also boosting Eurozone stock ETFs.

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Drop In Bond Yields Sends Caution Signal

Some caution crept into financial markets near the end of the week. Part of that was reflected in Friday’s sharp drop in bond yields. The chart shows the 10-Year Treasury Yield falling back below its 50-day average in pretty decisive fashion. That was blamed mostly on Friday’s CPI report which came in lower than expected. [The recent slide in commodity prices is dampening inflation expectations]. The red line in the chart shows the 2-Year Treasury Yield suffering its biggest daily drop since March. That reflects some doubt about how aggressive the Fed will be in raising interest rates. The short-term effects of Friday’s drop in yields boosted bond prices as well as some other safe havens.

*Click to Enlarge

Weekly Snapshot of Global Asset Class Performance

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Featured Articles & Interviews

Trump Tax Reform
On Wednesday April 26, 2017, President Trump outlined his goals and priorities for major tax reform that could have a significant effect on all businesses and individuals.  This one-page summary highlights the key features of the proposed tax reform which the administration is labeling, “The Biggest Individual and Business Tax Cut in American History.”
Written By: Scott Bishop, Executive Vice President of Financial Planning

Josh McGee, Ph.D
On Financial Planning Friday, Scott Bishop, Executive Vice President of Financial Planning for STA Wealth Management hosts a special edition of the STA Money Hour with guest Dr. Josh McGee Ph.D. Josh McGee is a vice president at the Laura and John Arnold Foundation and a senior fellow at the Manhattan Institute.  McGee is an economist whose work focuses on public pensions and finance and he routinely provides expert testimony and technical assistance on municipal retirement plans like the Houston Police Officers’ Pension System (HPOPS) for the city of Houston. ”

Councilman Jack Christie
On Financial Planning Friday, Scott Bishop, Executive Vice President of Financial Planning for STA Wealth Management hosts a special edition of the STA Money Hour with guest Houston Councilman Jack Christie (atlarge5@houstontx.gov). Councilman Christie is the Chair of the City Council’s Budget and Fiscal Affairs Committee.  As most of our Houston Police Officer clients feel that their HPOPS Pensions are in trouble, we wanted to get the Councilman on the show to share what Council Christie s doing in terms of Pension Reforms.

 

If you have any questions, please feel free to email me at luke@stawealth.com.

Luke

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)


Disclaimer:
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.

 

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