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STA Weekly Market Report – Technical Indicators Signal Caution

INSIDE THIS EDITION:

Technical Indicators Signal Caution
Chart of the Week: “Odds of Another Fed Rate Hike
401k Plan Manager
Weekly Technical Comment

As might be expected, a holiday interrupted week showed little commitment. The Dow Jones Industrial Average (Dow) only rose about 0.38 percent while the small cap Russell 2000 gained a paltry 0.05 percent. Still, the market seems lethargic since the last Fed rate hike.

Large cap indices, apart from the Dow, have lost a little ground since the rate hike on 15 June. Surprisingly small cap stocks and bargain/quality have advanced a little. This may be the first signs of the market turning back to normal behavior. It is far too early to tell if this will be a full reversal of recent trends, but it is long overdue.

Eugene Fama and Kenneth French were professors at the University of Chicago Booth School of Business.  Fama and French did research going back to 1926 and found Value stocks outperformed Growth by about 4.8% a year. However, the last decade has been working in an opposite fashion. We compared the Russell 1000 Value to the 1000 Growth index and found that Value underperformed by 3.35% a year. There was a lengthy period of this kind of abnormal behavior that ended in March of 2000. Between March of 2000 and December 2003 the large cap Russell 1000 Index fell 21.1% while the 1000 Value Index rose 10.8% and amazingly, the small cap Russell 2000 Value Index rose 74.2%. Having good quality, cheap stocks helps a lot when the market reverses direction.

Extended valuations and investor appetite for risk are early warnings of a coming change in the market. Companies are also issuing junk rated bonds at the fastest rate in history. Low overall interest rates and investor confidence in the future support this issuance but also indicates a high level of risk tolerance.

This week sees Q2 earnings season ramp-up as Wells Fargo, JP Morgan, and Citi all report Friday.

We have discussed over the past few weeks how risk levels, on a tactical and valuation basis, have risen for stocks. Having a slight bent towards being risk-adverse makes sense.

Chart of the Week: Odds For Another Fed Rate Hike

The Federal Reserve Act requires that the Federal Reserve Board submit a report to Congress that details monetary policy in the context of economic developments and future economic prospects. This is done semiannually and is typically delivered along with testimony from the Federal Reserve Board Chair. While the Fed did not have testimony scheduled for last week, the Fed did move ahead with submitting their report and provided some insight into monetary policy as the market odds of another rate hike this year slip below 50%. Our chart of the week shows how odds have changed for a September and December rate hike since March of this year. Currently, the odds for a September hike sit at just under 18%, while December odds have recently increased but still fall below 40%.

*Click to Enlarge Source: STA Wealth, Bloomberg

Lower odds of a rate hike are partially attributed to a lack of progress pushing through on the presidents’ agenda items in Washington. Looking at the overall macroeconomic picture, things haven’t looked bad however. Below we summarize some of the key points gleaned from the Fed report which did little to provide additional information regarding the timing for future rate hikes but does point to an economy in reasonable shape and a Fed committed to remaining flexible if economic conditions change.

Economic Takeaways

Labor Market: Still tight

Based on the report submitted, the Fed cites a labor market that has continued strengthening during the first half of 2017. That said, the current pace of labor market improvement has decelerated, as average payroll numbers over the first five months have come in below the average monthly increase we saw in 2016. However, because the current pace has been absorbed by new entrants into the workforce, the unemployment rate has declined to 4.3%, as of May, in a sign that the labor market remains tight.

*Click to Enlarge Source: STA Wealth, Bloomberg

Wages: Only modest growth

Although the labor market has remained tight during 2017, wage growth which we would typically expect to pick-up to a greater degree has not done so. As the Fed cites, this could be due to “the weak pace of productivity growth in recent years”.

*Click to Enlarge Source: STA Wealth, Bloomberg

Inflation: Still below 2% target

Inflation numbers retreated in May after the consumer price index showed a 12-month change earlier this year that approached 2%. However, the improvement in inflation numbers has been largely driven by the favorable comparison following the energy price decline. Excluding food and energy (core inflation as it is typically referred to), was lower than it was one year earlier at 1.4% in May in a sign that inflation remains subdued.

Economic Growth: Remains tepid

Real GDP rose on an annualized basis during the first quarter of 2017 at a pace of 1 ½ percent. Unfortunately, this pace is both unimpressive and below the growth target. However, economic growth looks like it wants to reaccelerate with help from increased consumer spending, improved consumer sentiment, job gains, more business investment, and strengthening housing market.

Financial conditions: Supportive of growth

Domestic financial conditions currently appear supportive for economic growth. Interest rates for both U.S. treasuries and mortgages remain low despite being above where they were last year. Broad equity markets have also seen price appreciation year-to-date. This has created a more confident consumer and has helped set the stage for some incremental economic growth.

Monetary Policy Notes

Interest rate policy: Still accommodative

During the first half of 2017, the Fed remained committed to a gradual reduction in monetary accommodation. By raising rates in March and June to the range of 1 to 1 ¼ percent we see today, the Fed was able to take a gradual step toward interest rate normalization while still remaining sufficiently accommodative to allow for further expansion of economic activity. More importantly, the Fed emphasized that monetary policy had no pre-defined course and the committee would remain flexible and responsive to new economic data as it is released.

Balance Sheet: Normalization on the horizon

Although accommodative monetary policy remains, the Fed continues to stress that it expects to start normalizing (i.e. reducing) the size of the balance sheet. However, again the Fed relied on tentative language in last week’s report that clearly says that it will be dependent on whether the economy continues to strengthen more broadly.

Weekly Technical Comment

Strong Jobs Help Stocks

A strong jobs report on Friday helped boost the S&P 500 back over its 50-day moving average (see below). That kept its May/June uptrend intact. Friday’s rebound also took place on lighter volume. Which brings us back to the seasonal patterns in the chart above. The market may be getting the benefit of a normal July bounce. That, however, is followed by the more dangerous seasonal months of August, September, and October. That may be a more likely time for a pullback to occur. September may be a pivotal month for some central bank decisions. The Fed and the ECB are widely expected to announce during that month plans to start reducing their bond holdings or purchases. There’s also a chance that Britain and/or Canada may hike rates during that period. Any central bank surprises could unsettle the stock market during a seasonally vulnerable period. Which bring us back to the chart below. If a pullback were to occur, the black box shows a potential support zone ranging from the May intra-day low at 2352 to the spring bottom. That would bring the SPX closer to a major support line extending back to its February 2016 bottom. And its 200-day average. A drop to the vicinity of its spring low would represent a pullback of about 5%.  The market seems due for a pullback or period of consolidation during the seasonally weaker months.

*Click to Enlarge Source: Stockcharts

The First Line of Defense

The first line of defense for the SPX is its mid-May intra-day low at 2352. More substantial support is at its March/April lows. That would still leave it well above its 200-day average and a major up trendline (green arrow). The chart below shows the green line as a rising support line drawn under its February 2016/ November lows. So far, no serious damage is being done to the market’s major uptrend. 

*Click to Enlarge Source: Stockcharts

 August And September Are Usually the Weaker Months

We have made references to seasonal patterns in our newsletter before. I’m referring mainly to monthly seasonal patterns. The first chart plots the percent of months the S&P 500 closed higher over the last ten years. Average percentage gains (or losses) are shown near the bottom of each monthly bar. Although the chart covers only ten years, it closely matches the monthly performances since 1950 (according to the Stock Trader’s Almanac). A couple of things stand out on the chart. First, the period from November through April is normally stronger than the period between May and October. After an April bulge, the performance bars usually decline from May to September. Hence, the “sell in May” mantra repeated each year. That doesn’t mean stocks always fall during the summer/fall months. It means they usually don’t do as well as the winter/spring period. Most corrections, however, do occur during the late summer/ early fall period. The two weakest months of the year are usually August and September. October often starts off weak and ends up strong, which makes it a tricky month. A lot of corrections and bear markets have bottomed during October. That makes the August through early October period the most dangerous of the calendar year. July normally experiences a summer bounce before the trend weakens again. 

*Click to Enlarge Source: Stockcharts

 Weekly Snapshot of Global Asset Class Performance

*Click to Enlarge

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)


Investopedia Announcement

Scott Bishop, our head of Financial Planning at STA Wealth, was recently invited to join Investopedia’s group of expert advisors that fields questions from users of their website.  If you would like to follow Scott’s weekly thoughts on financial planning topics, check out his Investopedia webpage at the link below.

Scott Bishop, Investopedia


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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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