Investing Environment Review and Outlook – Volume 45
There are anecdotal signs of speculation: Bitcoin’s popularity, the surge in IPOs, the proliferation of SPACs, high call option volume, and the Gamestop short squeeze. These have drawn comparisons to 1999– before the dotcom bubble burst. This month we discuss the implications of extreme investor positioning, the uptick in our inflation outlook indicators for the first time in 3 years, and the recent NYSE breadth thrust equity signal. Overall, indicators are bullish, giving us confidence that the bull market remains intact. However, we cut our U.S. equities rating from a max bullish 5 rating to a bullish 4 rating based on the extreme investor positioning. Foreign developed and emerging markets equities remain at a bullish 5 rating along with gold and commodities. Long-term bonds remain a cautious 1 rating, with the likelihood of higher interest rates hurting long-term bond prices.
Inflation Outlook Uptick: Negative for Long-Term Bonds/Positive for Equities
Inflation indicators ticked up to 77.8 this month, indicating higher inflation ahead for only the fifth time in the last 30 years. These indicators are designed to predict the direction, rather than the level, of inflation. Pressure is coming from the monthly ISM Manufacturing Prices Paid Index in the 96th percentile for January, the Dollar Index down 10% from its high, and strong coincident economic indicators like the Philadelphia Fed Index. Crude oil and agricultural commodity prices are up as well. Higher inflation outlooks in 1955 and 1966 might be comparable to this year, since inflation was below 2% in each case, before rising to 3-5%. The ultimate inflation peak depends on how long the indicators remain elevated and whether the Fed allows higher inflation, as they have promised. The post-vaccine demand surge could be transitory. Investors have learned to expect this pattern, as we saw in the 2010 and 2018 cases, when CPI rose, but only briefly, before rolling over.
More important than predicting the inflation peak is determining the implications for investors today. Tests show a higher inflation outlook combined with a strong economic outlook was negative for long-term bonds, as you would expect, with a -14.1% return annualized while conditions held. However, S&P 500 returns were strong, at +27.8% annualized, almost 3x the norm, when the inflation outlook was up and the Fed was loose. This compares to just a +5.2% return when the Fed was hiking interest rates. The level of inflation was also significant. The S&P 500 returned 18.6% when the inflation outlook was up and CPI was under 2% as it is today vs. just 0.7% return for the S&P 500 when CPI was over 4%. Historically, bond prices moved in anticipation of inflation, while stock returns remained positive, at least until inflation showed up and a Fed policy change was anticipated.
NYSE Breadth Thrust: Bullish for Equities
On February 12th, the 10-day NYSE Advance/Decline ratio reached 65%. This means that on average, NYSE advancing stocks were stronger than declining ones for 2 weeks, reaching the 99th percentile of historical readings, with just 27 prior cases in the last 60 years. This is a version of what Marty Zweig called a breadth thrust, and the implications are bullish for equities. For instance, 1 month out the S&P 500 returned an average of +3.9%, with 89% of cases higher, over 4x the norm. 3 months out the average return was +7.2% and 6 months out it was +14.6%. Finally, the next 10% move was higher in all but one case, giving us confidence the bull market remains intact.
Investor Positioning More Extreme: Negative
Since January, equity investor positioning extended further, with 7 of 10 investor groups extremely long. Positioning by itself is rarely a catalyst for a market turn, but it does raise the risk of a reversal, and more so in Q1 than Q4. For instance, since 2010 the S&P 500 returned just +1.2% annualized in Q1 with this kind of optimism vs. +18.9% in Q4. In the three prior cases with positioning this long in Q1, the S&P 500 declined between 5-10% (2011, 2014 and 2018). Those peaks occurred between January 15th and February 21st, around this time of the year. To recognize the risk of lower returns and a possible reversal, we cut the U.S. equity rating to a bullish 4 rating from a max bullish 5 rating.
Despite anecdotal signs of speculation with comparisons to 1999, conditions remain bullish for equities–particularly the strong economic outlook, positive tape signals, and the loose Federal Reserve. The uptick in the inflation outlook indicators is a natural part of the economic cycle, which for now is negative for bonds and still positive for stocks. The extreme investor positioning is a rough tool, but a good reminder to expect a 3-8% decline at any time. We will continue monitoring and testing economic and market conditions daily. Thank you for your support, and please contact your advisor with any questions.
This review and outlook report (this “Report”) is for informational, illustration and discussion purposes only and is not intended to be, nor should it be construed as, financial, legal, tax or investment advice, of Brenton Point Wealth Advisors LLC or any of its affiliates (“Brenton Point”). This Report does not take into account the investment objectives, financial situation, restrictions, particular needs or financial, legal or tax situation of any particular person and should not be viewed as addressing any recipient’s particular investment needs. Recipients should consider the information contained in this Report as only a single factor in making an investment decision and should not rely solely on investment recommendations contained herein, if any, as a substitution for the exercise of independent judgment of the merits and risks of investments.
This material is based upon information obtained from various sources that Brenton Point believes to be reliable, but Brenton Point makes no representation or warranty with respect to the accuracy or completeness of such information. Views expressed herein are current only as of the date indicated and are subject to change without notice.
This Report contains certain forward looking statements opinions, estimates, projections, assessments and other views (collectively “Statements”). These Statements are subject to a number of assumptions, risks and uncertainties which may cause actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by these forward looking statements and projections. Brenton Point makes no representations as to the reasonableness of such assumptions or the likelihood that such assumptions will coincide with actual events and this information should not be relied upon for that purpose. Changes in such assumptions could produce materially different results. Past performance is not a guarantee or indication of future results, and no representation or warranty, express or implied, is made regarding future performance of any financial instrument mentioned in this Report.
Any benchmark shown herein is shown for illustrative purposes only. No index benchmark is available for direct investment. It may not be possible to replicate the returns of any index, as the index may not include any trading commissions and costs or fees, may assume the reinvestment of income, and may have investment objectives, use trading strategies, or have other materials characteristics, such as credit exposure or volatility, that do not make it suitable for a particular person. This is not an offer or solicitation for the purchase or sale of any security, investment, or other product and should not be construed as such. References to specific financial instruments and to certain indices are for illustrative purposes only and provided for the purpose of making general market data available as a point of reference only; they are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities. Investing in securities and other financial products entails certain risks, including the possible loss of the entire principal amount invested, as the value of investment can go down as well as up. You should obtain advice from your tax, financial, legal, and other advisors and only make investment decisions on the basis of your own objectives, experience, and resources.
Brenton Point accepts no liability for any loss (whether direct, indirect or consequential) occasioned to any person acting or refraining from action as a result of any material contained in or derived from this Report, except to the extent (but only to the extent) that such liability may not be waived, modified or limited under applicable law.
This Report may provide addresses of, or contain hyperlinks to, Internet websites. Brenton Point has not reviewed the linked Internet website of any third party and takes no responsibility for the contents thereof. Each such address or hyperlink is provided solely for your convenience and information, and the content of linked third party websites is not in any way incorporated herein. Recipients who choose to access such third-party websites or follow such hyperlinks do so at their own risk.
All marks referenced herein are the property of their respective owners. This Report is licensed for non-commercial use only, and may not be reproduced, distributed, forwarded, posted, published, transmitted, uploaded or otherwise made available to others for commercial purposes, including to individuals within an institution, without written authorization from Brenton Point.
Source of data and performance statistics: Bloomberg L.P. and Factset Research Systems Inc.
©Brenton Point Wealth Advisors LLC 2021
Director of Market Research
Michael Schaus is the Director of Market Research for Brenton Point Wealth Advisors and Zweig-DiMenna. Since joining Zweig-DiMenna in 1992, his focus has been on macroeconomic research, the analysis of…READ MORE