There’s a Lady Who’s Sure All That Glitters is Gold

At this time last year the stock market had been falling since New Year’s Day.  It was the worst start to any year for stocks.  In the prior months, crude oil had collapsed from $100 per barrel in early 2015 to under $30.  Further there were broad worries that China would devalue their currency which would place additional pressure all developing economies.  Angst and pessimism abound.
The markets stabilized in mid-February and began a stair step journey that has lasted a year.  This pattern of advance, pause, advance, pause, withstood Brexit, the U.S. presidential campaign, elections in France and Italy, and of course, Donald Trump’s victory.
The chart below covers the S&P 500 for the past 12 months.  The red line is the 200-day moving average, the blue line is the 50-day moving average, and the black line is the 10-day moving average.   These lines provide context for viewing the markets for different time periods.  The 10-day line is an indicator commonly used by traders to gauge short-term movements.  The 200-day gives perspective for a longer time frame as it is the average for almost a year’s worth of trading and it considered significant when it is crossed – both advancing above and falling below.
As can be seen, once the 200-day (red line) was reclaimed in March, it was only tested in late June (Brexit) and just before the U.S. election.  Both times the level held and the markets bounced signaling the bulls were in control.  Since the election, the 10-day (black) and 50-day (blue) have acted as support for the rally.


The steadiness of the rise since the election is another noteworthy characteristic of the chart.  There has not been a daily drop of 1% or more since October.  This totals 89 trading days which is abnormal.  You would have to go back to before the financial crisis to find a streak this long.
Here are how the major averages have performed from the lows of last February.  Also included are the year-to-date numbers for 2017.
YTD 2017        Since Feb 2016 lows
Dow Jones Industrial Average                   +4.4%                      +31.70%
S&P 500                                                     +5.0%                      +28.54%
Nasdaq Composite                                     +8.5%                      +36.85%
Russell 2000                                              +3.1%                       +46.78%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
The Nasdaq has led the way so far in 2017 and it is part of the 37% advance over the past 12 months.  Below is a chart that calculates the Nasdaq’s rolling 1-year percentage change.  A couple of noteworthy observations.  First, this past year isn’t that significant as there are many years with higher returns.  Secondly, there are many examples of disappointing years following a 30% or better gain.(i)
“‘Cause You Know Sometimes Words Have Two Meanings”
Looking in the rearview mirror, it’s easy to think it was a good time to make money and that everyone had a great year.  That does not appear to be the case.  A lot of money was pulled out of equity mutual funds during the past few years and we have mentioned this in previous newsletters.  Of course, a good portion of that capital stayed invested but used exchange traded funds which can be traded throughout the day and, in many cases, have lower expenses.
The chart below show the weekly equity mutual flows for the past two years.(ii)  Notice the massive and steady outflows especially in the past year as U.S. stocks zig-zagged higher.  There was even a large outflow in December as the Trump rally was well underway.  Also, please note that there was a net inflow in the last report.  On one hand this could be the start to a trend which could help fuel further stock gains.  On the other hand, this could mark a capitulation top as the crowd has a history of poor timing.

There is an old market adage that stocks climb the stairs up but take the elevator down.  In other words, moves lower happen a lot faster than the rallies.  The U.S. stock markets have clearly been taking the stairs for the past year.  Is there an elevator trip in our future?  At some point, probably.  But that can provide an opportunity for investors who are properly positioned to put capital to work.
The markets have been strong so far in 2017.  There have been a series of record highs together with strong breadth.  Looking forward, we anticipate that the markets will be much more challenging than they appear in the hindsight of the past 12 months.  Remember the volatility surrounding Brexit and Donald Trump’s upset win?  It was easy to move to the sidelines and into cash.  There will be those types of trials again.  But opportunities arise out of these types of situations and a new stairway will appear.
Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
130 Riverside Drive
Binghamton, NY 13901

i.The Bespoke Report, ,February 17, 2017
ii Topdown Charts, February 17, 2017

“The First Thing we do, Let’s Kill All the Stockbrokers”[i]

January’s employment report estimated that 227,000 new jobs were added to the economy during the month.  This was the largest monthly gain since September.  Despite this good news, however, the unemployment rate ticked up to 4.8% from 4.7%.  This was the result of more Americans, who previously were not looking for work, joining the workforce.  The labor force participation rate moved up to 62.9% which was an improvement from recent readings but remains well below the mid-to-upper 60% readings from before the financial crisis.
Of course, some jobs are more desirable than others.  Likewise, some jobs are more respected than others.  As evidenced by the fact that every politician (on both sides) campaigned strongly against it, Wall Street, for many, is near the bottom of the respect scale.  Not that politicians are widely adored, but for now they have someone other than lawyers below them.
Despite its lowly status, Wall Street rescued the stock market last week.  Specifically, it was the stocks of Wall Street that saved the Dow 20,000 level. Returning to the beginning of last week, stocks opened broadly lower and the Dow dropped below 20,000.  This was the first trading day after the White House announced the immigration restrictions and there was angst over its fallout.  As the markets fell, the buzz was the this marked the end of the Trump rally.
After this selloff, the Dow and the rest of the stock market slinked sideways until Friday.  With the strong January jobs report, stocks jumped and the Dow reclaimed the 20,000 level.  The Dow was up 186 points on Friday which was the biggest one-day gain in almost two months.
Looking closer at this, four stocks accounted for 66% of the move.  American Express, Goldman Sachs, JP Morgan, and Visa were alone responsible for 124 of Friday’s spike.  Goldman alone accounted for 72 points of the move.  Thank you, Wall Street!
Here is a chart of two banking indexes since the election.  The blue line is the S&P bank ETF while the green line is the regional bank ETF.  The purple line is the S&P 500.  The banking stocks have clearly led U.S. equities since November 8th.[ii]  The ETF represented by the blue line includes the major Wall Street banks.  If this continues, investment bankers, stock brokers and hedge funds might claw their way above lawyers and politicians.
Friday’s rally helped push the major averages’ YTD performance.  The Dow and Russell had some trouble keeping positive during January.  After the push higher to start the year, prices drifted lower in the last half of the month.  The Dow, S&P 500 and Russell had a three-day losing streak going into Friday’s move.  Here are the year-to-date number for the major averages.
                                                                                              2017 YTD
Dow Jones Industrial Average                                                 +1.6%
S&P 500                                                                                   +2.6%
Nasdaq Composite                                                                   +5.3%
Russell 2000                                                                             +1.5%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividend.
The fixed income market was much less volatile than the equity market.  Treasury yields were a little higher week over week.  The 10-year Treasury note closed Friday at 2.496% up from 2.48% the prior week.  This yield peaked out in mid-December above 2.6% and since then it has traded in between 2.3% and 2.5%. There appears to be some sellers around the 2.3% level which pushes yields back up once it is reached.
Other fixed income chatter involved future Federal Reserve interest rates increases.  The March FOMC meeting now has a greater chance of another fed funds rate increase given January’s employment report.
Besides the jobs data, the news flow been hectic.  In addition to the fast-moving developments in Washington and President Trump’s Twitter account, year-end earnings reports were in full swing.  There have been around 1,000 companies that have released year-end and quarterly results.  65% of the reporting companies have exceeded consensus earnings estimates and 56% have beaten revenue estimates.[iii]
While analyst estimates still involve a management wink and nod, the 65% beat rate, if it finishes there, would be the highest quarterly result in many years.  The 56% revenue beat is better than recent quarters but below levels of many prior quarters.[iv]
Another important earnings season metric is management guidance for future financial performance.  There is a negative spread between companies raising guidance to those lowering expectations (more companies lowering numbers).  This is typical in recent years.[v]
Part of the reason for this is that analysts begin with optimistic annual predictions which then gets ratcheted lowered over time.  An example is the forecast for the S&P 500 annual earnings number – it starts at a high number showing strong year-over-year growth but gets lowered throughout the year ending up with a much more subdued final number.  Again, this has been a pattern for many years.  Several market skeptics have been critical of this ‘game’ but the markets have chosen to play along (so far).
U.S. stocks have traded sideways for the last few weeks.  Given the rally from election day into mid-December, this is a healthy price action.  Further, we have seen a rotation of market leadership.  Technology, which lagged in the weeks after the election, is the leader in 2017.  Also, it’s especially noteworthy that stocks have had plenty of opportunity to correct or selloff but haven’t.  With all the acrimony, protests, and general mudslinging since the inauguration, we have had plenty of reasons for investors to reduce risk.  Yet stocks remain at record levels and that is encouraging.
The economic fundamentals (strong jobs report, corporate earnings, low inflation, etc.) point to growth.  This could help support stocks and even push prices higher.  There is a lot of uncertainty and stocks valuations are not cheap.  But market tops are rarely caused solely by stock valuations.  More importantly, if the markets keep climbing, Wall Street may ascend the reputational ladder and we may stop worrying that Henry VI’s line will be changed.

Jeffrey J. Kerr, CFA
Kerr Financial Group
Kildare Asset Management
10 Riverside Drive
Binghamton, NY 13901

[ii], February 3, 2017, Factset
[iii] The Bespoke Report, February 3, 2017
[iv] ibid
[v] ibid