Key Points
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U.S. stocks have made limited headway since January 2018; with much of the choppiness tied to trade-related news.
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The S&P 500 broke out of its recent range on the upside; but we’ve yet to see any confirmation by small caps or equally-weighted indexes.
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Sentiment measures reflect the confusion investors are feeling courtesy of the trade war’s impact on short-term market movements.
I’ve been using the tail end of a Shakespeare quote to characterize the U.S. stock market’s behavior over the past 20 months or so: “…full of sound and fury, signifying nothing.” Well, maybe not “nothing,” but not much either.
As you can see in the chart below, although the S&P 500 has broken out on the upside of its recent range, it has made little headway (+3.7%) since it hit its January 2018 high and hasn’t yet broken above its July 2019 high. We headed into 2018 with the theme to our outlook of “it’s getting late” (in reference to the economic cycle); with a conclusion that we were likely to experience more frequent bouts of volatility, but less robust upside performance. Our 2019’s outlook theme was “be prepared.” In keeping with that, we have been recommending investors consider rebalancing more frequently as the market’s swings provide favorable opportunities. That continues to be our recommendation in the context of being tactically “neutral” to U.S. equities.
S&P’s Limited Headway
Source: Charles Schwab, Bloomberg, as of September 6, 2019.
Living large
Within U.S. equities, we continue to recommend an overweight to large caps and an underweight to small caps. As you can see in the first chart below, relative weakness in small caps has been fairly persistent; with the Russell 2000 Index of small caps making a series of lower highs, and remaining well below its August 2018 high. Also reflecting the prevalence of large cap leadership, the Value Line Arithmetic Index (VLA) has also been making lower highs and is well below its August 2018 high, as seen in the second chart below. For those unfamiliar with the VLA, it comprises 1700 stocks—all 500 stocks in the S&P 500 plus the next largest 1200 stocks. But unlike the cap-weighted S&P 500 the VLA equally weights every stock.
Small Caps’ Lower Highs
Source: Charles Schwab, Bloomberg, as of September 6, 2019.
Value Line’s Lower Highs
Source: Charles Schwab, Bloomberg, as of September 6, 2019.
The VLA is often called the “greatest index of all time” because of its record of outperformance relative to cap-weighted indexes. As noted by Cornerstone Macro in a report this morning, the VLA since inception in 1983 is up 5,103%; while over the same period the S&P 500 is up “only” 2,392%. The latest “non-confirmation” of both small caps and the VLA suggests the underlying health of the stock market is less robust than the level of the S&P 500 would suggest.
No end to trade war timeline
Much of the choppiness in the S&P 500, especially over the most recent month or two, has been driven by trade war-related headlines. I have my research associate, Kevin Gordon, keeping a timeline of the ongoing trade war’s announcements/threats from both the United States and China.
Source: Charles Schwab, as of September 6, 2019.
The S&P 500 chart below has yellow dots placed on it for each of the dates in the table above. As you can see, the last few months have seen increasing announcements/threats/retaliations; with correspondingly increasing choppiness by stocks.
Stocks at Mercy of Trade News
Source: Charles Schwab, Bloomberg, as of September 6, 2019.
The chart below takes a look at each of the dates associated with the table above. The full length of each bar represents the low-to-high range on each day (based off the opening tick); with the yellow dots representing the return for each day. The average absolute value of returns on trade news-related days has been .90%; which is well above the .57% average absolute value of returns for all days over the same period excluding the trade news-related days.
Trade News Driving Larger Swings
Source: Charles Schwab, Bloomberg, as of September 6, 2019.
Don’t try to trade around trade news!
One of the lessons that should come from observing what’s above is that trying to trade around these trade headlines is a potentially-treacherous exercise. With so much daily noise, we continue to recommend a disciplined strategy around diversification and rebalancing. Tied to that has been our sector strategy; which has been fairly “neutral” over the past year—having only one outperform rating (health care) and only one underperform rating (communications services). The remaining nine sectors have market perform ratings. That said, we have been generally emphasizing a somewhat-defensive positioning, with a bias toward sectors like health care; and utilities, REITs and consumer staples within the market perform-rated sectors.
Frankly, what has “worked” well over the past year or so have been factors over sectors. Stocks with low volatility and strong price momentum have consistently led the pack; while traditional and relative value factors have lagged the most. But as overall market volatility declined last week, both value factors and more cyclical sectors rebounded, along with higher volatility stocks. This bears watching to see whether factors become as volatile as sectors; and/or whether a more cyclical leadership trend portends a better economic outlook.
Quilting the sectors
Highlighting the volatility of sectors and the rationale for a relatively neutral overall recommendation, we put together a handy “quilt chart” showing the movement of the S&P 500’s 11 sectors on a month-to-month basis over the past year. Similar to quilt charts that show asset classes on a year-to-year basis; this version highlights the difficulty of trading sectors in the short term. Although technology and REITs were the best and second-best performers, respectively, for both 2018-to-date and 2019-to-date; and energy was the worst performer over both of those periods; the monthly fluctuations have been all over the place.
Sectors’ Leadership Volatility
Source: Charles Schwab, Bloomberg, as of August 31, 2019. Sector performance is represented by price returns of the following 11 GICS sector indices: Consumer Discretionary Sector, Consumer Staples Sector, Energy Sector, Financials Sector, Health Care Sector, Industrials Sector, Information Technology Sector, Materials Sector, Real Estate Sector, Communication Services Sector, and Utilities Sector. Returns of the broad market are represented by the S&P 500®.
All of the aforementioned choppiness helps to explain the confusion being expressed by investors in myriad sentiment measures. In the case of Ned Davis Research’s Crowd Sentiment Poll (which is an amalgamation of seven distinct sentiment measures, some attitudinal and some behavioral), even with the latest rally in stocks, sentiment dipped slightly into the “extreme pessimism” zone as you can see below. That has historically been the second-best zone for stocks in terms of annualized performance.
Pessimistic Crowd Sentiment
Source: Charles Schwab, Ned Davis Research (NDR), Inc. (Further distribution prohibited without prior permission. Copyright 2019 © Ned Davis Research, Inc. All rights reserved.), as of September 3, 2019.
Another sentiment indicator I track daily is SentimenTrader’s “Smart Money / Dumb Money Confidence” which is a behavioral measure of how each cohort is investing (at extremes, the former is the non-contrarian indicator, while the latter is the contrarian indicator). Right now, both cohorts are in the “neutral” (or confused?) camp.
Smart and Dumb Money Equally Confused
Source: Charles Schwab, SentimenTrader, as of September 6, 2019.
In sum
It continues to be a difficult environment in which to trade around short-term news; even if short-term news is having an outsized impact on day-to-day and month-to-month market behavior. As I often say, investing should always be a process over time; never about a moment in time. There are no free lunches in the business of investing; but sticking to the tried-and-true disciplines around diversification and periodic rebalancing is as close as it gets.
Important Disclosures:
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
©2019 Charles Schwab & Co., Inc. All rights reserved. Member SIPC.
© Charles Schwab
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