Published May 18, 2018
This week we bring you a revisit to a prior article from January 2017. Recall that in January 2017 we were in the early days of the new Trump administration. Stocks had popped higher on expectations for a more business-friendly government (and later continued higher on a surge in corporate earnings and a rare (and brief?) period of synchronized global economic growth). We highlighted in the article a few of the market themes and sectors that were poised to lead the way higher. Since that article was published, we had a broad rally in stocks across almost all sectors as shown below.
Take a step back to January 2017 and the launch of the rally that ran through January 2018 before the recent three-month pause:
How a Market Rally Begins and Keeps Going
A stock market rally is rarely about any single thing. While one event, news item, or good market day can certainly change the tone of the market, it takes a full menu of inputs turning positive to sustain and build a lasting rally. Such as been the case over the past three months. This overview of the past three months provides a good general display of how a stock market rally gets going and stays going. Whether this rally marks more time and higher prices for beyond three months is anybody’s guess.
Stocks ripped higher after the 2016 Presidential election, giving a great big exhale of relief once the uncertainty and tension of that event had passed. Immediately embracing the pro-business, pro-growth stance of the incoming Trump administration, money poured into the smallest companies in the market as investors figured these companies would benefit most from the new government’s policies, increasing protection for domestic companies at the expense of larger global companies. Smaller companies are viewed as being the most sensitive to changes in the economy. When they lift off, it is often a good sign for stocks in general.
Chart 1 – the smaller the companies the bigger the move higher post-election
While small companies surged after the election, the large technology and consumer companies were far less impressive (shown in the green line above). Amazon, Facebook, Google/Alphabet, Apple, and other larger technology and consumer companies did not appear to be the focus of the Trump Administration’s economic thrust. They were left behind in the post-election rally.
But there were other factors at work behind this rally. For one, energy companies looked poised to return to making money now that oil prices had recovered from an 18-month plunge. Positive earnings in the oil patch lagged the upturn in price by almost a year. But as oil prices climbed and held above $40, and then $50, it became clear that the wave of bankruptcies and losses in the energy patch would be coming to an end. Note that the bottom in stocks last February coincided with the bottom in oil price.
Chart 2 – How oil prices influence the stock market
This correlation between the stock market and oil prices was seen even more acutely in global stocks (the middle chart above). Oil prices are viewed as a proxy for global economic growth as more growth demands more oil/energy. Thus, as oil and commodity prices go, so goes many international markets often.
Another factor in the rally: the pro-growth tilt of the new administration sent interest rates sharply higher. Two years ago this would have been bad news for stocks. But not these days! Stocks have been long-prepared by the Federal Reserve that higher rates were coming. Stocks have adjusted to that coming reality. When interest rates shot higher on expectations for faster economic growth, markets were ready with financial stocks the main beneficiaries. The Trump Administration’s lighter touch on bank regulations added more fuel to the jump in financial stocks.
Chart 3 – Financial stocks like rising interest rates
So we have rising oil prices bringing energy stocks back from the dead and we have financial stocks finally getting a long-awaited lift from a jump in interest rates. These are two areas of the market that had been dead for two years. They were ready and waiting for some trigger to get them moving. Financial stocks account for almost 20% of the global stock market. These stocks get going for the first time in two years and good things will happen.
Making the rally stronger has been the fact that the tech/consumer stocks, left out of the initial rally, caught up! As new money comes into the market, it seeps into previously “undiscovered” or neglected portions of the market.
Chart 4 – The rally expands to include Tech/consumer stocks
The strength begets more strength. Investors hear on the news about stocks rising day after day, hitting new highs, et al. They want to join the party. That brings another round of new money into the market fueling the rally anew. Pauses in the market are just that – pauses for investors to catch their breath and assess how far stocks have come. Rather than sell off and fall, however, every little dip in prices brings buyers who felt they missed out on the first move higher. This chart of medium sized companies shows how rallies go through leaps in price followed by pauses to refresh.
Chart 5 – Strong markets stair-step higher with minimal drops in price
Stocks break out to new highs, again and again, until all the money that wants to come into the market has done so. With the new money already invested, stocks become poised for a drop. Investors look to lock in their gains and buyers have become more scarce. Stocks fall with investors this time NOT stepping in to buy the dip. Seeing this behavior – more sellers with few buyers – active market watchers sense the rally is over and sell their shares. Ultimately selling begets more selling, and markets drop to a point where investors once again get excited about buying. That new buying can be triggered by attractive prices or by new and positive information. And the cycle begins anew. But it takes a fairly wide swath of “new” market inputs like those described above to really kickstart a solid and sustained rally.
Our powerful TimingCube models are built to monitor all of this price and market action for you, telling you when conditions are favorable for stock prices to rise or fall. We take the guesswork out of investing. Our models are trend-following, meaning that they do not predict turns in the market, but rather follow and react to those turns. Thus, we will miss out on the initial jump in price but will quickly get on board the rally. This allows us to capture the bulk of the market’s moves. Most importantly, our models keep us out of harm’s way when stocks are plunging, as they do every few years. By avoiding the market’s damaging drops, we preserve our wealth to benefit from the next rally. A buy and hold strategy, where a portfolio does not make a dramatic adjustment during seriously falling markets is a major concern of the new crop of “robo-advisors”. These automated portfolios are built to stay invested at all times regardless of whether stocks are going up or down. We take the opposite view – there are times to BE invested and times NOT to be invested. Be smart about your hard-earned money. Recognize that markets are emotional beings – they have periods where they are happy and everyone makes money; they have periods where they are very sad and most everyone loses money. Here at TimingCube we seek out the happy markets and avoid the sad markets. Simple as that.
After appearing to break out of a 3-month correction last week, stock bulls hoped to continue pushing the indexes upward this week. They were able to do so with small-cap stocks, but not with the larger company shares. Monday started strong with positive tones from the Trump administration on a trade issue with China appearing to support tech stocks. But the U.S. 10-year Treasury bond yield touched the closely-watched 3% level in the afternoon. That seemed to bring some pressure to stocks, sending the market averages back to a flat close. The yield accelerated its rise Tuesday, pushing almost to 3.1%. The sudden lift in rates after three flat weeks unnerved the stock market a bit. The rise in yields came after a strong report on retail sales growth. The stock market closed down -0.7%. Over half of that downdraft was recouped Wednesday as investors appeared to key off a surprisingly good earnings report from another retailer, Macy’s (M) department store. Stocks rose +0.4% with small-cap stocks vaulting +1% to a new high. Another flat day Thursday with stocks weighed down by the negative market reception to generally good earnings from Cisco Systems (CSCO) and Walmart (WMT). A mixed bag of earnings reactions sparked Friday’s outing. Semiconductor stocks suffered on a cut in revenue outlook from Applied Materials (AMAT), while heavy equipment manufacturer Deere (DE) shot higher by +6% on earnings enthusiasm. Yields dropped back a bit, which appeared to pressure financial shares.
Stocks gave back a chunk of the prior week’s good advance with the S&P 500 slipping -0.56% while the Nasdaq 100 (QQQ) dropped -1.18%. The small-cap Russell 2000 (IWM) bucked the trend and broke to a new high with a +1.27% advance.
Warm wishes and until next week.