Bob’s Journal for 2/28/19

There have been quite a few changes in the markets the last few months. Let’s review some of them today.

Most stock indexes hit lows on Christmas Eve 2018 and have been moving higher since then. Earnings and other fundamentals haven’t been improving as much. The result is stocks generally sell at higher valuations than they did back in December.

There’s now a very stark valuation gap between some U.S. stock indexes and stock indexes of most other countries. It is normal for U.S. stocks to sell at higher valuations than stocks in most other countries. That’s the advantage of being the world’s largest economy and having the reserve currency, among other factors. But the numbers are especially significant today for some U.S. indexes.

The S&P 500 and Dow Jones Industrials aren’t too far out of line with other developed nations. The price-to-earnings (P/E) ratio for the S&P 500 is about 18.50, while for the Dow it is 16.6. For Europe, the P/E ratio is 16.6 for the Stoxx 600 and about 15 for the Stoxx 50. It is 15.7 for the U.K.’s FTSE 100 and 13 for German’s DAX.

But the Nasdaq now has a P/E of over 32, and the Russell 2000 small stock index has a P/E of almost 55.

Other measures, such as the dividend yield and price-sales ratio, show similar gaps. In fact, dividend yields on all the U.S. indexes are very low compared to the rest of the world.

If you’re looking for cheap stocks, take a look at Chinese markets and stocks in countries with heavy exposure to China’s economy.

Hong Kong’s Hang Seng index has a P/E ratio around 11. The Shanghai offshore index has a P/E ratio under 10. Taiwan’s P/E ratio is under 14. Korea’s P/E ratio is under 11, while Singapore’s is under 13.

But valuations are a tricky investment tool. While valuations have a good record of forecasting the total return from stocks over the next 10 years or so, they don’t have much correlation with returns over shorter periods. Expensive stocks can stay expensive, and even become more expensive, for a long time. The inverse holds for inexpensive stocks.

That’s why it’s important to look at other factors before making a decision about stock markets. Those other factors paint a mixed picture.

Most markets around the world are in overbought territory. That means the indexes are more than one standard deviation above their 50-day moving averages. While some analysts believe this means stocks are ahead of themselves and are due for at least a brief correction, the record shows that positive momentum of this sort tends to continue for a while.

It is interesting that despite their low valuations, stocks in China also are in overbought territory.

Other technical indicators of U.S. stocks are positive.

The number of stocks reaching new highs solidly outnumbers those reaching new lows. Also, the number of stocks increasing in price outnumber those declining. A solid percentage of stocks are selling above their 200-day moving averages.

Most of these technical measures are not as strong as they were during the 2017 rally, but they and other measures indicate positive returns are likely to continue. There’s wide participation in the stock markets and a broad range of stocks are taking part in the rally. The technical indicators say the rally has a good probability of continuing for a while.

The Data

A lot of housing data were released this week. The data indicate the sector still is weak but might be beginning a recovery.

Housing starts declined 11.2% in December, which was well below expectations. It was the weakest month since September 2016. Single-family home starts declined 6.7%, while apartment starts fell 20.4%.

Permits for new housing increased 0.3% in December. That exceeded expectations, but the permits were bunched in apartments. Single-family home permits decreased 2.2% for the month.

Pending home sales increased 4.6%, compared to a 2.3% decline last month, according to the National Association of Realtors. That reverses three months of declines and probably is the result of lower mortgage interest rates. Over 12 months, pending sales are down 2.3%.

Home prices increased 0.2% in December and 4.2% over 12 months, according to the S&P Corelogic Case-Shiller home price index. This is below expectations and the lowest 12-month rate since November 2014.

Likewise, the FHFA House Price Index increased only 0.3% in December and 5.6% over 12 months. That’s the lowest rate since February 2016 and well below the 7.7% rate of early 2018.

The Dallas Fed Manufacturing Index joins those measures that say the dip in manufacturing might have ended. The index increased to 13.1 from 1. It was minus 5.1 two months ago.

The Richmond Fed Manufacturing Index joined the trend, coming in at 16 compared to last month’s negative 2. So far this month, only the Philadelphia Fed Business Conditions Index has indicated a continuing decline.

The Chicago Purchasing Managers’ Index rose to 64.7 from 56.7 last month. That puts it at a 14-month high. New orders were the strongest part of the report, registering the largest increase in two years.

Factory Orders also improved a bit, increasing 0.1% compared to decline of 0.6% last month. But expectations were for a 0.6% increase. A decline in global demand due to a slowing economy is the main culprit in the disappointing data.

Consumer Confidence as measured by The Conference Board jumped to 131.4 from 120.2. The end of the government shutdown appeared to be the major cause of the increase. This ends three consecutive months of declines. The biggest gain in the index was in expectations, while the current conditions measure was stable.

New unemployment claims increased by 8,000 for a total of 225,000 claims. The four-week average also declined. Both numbers still are well below historic averages but above the historic lows reached in the last six months.

The first estimate of fourth-quarter gross domestic product (GDP), as expected, showed that growth declined in the fourth quarter. The report estimated growth at 2.6% annualized, down from 3.4% the previous quarter. I expect the growth rate will be revised down in the next two estimates.

The Markets

The S&P 500 gained 0.28% for the week ended with Wednesday’s close. The Dow Jones Industrial Average rose 0.14%. The Russell 2000 declined 0.04%. The All-Country World Index (minus U.S. stocks) increased 0.59%. Emerging market equities gained 0.80%.

Long-term treasuries fell 1.24% for the week. Investment-grade bonds were unchanged. Treasury Inflation-Protected Securities (TIPS) declined 0.07%. High-yield bonds increased 0.35%.

On the currency front, the U.S. dollar declined 0.35%.

Energy-based commodities were unchanged for the week. Broader-based commodities rose 0.18%. Gold declined 1.40%.

Bob’s News & Updates

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