Bob’s Journal for 3/21/19

Markets have been rallying, but investors don’t seem to be very bullish.

Stock indexes, of course, have strong returns so far in 2019. The NASDAQ 100, as represented by the QQQ exchange-traded fund (ETF), is up about 14.5% for the year to date. The S&P 500 gained more than 12.5% and the Russell 2000 index of smaller company jumped more than 15%.

Even most international indexes are up about 10% for the year, give or take a couple of percentage points. Plus, many of the internal market indicators are strong.

There are significantly more stocks advancing compared to those declining in price. The number of stocks hitting new highs outnumbers those sinking to new lows. (The exception is the Russell 2000 index.)

The average stock is doing well. We know this because the equal-weighted S&P 500 is keeping up with the widely quoted capitalization-weighted index. This means that a few large company stocks aren’t pushing the index higher and disguising weakness in the rest of the market.

Yet, most investors aren’t embracing this rally.

In the AAII Investor Sentiment survey, bullish sentiment has been relatively low all year and recently took a sharp drop even as market indexes marched higher. Bullish sentiment last week was only 32.42%. At the same time, bearish sentiment is increasing, though it isn’t back to the highs reached in December.

Cash flows into mutual funds and ETFs also indicate investors are cautious.

Flows into stock-based mutual funds and ETFs peaked in early 2018 and continue to decline, according to the Investment Company Institute, even as stock prices rise. Flows into bond funds and ETFs have increased steadily in 2019.

The picture is increasingly stark when we separate U.S. stock funds and international stock funds. Flows into international stock mutual funds have been steady since early 2018, while flows into U.S. stock funds have been declining since then, even as stock indexes increased.

Some argue these numbers show there’s a lot of potential for higher returns in U.S. stocks. They talk about “cash on the sidelines.” They also say markets won’t peak until bullish sentiment is high.

Others say the data show that relatively few investors are behind the market rally and others aren’t likely to join it. Once the investors who currently are bullish are fully invested, the market rally will stop.

These are only arguments, and they aren’t backed by long-term results. History indicates that sentiment surveys and cash flow data aren’t reliable as short or intermediate-term market predictors. They only tell us what investors have been doing and thinking, and what they’re telling us is that a lot of investors haven’t been participating in this rally.

That’s probably because investors see that economic growth is slowing. It will slow some more as last year’s tightening by the Fed continues to make its way through the economy and the effects of the 2017 tax cuts fade.

Slower growth should reduce corporate earnings and hurt stock prices. It is likely the Fed stopped its tightening early enough to avoid a recession and bear market. But growth is likely to stagnate without additional monetary or fiscal stimulus, and neither type of stimulus seems on the horizon.

The Data

Manufacturing is still growing but at a lower rate in the New York area, according to the Empire State Manufacturing Index. The index fell to 3.7, compared to 8.8 last month and 20 back in November. This reading is the lowest since May 2017.

But the Philadelphia Fed Manufacturing Survey had different results. It came in at 13.7, compared to a negative 4.1 last month. Expectations were for an increase to 4.5. Most components of the index were positive. The main negative component is that businesses are less optimistic about the future. That component of the survey is at its lowest level since February 2016.

Industrial Production also showed weakness. The 0.1% increase was better than last month’s 0.4% decline, but it was well below expectations. Even worse is that manufacturing production declined 0.4% for the second straight monthly decrease and business equipment production declined 1.0%.

Home builders still are optimistic, according to the Housing Market Index from the National Association of Home Builders. The index was 62, the same as last month and well above the 56 recorded in December. The home builders say lower priced and affordable homes are selling well, and they expect a solid spring selling season.

Consumer Sentiment, as measured by the University of Michigan, increased to 97.8 from 93.8. Households are more positive about both current conditions and expectations. But the increased optimism was concentrated among households in the lower two-thirds of income distribution. Households in the upper-third of incomes are less optimistic than last month, though their sentiment level still is well above the historic average.

The Leading Economic Index from The Conference Board increased 0.2%. That’s an improvement from no change in January and a 0.1% decline in December. The Conference Board indicated this is the first increase in five months. The performance of the index shows that growth will slow through 2019.

There wasn’t much change in the labor market in January, according to the JOLTS (Job Openings and Labor Turnover Survey) report. The number of job openings, hires and separations were about the same as in December and indicate continued strength in the labor market.

Initial unemployment claims declined by 9,000, which was better than expectations. Continuing employment claims also decreased.

The Markets

The S&P 500 rose 0.51% for the week ended with Wednesday’s close. The Dow Jones Industrial Average added 0.19%. The Russell 2000 tumbled 1.11%. The All-Country World Index (excluding U.S. stocks) gained 1.72%. Emerging market equities rose 2.25%.

Long-term treasuries gained 0.70% for the week. Investment-grade bonds rose 0.81%. Treasury Inflation-Protected Securities (TIPS) added 0.89%. High-yield bonds increased 0.48%.

On the currency front, the dollar declined 0.66%.

Energy-based commodities rose 1.95%, while broader-based commodities increased 1.45%. Gold gained 0.24%.

Bob’s News & Updates

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