Weekly S&P 500 #ChartStorm – 12 Aug 2018

So here’s the another S&P 500 #ChartStorm write-up!
1. S&P500, Emerging Market Equities, and the US Dollar: First up is what I think is an important chart, particularly for H2 this year. It shows EM equities diverging to the downside vs the S&P500 – and it’s no mistake that the US dollar index is included in the bottom panel. Basically the Fed is in tightening mode (rate hikes and quantitative tightening) and the US dollar is strengthening, and that typically spells bad news for emerging markets. US equities can and often do simply shrug off issues in emerging markets… to a certain point. But if emerging markets come under enough pressure there are a few contagion channels by which this will pass through to US markets, so it’s not something to dismiss.
Bottom line: EM equities are coming under pressure due to a stronger dollar and Fed tightening.

2. S&P500 vs the Economic Noise Index: Next, onto and odd looking indicator, this one I call the Economic Noise Index – it combines the signal from the economic surprise index and the economic policy uncertainty index. Basically it works like a momentum/sentiment indicator where at extremes is seems to offer a contrarian signal, and when it moves through the range can provide clues on the next step. For instance, when it rolls over (e.g. like now) it can be a harbinger of a short term market correction or selloff. So it’s one to be mindful of.
Bottom line: The economic noise index has rolled over, which can be a short term bearish warning sign.

3. Stockmarket Seasonality Pattern: Another chart with short-term bearish implications is this cycle composite chart from Ed Clissold. It shows the composite cycle/seasonality signal across 3 different time frames and so far this year the market has been tracking somewhat in line. But the key point is the next couple of months typically bring challenging times for the S&P500. So that’s another short term bearish warning sign.
Bottom line: Composite cycle/seasonality analysis points to a challenging couple of months ahead.

4. Extremes in Stock vs Bond Futures Positioning: This peculiar chart shows speculative futures positioning in equities (aggregated across all US index futures) and bonds (US 10 year treasury futures)… and most notably, the spread between them. With bond traders the most crowded short in recent history, the spread between bonds vs equities positioning is at an extreme. So what? Basically what we’ve got is traders doubling down on a view that growth and inflation heats up even further from here. If the short term downside risks materialize it will see a sizable body of traders caught wrong footed if this chart is anything to go by.
Bottom line: Trader positioning is stretched long on equities and short on bonds.

5. The Investor Movement Index: This chart is called the Investor Movement Index or IMX for short. It is put together by TD Ameritrade and it derives a composite view of investor sentiment based among other things on the activity of clients of the TD Ameritrade brokerage business. It almost looks like a case of “once bitten, twice shy” for investors here. The big hyped up surge in sentiment late last year has been completely unwound, but investors look reluctant to get back on the horse if this indicator is anything to go by. Still, at 5.45 the indicator is around the top end of the range of the last few years, so they’re hardly bearish either.
Bottom line: The investor movement index shows investors have been reluctant to pile back in.

6. The Euphoriameter: On a similar note, my own Euphoriameter shows the same kind of conclusion. The indicator (which likewise takes a composite view of investor sentiment based on surveys, forward valuations, and implied volatility) made a material reset during the correction, and so far the indicator has only mildly ticked up. But again, at just over 0.5 it’s far from bearish. So we have a picture of maybe cautious optimism or certainly at least toned down optimism, and it could go either way from here.
Bottom line: The Euphoriameter likewise shows investor sentiment still bullish, but toned down a notch.

7. Earnings, Liquidity, and Valuations: Speaking of valuations and things toned down, this chart from Jurrien Timmer of Fidelity highlights a really important point. Earnings have continued to track higher (both on a forward and trailing basis) and this along with relatively lackluster price action has kept a lid on valuations. Indeed the more the market chops around in the face of solid earnings growth the more valuations will steadily drift lower. A sort of stealth correction in valuations is happening in the background.
Bottom line: Solid earnings growth is keeping a lid on S&P500 valuations.

8. Corporate Cash on the Sidelines: This next one, shared by Alex Goncalves on Twitter, has a few things going on, but the part that stands out to me is the percentage of corporate cash on the balance sheet. This is interesting for a few reasons. Firstly one might think of it like “cash on the sidelines” – a war chest of capital which can be deployed to buybacks, M&A and capex. The other angle is that cash is trash… i.e. it earns next to nothing, but progressively rates are rising, so while it’s likely small in the overall scheme of things, a greater holding of cash means that firms would benefit slightly more from interest rate hikes.
Bottom line: S&P500 companies still have a lot of cash on the balance sheet.

9. S&P500 Buyback Announcements: Speaking of cash and buybacks, here’s a really interesting chart from Driehaus Capital. It shows the pace of buyback announcements for the S&P500 and the last two quarters have seen a surge in buyback announcements. All else equal this is a bullish tailwind for stocks. If it continues and as the announce buybacks are executed it will mean a torrent of buying flow in the market.
Bottom line: Buybacks are back and they’re booming.

10. S&P500 Earnings – Offshore vs Onshore: Final one looks at the earnings and revenue growth performance differential for S&P500 companies who have a dominant share of earnings in the US vs those with a dominant share of earnings internationally. Interestingly it’s those with greater international exposure who’ve been disproportionately driving earnings and revenue growth. The bad thing is those guys are at risk from trade wars and a stronger dollar, and any deepening of stress in emerging markets. So as I noted at the start, EM stress may not matter until it does…
Bottom line: Companies with greater offshore exposure have been disproportionately driving earnings growth.

So where does all this leave us?

This week there are probably 3 areas of note:

  1. Bearish warning signs

The first chart of EM equities and the US dollar and S&P500 gave reference to the point that if EM stress becomes to intense it could easily spillover to US equities (the final chart also gives nod to that). The other short-term bearish warning signs were the economic noise index and the composite seasonal/cycle signal.

  1. Sentiment snippets

On sentiment we saw very similar action in both the Investor Movement Index and the Euphoriameter where investors have toned down their enthusiasm… yet indeed remain enthusiastic. On futures positioning we saw how traders are stretched long in equities and short in bonds.

  1. Cash and buybacks

On cash and buybacks we saw how substantial the cash on corporate balance sheets is (cash on the sidelines?) and the boom in buyback announcements which is putting a big bullish tailwind into the market.

With investors still relatively optimistic on the outlook it’s clear that the correction only drove a partial shakeout of positioning, and with the confluence of short-term warning signs there’s every chance we see another leg down and a more meaningful shakeout in sentiment and positioning. Yet with solid earnings growth keeping a lid on valuations and a powerful buyback tailwind in play, though we are late cycle, it still seems like if we get another correction it could be a buying opportunity. Until next week, keep watching the charts…