Here are some semi-random items that should help you think about what’s happening in the markets at this time.
— The major indexes are off to a stunning start in March, with the S&P 500 up 3.5% (now -1.7% ytd) and the Nasdaq up 3.06% this month (-5.6% ytd).
— But the stars have been the small fry. S&P 400 Midcap Value (IJJ) is +5.7% and Smallcap 600 Value (IJS) is up 5.2%.
— The best sectors this month so far are SPDR Energy (XLE), +7.7% (-22% last 12 months) and SPDR Financials (XLF), +5.6% (-8.2% last 12 months).
— Best overseas action is iShares Brazil (EWZ), +21.9% this month (-24.8% trailing 12 months); and iShares Australia (EWA), +10.2% month to date (-19% TTM). All emerging markets together, iShares Emerging Markets (EEM), is +8.3% this month (-17.8% TTM).
— People are so excited about gold, but it’s only up 1.6% this month. Russia (RSX) is up 8.9%; Wisdom Tree India (EPI) is up 10.7%. Gold bugs make a lot of noise, but the metal usually pales next to its equities.
— While the energy producers’ rally has earned the most ink, we need to point out that the materials rally has been just as extreme, if not more so. U.S. Steel (X) is up more than 100% in the past three weeks alone, from $6.11 at the end of January to $12.98 on Friday. Agricultural and industrial chemicals maker LSB Industries (LXU) hit a low of $3.68 in mid-January and closed Friday at $10.44, a 183% move in six weeks. In the energy patch, our very own Atwood Oceanics (ATW) was $4.82 in early February, and closed Friday at $9.84, up 105%.
— These materials and energy stocks could just be tracing out huge bear-market rallies off of very depressed conditions. But I should point out that this is typically how major legit rallies start, with massive moves off bottoms that indicate a completely sold-out condition. The fact that most of these stocks have set pretty nice bases of three to four months adds weight to the bullish case.
— Bears will point out that crude oil, which appears to have sparked the broad-based rally, has experienced four separate 15% to 21% rallies since late 2014, and each has ended in tears. Crude oil has not rebounded over its two-year downtrend yet, as shown above, so if you were to look at one chart as a benchmark for whether the rally has legs, it is SPDR Energy. If it gets slammed back at its downtrend line at around $64, the whole rally will probably come to a screeching halt. But if it breaks through, bulls will be seen as the comeback kids.
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Unexpected Strength
The rally since the mid-February low was largely unexpected and has been fought all the way by most active market participants. This lack of belief has actually given the rally fuel, as bulls have been able to squeeze short-sellers until they scream. Witness the strength of iShares Russell 2000 (IWM), which was heavily sold short through mid-February, but then exploded higher later in that month and early this month as sellers gave in, cried “uncle,” and bought to cover.
Now the curious thing about the equity rally is that individual investor sentiment has barely budged higher, according to a note from Bespoke Investment Group. These analysts observe that in the latest poll of investor sentiment from the American Association of Individual Investors (AAII), bullish sentiment rose from 31.2% to 32.0%.
That was the 18th straight week where bullish sentiment has been below 40%, and even more amazingly, notes Bespoke, it is the 52nd week in the last 53 where bullish sentiment has been below 40%. In the history of the AAII survey, there has never been a stretch where we saw more sub-40% readings over a 53-week period. Note that the current level is around the same level as early 2009, just as the six-year bull market was getting started.
More indications that investor sentiment remains at epic levels of moroseness come from a Twitter posting by @BrattleSt.Capital. In the following Merrill Lynch chart you can see that the average cash balance of global fund managers is higher than at the lows of the 2008-2009 financial crisis and on par with the end of the 2002 bear market.
And finally, allocation to U.S. stocks is at an unusually low ebb as well. Brokerage data shows that investors in aggregate are now underweight U.S. equities for 12 straight months, and the current allocation is 0.7 standard deviations below the long-term average.
In the chart above, when the blue vertical bars are above the zero line, U.S. stocks are overweight in asset allocators’ portfolios, and when they are below the zero line, the world’s asset allocators are underweight U.S. stocks. The current levels are worse than the levels seen at the start of the bull market in 2009.
All of these charts in aggregate, show that investor sentiment through last week was far from overly bullish, and if people have indeed started to believe there will not be a recession this year and that the market might muddle through, then they need to buy a lot of equities just to get back to a normal allocation.
This suggests that the major indexes might not have trouble capsizing the hopes and dreams of the bearish majority at risk. That would mean prices could head toward December or October highs. Keep in mind that such an advance would still be a bear-market rally, and in turn set up an even greater decline over the rest of the year.
If all this sounds confusing, here’s the bottom line: Sentiment was so poor through the end of last week that there was plenty of fuel for a sharp advance that nonetheless falls short of the mid-2015 highs, and then tips over and falls back into bear market territory mid-year. This makes sense because bear markets are all about ripping investors’ hearts out, and what better way to do that than to provide an epic mid-course head fake. It happened in 2000-2002 and it happened in 2007-2009, so it can surely happen again.
Best wishes,
Jon Markman
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