Tuesday, August 2, 2016
Stock indices rallied sharply in July, helping broader averages turn positive for the year after an eventful late June punctuated by the Brexit vote and related market volatility. For the month, the S&P 500 rose 3.6% and the Nasdaq-100 was up even more, adding 7%.
Central banks seemed to have given more than enough medicine to the markets to allow them to not only retrace Brexit losses, but also to propel the market to new highs. Equity averages were assisted by the next leg lower in bond yields across the globe, which left investors scrambling for alternatives in developed and emerging markets. German bond yields fell as low as -19 basis points and Italy, despite being at risk for a full blown banking crisis had 30-year debt that ended July at 2.2%. An estimated $13 trillion in global debt is now in negative territory. There was “only” $11 trillion before the Brexit vote and very little as recently as two years ago. Reaching for substitutes, investors in U.S. stocks have ignored negative Q/Q earnings comparisons and have bid up stocks to a forward PE of 18X.
Crude Oil declines were surprisingly sharp this past month, with the commodity falling 14%, the largest monthly percentage decline in a year. The inverse relationship between crude and stocks is in contrast to the first half of the year, when sharp declines in oil were met with similar declines in stocks. Traders will be watching to see if the correlations return and what this might mean for oil vs. stock prices.
With the July rally in equities, cyclical sectors that were not in favor when investors looked for defensive dividend-paying bond substitutes are now starting to catch a bid. The Technology sector was the best performer this past month, adding more than 7.8%. The year-to-date performance of Utilities and Telecom shows the strength of safer yield substitutes YTD, but it should be noted that this sector declined slightly in July, indicating a renewed preference for “risk-on” sectors. We also note that during accelerated advances for U.S. stocks, technology stocks often outpace the broader markets. Since the start of 2013, we’ve seen seven different periods of sharp gains in the S&P 500 (+ 7% over 20 trading days), and during every one of those trading periods, the Technology sector outpaced the broader markets.
Below are price returns for S&P stocks by sector so far this year. The chart clearly shows the broad market decline in January and the rallies in March and July. Note that most sectors gained in July, save for a 2% decline in Energy shares owing to crude’s sell-off and modest declines in Staples and Utilities. In between, performance across various sectors varied widely from month to month.
What could wind up being a major positive for equities is that the weakest performing sectors YTD in the S&P 500 make up the greatest weighting in the index. Technology, Financials, Healthcare, and Consumer Discretionary have a combined weighting of 64%, yet on an unweighted basis the four sectors have returned a combined average of 3.59% YTD. Conversely the remaining six sectors,which have a combined weighting of just 36%, have returned an average of 13.75% YTD. For this reason the weighted return of the SPX has gained just +6.34%. A return of leadership to the more heavily weighted sectors could be bullish for the broader market.
The reason for optimism is that the four sectors making up the largest weightings in the S&P 500, the laggards, are each just beginning to, or are on the cusp of breaking out above long term resistance levels. Knowing that breakouts above long term resistance levels are often accompanied by accelerating upside momentum, the S&P 500 could continue the bullish breakout higher driven by a rotation into its largest components. Can the four laggards morph into leaders? Time will tell.
According to the latest Earnings Insight report from FactSet, the blended earnings decline for the S&P 500 is (3.8%), better than the (5.5%) predicted at the end of the first quarter. In addition, of the 319 S&P 500 companies that have now reported for Q2, 71% have beat consensus EPS estimates, just ahead of the 70% one-year average. In the aggregate, companies are reporting earnings that are beating expectations by 4.4%, compared to a one-year average of 4.2%. The S&P 500 has not seen Y/Y revenue growth since Q4 2014. Other key top-line metrics have also been strong with 57% reporting revenue ahead of consensus expectations,nicely above the 49% one-year average. In the aggregate, companies are reporting revenues that are 1.2% ahead of expectations, much better than the 0.0% one-year average. The report also highlighted somewhat better sentiment surrounding Q3 based on earnings guidance.
Markets appear to be at a crossroad entering the midpoint of Q3. Following 13 months of corrective price action, the large cap US equity indices made a bullish breakout to new all-time highs during the month of July. Often a breakout above a large consolidation range is followed by accelerating upside momentum; however seasonality and divergences in other asset classes are potential red flag as the markets roll into August.
Along with treasury yields still near historically low levels, a more recently developing concern has been the decline in the price of oil. Since making YTD highs in early June, WTI crude has declined more than 20%. Although the direct relationship between oil and equities seems to have broken since oil’s near 100% correlation from February to June, the below chart shows the prior declines of 20% or more in WTI oil were followed with a lag by a meaningful selloff in the S&P 500. The vertical lines plot the initial declines in WTI oil (upper panel, yellow line) back in June and October of 2015, followed weeks later by a decline in equities. Thus if WTI fails to rebound soon from its current down trend, equities could soon be following it to the downside.
Over the near term there are other reasons to be cautious. Seasonally the month of August tends to be one of the worst performing months for stocks. The below table shows August has been the worst performing month over the prior five and 20 years. Going all the way back to 1951, only September has performed worse.
Generally the summer is supposed to be quiet in terms of market action, with August seeing the least action. Over the last two years, the August price changes have been more pronounced than the prior or following month. August 2015 saw as 6.6% decline after a 0.4% July increase and a 1.5% September decrease. For August 2014, the S&P 500 rose 3.2% after a 1.6% decline the prior month and a 0.3% September decline. August 2011 was particularly volatile around the U.S. debt downgrade. So, ‘Sell in May and go away’ may not be dead, but traders will have one eye on the news and economic releases. Italy may also come into sharper focus as will the main drivers of the market - speculation on Fed, ECB and BOJ actions.
The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. All information contained herein is obtained by Nasdaq from sources believed by Nasdaq to be accurate and reliable. However, all information is provided “as is” without warranty of any kind. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.
Nasdaq's Market Intelligence Desk (MID) Team includes:
Michael Sokoll, CFA is a Senior Managing Director on the Market Intelligence Desk (MID) at Nasdaq with over 25 years of equity market experience. In this role, he manages a team of professionals responsible for providing NASDAQ-listed companies with real-time trading analysis and objective market information.
Jeffrey LaRocque is a Director on the Market Intelligence Desk (MID) at Nasdaq, covering U.S. equities with over 10 years of experience having learned market structure while working on institutional trading desks and as a stock surveillance analyst. Jeff's diverse professional knowledge includes IPOs, Technical Analysis and Options Trading.
Steven Brown is a Managing Director on the Market Intelligence Desk (MID) at Nasdaq with over twenty years of experience in equities. With a focus on client retention he currently covers the Financial, Energy and Media sectors.
Christopher Dearborn is a Managing Director on the Market Intelligence Desk (MID) at Nasdaq. Chris has over two decades of equity market experience including floor and screen based trading, corporate access, IPOs and asset allocation. Chris is responsible for providing timely, accurate and objective market and trading-related information to Nasdaq-listed companies.
Annie O'Callaghan is Director on the Market Intelligence Desk (MID) at Nasdaq. Annie has worked for NASDAQ in a variety of roles including support of Nasdaq C-level management in client retention and customer service. Annie also served as a Sales Director in Nasdaq’s Transactions Services business. Prior to joining Nasdaq, Annie worked at AX Trading, managing accounts for its Alternative Trading System and served on Credit Suisse's trading desk as an Electronic & Algorithmic Sales Trading Analyst.
Brian Joyce, CMT has 16 years of trading desk experience. Prior to joining Nasdaq Brian executed equity orders and provided trading ideas to institutional clients. He also contributed technical analysis to a fundamental research offering. Brian focuses on helping Nasdaq’s Financial, Healthcare and Airline companies among others understand the trading in their stock. Brian is a Chartered Market Technician.