Dalton — The stock market decline of last week was mild enough to still leave investors with a lot to be thankful for. The decline prior to Thanksgiving week clipped what ended up being an impressive seven-week winning streak for the Nasdaq, and six weeks for the S&P 500. Following such streaks, is it safer or riskier to remain invested? Are streaks such as these the beginning of longer-term positive trends? Or has the stock market become overbought, and if so, is it time for a price reset?
Going back to 1971, there were 34 prior seven-week winning streaks for the Nasdaq. The average and median returns over the next month, quarter, six months and one year after such streaks for the Nasdaq have realized better than average returns for all periods since then. The same is true for the S&P 500 going back to all periods since 1945 following six-week winning streaks.
Not that we can ever rely on one indicator, but those historical instances of outperformance suggest that we haven’t yet seen too much of a good thing. That’s not to say the market can’t have a historical tailwind and simultaneously be on the verge of some sort of price reset. Often the culprit in a sell-off is that the market is overbought, which is to say it’s run up too much in the short term and has gotten ahead of itself. On the surface, if a pullback were to occur, that rationale makes sense. After a surprisingly lackluster year of cash inflows into equity mutual funds and exchange-traded funds, there’s been a real pickup in the last four weeks, suggesting a short-term overbought condition. However, I prefer not to just look under the hood, but to take the engine apart. And when I did that, I found that only about 55% of the stocks prices of operating companies are trading above their 10-day moving averages. (Operating companies are the companies that customers buy products or services from, as opposed to other issues that trade on the exchange, such as preferred stocks. Once upon a time, folks like me used to just include all the issues traded on an exchange, but with the influx of nonoperating company issues trading on the exchanges, that technique is not as useful as it used to be.) Or, said another way, nearly half of those stocks were in short-term downtrends, and at the same time the major stock indices were hitting new highs.
When the participation in a rally by the stock market indices’ components shrinks, it’s timely evidence of a potential short-term top. Let me step back and examine all the caveats I tossed into that sentence: evidence, not facts; potential, not certainty. What I want you take away from this is not how wishy-washy I can be, but that I’m not rushing to get cash invested at this level. If you have a few percentage points of your portfolio in cash, and if you’re not risk-averse, just do it. There is no need to get too cute on the timing of a little bit of cash, even if a short-term pullback is likely. If you’re sitting on cash levels that are more significant, or if you are risk-averse, I’d dollar-cost-average into the market — not that you should ever rely on just one indicator, like fewer and fewer stocks lifting an index higher. An index can go higher by being pulled up by a smaller number of stocks in that index. But if you couple that deterioration of participation with elevated levels of bullishness (which we contrarians find worrisome), it wouldn’t be outlandish to expect a very small drop (in the 2- to 4-percent range) over the next month or so.
I want to be clear. I don’t care at all about a little drop like that in the stock market. It’s not going to disrupt anything I’m trying to do longer-term. I am recommending dollar-cost-averaging for those of you who are either risk-averse or have a larger percentage of your portfolio still in cash. If you’re invested, stay invested. If you’re more “moderate” (however you want to define that, but essentially not overly sensitive to short-term price fluctuations), go ahead and get those smaller amounts of cash to work.
Want a car? No, thanks.
Not to say all things are perfect in the economy, which, of course, would support stock prices. However, apparently the economy is good enough to shrug off impeachment inquiries, even though this quarter is tracking only at about a 0.4% rate, according the Atlanta Fed’s GDPNow estimate. These weak estimates have been mostly due to lackluster corporate spending and investment. The consumer, however, has been robust. And we know that the consumer has been unshakable because every Wall Street analyst worth their weight in pom-poms has been cheerleading the strength of consumers, who carry the weight of about two-thirds of U.S. gross domestic product. And that’s been strong enough to support the U.S. stock market. And I haven’t disputed that much, until now.
More accurately, I’m not so much disputing the present assessment of the consumer as I am arguing that it’s dangerous to ignore the signals that may lead to weaker consumers. I’m not (yet) predicting for this cycle that the consumer has died, or even gotten the flu. But he’s standing in the cold, wearing no hat, with a wet head, and forgotten to take his Zicam. There are risks, and I wouldn’t be all that surprised if the consumer, at least, caught a cold.
As mentioned earlier, capital expenditures have been weak as corporations have been hesitant to invest in plant, property and equipment. When businesses find reasons to reduce cap ex, they also tend to be less enthusiastic about adding to their payrolls. That seems to be true now. Year over year, the drop of job openings has decreased by 5%, which shows that companies are less interested in hiring. I know, I know: That hasn’t affected the unemployment rate. But it’s not as if the unemployment rate drops out of the blue; there are things that happen, like reduced hiring, before unemployment goes up. And when unemployment goes up, even employed consumers spend less out of fear that their jobs may be the next to go. I’m getting ahead of myself in terms of this being “news,” but I figure if I wait until it’s news, it’s already happened, and your portfolio already felt the damage. I want to get ahead of the news.
Also, at the risk of sounding as if I’m crying wolf, there are signs of consumer strain in what has otherwise been a healthy appetite for more. And more. And more. But, again, let’s look under the hood. In the aggregate, retail sales are advancing. But I’m seeing that new vehicle sales are off their peak, which has historically picked up as interest rates have declined (which they have). When I saw that, I didn’t like what I saw under the hood, so I took apart the engine. It’s particularly interesting to look at wealthier consumers. The lower your income, the smaller the amount of discretionary income you have to spend. Spending growth for lower-income households is largely dependent upon factors such as cost of capital, job security and wage growth. Wealthy households, however, are more affected by demand saturation, which is to say they’re all shopped out. Spending by the top 20% of the income strata has gone mostly sideways over the last year, while spending by those in the top 10% has declined. That hasn’t happened since the Great Recession of 2008. You may wonder why it matters to you what these “rich folk” are doing. Well, the top 10% of income earners account for nearly half of all personal outlays. That softer spending could be out of concern for the economy. Or it could be that Boomers are getting ready to retire and are focusing on preserving their portfolios. Or it could be that they’ve already done a lot of shopping, and buying more now isn’t as fulfilling as it was a year ago. Either way, or for any other reason, it’s a crack in what is an otherwise solid foundation for the typically stalwart consumer.
Glass half empty, then knocked over, and it stained the carpet
I am taking things that look outstanding, such as record high stock prices and record low unemployment rates, and finding reasons to complain. No one looks dumber than the guy who screams, “look out!” when someone is tossing flowers and candy in your direction. I sound like a madman. But don’t let that mask the actionable advice of the day. Despite the growing likelihood of a small decline in the stock market in the weeks to come, so long as you don’t define yourself as risk adverse, it’s OK to get cash invested into the stock markets today. If you’ve got a lot of cash, it’s still OK, but it’s always a good idea to dollar cost average in. I’ve been bullish since the end of 2018, and while I’m a little more concerned now than I was a year ago, I’m still in the stock market.
This article originally appeared in The Berkshire Edge on November 27, 2019.