The performance of the Russell 2000 versus the other indices ought to be cause for concern as we believe this may be the proverbial canary in the coal mine singing a sickly song.
We saw last week the largest IPO in history for Alibaba (BABA), which has some suggesting that it may have signaled the market's top. While that would provide excellent irony for the next Michael Lewis tome, it is unlikely we'll have such perfect correlation.
It is clearly true, however, that such an IPO would never occur at a market bottom or even in the bottom to middle of a market run, but rather somewhere in the top half. We'll argue closer to the top than middle. FactSet issued a great chart this morning showing the magnitude of Alibaba's market cap if it were to be included in the S&P 500, which it isn't. It would be the 12th largest in the index overall.
The IPO occurred when market sentiment is exceedingly bullish, with only 15.2% of advisors describing themselves as bearish in the most recent Investors Intelligence Sentiment Survey of Investment Advisors.
If we look at the various indices, we see additional cause for concern in divergence. While the S&P 500 and Nasdaq have been trending higher and higher this year, the Russell 2000 is actually down for the year by nearly 3% as of Tuesday's close.
According to Bespoke, the new 52-week lows Tuesday outnumbered new 52-week highs in the S&P 500 by a margin of 12 to 5. In the Russell 2000, new lows outnumbered new highs by 121 to 8! We think that it is an unhealthy bull market that relies on the strength of fewer and fewer large-cap stocks to prop up indices.
Market tops are often accompanied by the phenomenon of large-cap indices reaching new highs while secondary stocks hit new lows. The performance of the Russell 2000 versus the other indices ought to be cause for concern as we believe this may be the proverbial canary in the coal mine singing a sickly song.
If we look over at the bond market, we get confirmation that something doesn't smell too good here. You might call it even a bit fishy. High-yield fixed income is often closely correlated with the equity market because it is at the riskier end of the fixed income spectrum. High yield has been a strong performer this year, hitting multi-year highs at the beginning of the summer, then later correcting by almost 3%. August saw a rebound, which reversed nearly all of that loss, but that has now been again reversed in recent weeks.
The chart below illustrates how well the peaks of the Russell 2000 have matched with those of the iShares High Yield ETF (HYG). As we've mentioned in earlier posts, this is unsurprising as higher-risk investments are much more sensitive to changes in liquidity. As the Federal Reserve cuts the last round of QE and talk of rising rates abound, liquidity expectations decline. If the trend in high yield continues, it is yet another canary whose song is more of a breathy whisper.
For investors who like holding bond positions in their portfolio, but are concerned with increasing inflation expectations, a long position in the iShares TIPS Bond ETF (TIP) may be a good choice. It will appreciate as real yields fall.
Signs of a weakening Eurozone economy continue to mount. The German lfo business confidence index dropped for the fifth month in a row in September to 104.7 from 106.3 in August, missing consensus views of 105.8.
We learned Tuesday that growth in German factory activity hit a 15-month low in September. This could be good news for the markets as it may induce even more aggressive actions by the European Central Bank. Japan's PMI has also dropped 0.5 points to 51.7 this month. As we mentioned last week, China also is experiencing considerable slowing in its economy.
This all means that the global economy is quite bifurcated with the U.S. economy showing increasing signs of strength:
- The Richmond Fed gauge of manufacturing activity improved in September to +14 (versus expectations of +10) from +12 in August to the highest level since March 2011;
- Richmond service showed the overall revenue index stayed steady at the cycle-high of +21;
- Employment indicator fell from the nine-month high of +17 in August to a still strong +13 while the average wage increased to +13 from 5 month low of +12 in August, (consistent with our theme of the cash-strapped consumer with wages not reflecting the increasing strength in the economy);
- Markit's August manufacturing PMI registered with continued strength and saw employment growth hit a two and half year high during the month. That's the good news, the bad was the continued move higher in input costs with the latest increase in overall cost burdens being the sharpest since December 2013.
When we do get the inevitable market pullback, it is likely that it won't be terribly drastic -- at least initially -- given that so many are expecting it any day now. As that time comes, investors need to be prepared with their shopping list.
As we all know, the best time to get exposure to a sector is when it is least loved. Basic resources have unquestionable been out of favor for years, particularly with all the bad news coming out of China and the ongoing struggles in Europe.
This sector performs well in an inflationary environment, however, and we did just mention rising inflation expectations. One that has taken a serious beating is ArcelorMittal SA ADR (MT) as it is the largest steelmaker in the world, with approximately 40% of its sales from Europe, 40% from North America and 20% from the rest of the world. It is one of the largest iron ore producers in with world, operating mines on five continents.
If we see increased stimulus out of Europe, ArcelorMittal could do well as growth in the U.S would provide a boost. Another is Freeport-McMoRan Inc (FCX), or as Versace likes to say, "Dr. Copper." FC has an attractive yield of over 3.7% to help boost its attraction.
Finally, we recently learned that sales of existing homes in the U.S. fell for the first time in five months. They were down 1.8% month-over-month from July's 10-month high of 5.14 million annualized unit sales versus expectations of an increase to 5.20 million.
The most interesting aspect of the report to us was that distressed home sales fell to just 8% of the total from 9% in August and 12% last year, for the lowest level since the recession ended. All cash sales of existing homes also fell to 23% from 29% in July for the lowest overall share since December 2009.
This indicates that investors in existing homes are pulling back. This may give first-time buyers more opportunities as they've represented less than 30% of all buyers in 16 of the last 17 months.
Hawkins is taking the admirable high ground and not gloating too much around Versace, who at one time was more optimistic than she concerning the future of the housing market. Hawkins still maintains that for the housing sector to get some real legs under it, household income levels have to get a lot stronger. Median personal income needs to close the 8% gap between what it is and what it was several years ago