The S&P 500 is up 16% since the market debacle witness on December 24 last year. It has been up on twenty-one out of twenty-eight days -- a pretty consistent uptrend! Volatility (as measured by the VIX) has eased back as markets have slowly ground higher. Was it all just a bad dream or is there something more ominous ahead?
Since Fed Powell's first appearance on January 4 2019 and through his subsequent speeches, he has spoken with an underlying dovish tone -- implying a "patient" and "accommodative" Fed. In other words, the once-adamant Fed determined to raise rates and normalize balance sheets has thrown in the towel, at least for now. The markets were in a tailspin at the end of last year as threats of global recession mixed with the Fed tightening the system even more drove asset classes to be sold down relentlessly. At least the Fed is playing ball now, and has caused the market to recover back to its mid-November levels.
According to a Deutsche Bank report, U.S. Equity funds have seen large outflows of $40 billion since December following the $77 billion outflow from October through December. The fourth-quarter 2018 outflow is certainly understandable, but outflows in January when the market is up 9% does not seem to make sense. According to TD Ameritrade, retail investors' positioning is down to its lowest since July 2012. Simply put, the markets are up and investors are not benefitting from this rally as they just do not believe it, but can see their screens flashing green every day, filled with a sense of fear of missing out (FOMO).
So, who is pushing this market higher, and why?
The short answer is momentum funds. There had been significant technical damage done to markets in December. Momentum funds chase trends; they are agnostic of direction. In December, they were short leaning over the market, today they are long chasing it higher. As the market has breached 50-day and 100-day moving averages to the upside, in some cases even the key 200-day moving averages, it is apparent that momentum funds are now long.
Of the 258 companies in the S&P 500 that have reported earnings to date for Q4, 70.9% of them have beaten analyst expectations (I/B/E/S). This is above the long-term average of 64%.
The trading pattern witnessed this earnings season has been interesting. Bombed-out stocks that disappointed on earnings opened down on the day, but then slowly trended higher towards the close and in days that followed. Apple (AAPL) , Facebook (FB) , Micron (MU) , and Alibaba (BABA) are great examples of this -- stocks once penalized by investors now moving higher to close the so-called "valuation gap."
Buyback have been a massive tailwind for Equity market performance last year. As most companies have reported their earnings, only 15% of companies are left in the "blackout period", leaving 85% of companies free to buy back their stock. This tailwind should not be ignored, as it can certainly help fuel the momentum already in place by the CTA (momentum) funds.
With the Fed providing a firm put in place until the U.S./China trade talks reach a conclusion or the S&P 500 goes back to 2900, whichever comes first, equity markets can continue to move higher and regain lost performance seen in Q4. Valuations are supportive and company's earnings are not as bad as feared.
The only caveat is U.S./China Trade Wars deadline on March 2. Steve Mnuchin and Robert Lighthizer travel to Beijing next week to resume talks. We have yet to hear if Trump will just fudge some sort of a deal to save face with the American people and take credit for a "massive win" or play hardball, we do not know. Only time will tell.
The key issues are still being debated: Chinese structural reform issues, Intellectual Property theft and foreign company ownership laws. In the meantime, do not fight the trend as a lot of investors are not involved in this rally and beating themselves with a stick for selling out in December last year. The pain trade seems to be a gradual grind higher for now. Especially in light of fundamentally weak macro data, most did not expect it or cannot rationalize it. The power of Fed and liquidity injections should never be underestimated so ride the train for now.