First Quarter Overview – The Long Read

Confidence Game

At this point in the year, it’s customary for our team to monitor, sift, rank, summarize and make practical sense of the world around us. 

Overall we concluded that while the quarter was a decent one for investors, the past few weeks certainly has seen investors caught up in a confidence game.  Basically, you can pick your poison on this level, it could be confidence in US President Trump next policy moves one day, consumer confidence the next, economic data the day after that, geopolitical confidence the next.  The level of noise and levels of confidence can be critiqued, all day, every day at a different level.  We mentioned in our opening banner that this is a long read. It is our intention to educate readers on some of the key indicators that we monitor and provide our comments, against this backdrop for the current market environment.

Technical Survey

The S&P 500 has been a tough hold for some investors over the past 12 months, and this past month saw a technical move that would unnerve some investors using this metric. Investor confidence dipped, as the S&P 500 benchmark dipped below its 50 day moving average, for the first time since Sept 2016.  At the prior occurrence, the S&P 500 fell further to test its 200 day moving average.  This time around, the dip was short-lived, and the bounce off these levels seems to provide a sense of a short-term recovery or at least sideways action. 

Illustrated below with both the 50 day moving average and the 200 day moving average highlighted:

Source: VIP Wealth Solutions and Bloomberg

Consumer Confidence Survey

Can we attribute the market’s positive returns to just the Trump effect, or do we worry that it has been 117 weeks since more than half of individual investors surveyed in this metric, were firmly in the bullish camp? On the other side of the ledger, bearish sentiment ticked higher this week, rising from 30.5% up to 37.4%.   The next chart plots bullish sentiment against the backdrop of the S&P 500 over the last 10 years.

Source: VIP Wealth Solutions and Bloomberg

The yearly change in this metric showed consumer confidence numbers were mildly bullish for 2016, up 3% year over year.  Yet for the 8 weeks prior to the US elections, this metric dropped dramatically by about 9%, bottoming 2 weeks before the US elections.  Ending 2016, the consumer confidence numbers are at decade highs, levels not seen since a year prior to the 2008 financial crisis.  History shows that equity prices can continue rallying a very long time on these types of expectations, as confidence can spur real activity, but there is really no way to know for certain, the future outcome of confidence.  Only time will tell.

Valuation Survey

More recently, we have had a lot of queries as to the mature nature of the market and most specifically if we are in a bubble or at the top? For the record, no one knows the ultimate answer to this, yet when asked this, it circles us back around to degrees of confidence.   If we look at pure fundamentals, today are companies on a historical basis expensive? Looking at the S&P 500, this gives us the broadest indicator of the most efficient stocks in the world (presumably).  The chart below gets a bit busy, yet it is a good illustration of where we are from a historical valuation perspective. The long-term (30 years) historical average valuation of the S&P 500 index is 19.15 times Price Earnings (“PE”) ratio.  That is represented by the solid red line in the chart.  Today this index trades at a current PE valuation of 21.66 times.   This is simply more expensive than the average.

Source: VIP Wealth Solutions and Bloomberg

So how high are valuations today in context?  We like simplicity: the S&P 500 P/E ratio is comfortably above its 30-year average (19.15x) and median (18.10x) valuation.  That said, it’s only about 2/3rds of where it was prior to the equity bubble peak in 1999, and has actually been higher more than 25% of the time in the last three decades. Using solely this metric is a dicey game at this point because the market, in broader terms, is not really expensive or really cheap.

GDP Survey – Any growth?

We won’t get too deep into this, but the US economy’s final quarterly GDP number, was revised up to 2.1%, which was slightly ahead of the expectation of 2.0%.   This is nothing to write home about but if you consider that there are typically some headwinds to start the year with delayed tax returns and some degree of uncertain confidence, then this number could surprise to the upside, in the future. Bottom line here – some growth exists.

Everyone gets excited about more jobs!

Perhaps more than any, this chart tells a better story of the state of the economy… or does it? Basically, the theory goes that if we are not claiming unemployment benefits we must be working and by that measure, adding positive growth to the economy.

Source: VIP Wealth Solutions and Bloomberg

The observation here would be that generally, things are better than pre and post 2008/09 from a jobless claims perspective.

Gasoline Survey - Everybody LOVES Oil!

Okay maybe not everyone… Oil has been a huge economic lever over the past several quarters.  One day we seem to have too much oil, the next day, not enough.   Late last year, OPEC announced production cuts and opportunistic US producers were able to produce more.   More recently, the US Energy majors have been selling Canadian oil assets and Canada energy majors have been buying.  We recently witnessed Cenovus buying Conoco assets. It would stand to reason that if the economy is doing slightly better, we are going to consume more gasoline, take a trip, drive our car more, and perhaps seasonality has some effect on prices?  Either way, it remains front and center for us as asset managers to see and measure the weekly changes in this developing thesis. The chart below shows the daily average national gas prices provided by the American Auto Association.

Source: VIP Wealth Solutions and Bloomberg

This chart shows that gas prices have started to move up with the warmer weather (last $2.36 a US gallon), but is nowhere near the peak expense levels in the period 2011 through 2014 (peak of $3.92 per gallon).   Should we perhaps prepare for higher gas prices in the summer ahead?

Always Be Careful

We are often mindful of the realities of how difficult it is to simply use a few charts or surveys to measure the broader market and make dramatic changes to your investment strategy.   We are constantly on the lookout for things that can bite us.  There is no crystal ball, only a rigorous and constant review of data and analysis that brings us to the point of discovery.  We recently took a bit of a deeper look at the impact of confidence and what that means. There are a couple of key indicators:  the Conference Board Indicator and the University of Michigan Indicator.  Historically, these metrics have been closely related.  However, at periods of time, there have been gaps in that relationship. Typically when those gaps emerge, we see some type of US recessionary response. The chart below illustrates this.

Source: VIP Wealth Solutions and Bloomberg

The gap, as you can see above, has recently started to widen. There is no call to action today, but it is worth noting. 

China Survey

Next to the US as arguably the most important economy, coupled with the largest consumer population base in the world, has the RED DRAGON reemerged?

The chart below shows the Chinese Manufacturing PMI (Purchasing Managers Index).   Since the peaks in 2007, this has been on a downslope.  The red line shows the trend line.  The recent uptick in the blue line above the red trend line suggests an increase in China’s manufacturing activity.  The rule of thumb has been that a number above 50 was an expansionary number. If this trend above 50 persists, we could see greater global growth contribution again from China.  

Source: VIP Wealth Solutions and Bloomberg

This takes us to more optimism around emerging markets!

Banking Survey

The banks in the emerging markets are starting to lend again. The chart below shows the increase of the Singapore bank loans, month over month. The trend is optimistic but not crazy – perhaps cautious?

Source: VIP Wealth Solutions and Bloomberg

Reflation and Bonds?

A lot has been said about this subject and to date, the only real data lies in the 10-year bond yield.  The one key metric here is the yield offered on the US 10 year Treasury Bonds.  Viewed longer term the trend is down, (pity GIC investors).  At the lows, in July 2016 the yield was an abysmal 1.37% (annualized).  Yields started to move off these bottom before Trump and spiked after Trump.  It has now settled into a range and appears to be waiting for the FEDs next move and/or more economic data supporting a more normalized (low) rate environment.  Current yield is 2.35%.  Maybe something around 3% is more normal? Maybe this is normal?

Source: VIP Wealth Solutions and Bloomberg

Putting it all Together

Today we don’t see a bubble.   That could convey a sense of bullishness, yet we also are not seeing a super cheap market.  Which means these are not times to go out and buy indistcriminently.  We are seeing some rotation out of domestic markets because of valuation and policy concerns and into cheaper markets where valuation is better. Growth is okay but not fantastic suggesting more grind. So we continue to step cautiously and prudently, as we have experience in navigating these types of markets.

Thank you for taking the time to review this and we will keep you posted as we grind forward.   


The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.