Stall and Dysfunction

If like many investors you don’t currently have significant single stock exposure to the large cap tech vertical, you have probably been scratching your head in recent weeks.

We continue to hear and read headlines that speak to record highs for the market, soaring consumer confidence, and a widely held view that the economy and corporate profits are set to re-accelerate in Q2 through year end. Even the Federal Reserve’s FOMC notes clearly indicate that tightening is priority #1 as we head deeper into the calendar year. In short, optimism abounds. However, equity prices have largely remained range bound since April 24th. In fact, since March 1st, equity prices as measured by the S&P 500, have actually ticked fractionally lower. This protracted period of stagnant pricing has been coupled with extremely low volatility. S&P 500 volatility as measured by the VIX hit a 23-year low of 10.40 last week. What gives?

We can be certain that our recent period of investor complacency, as measured by the VIX, combined with a protracted period of flat equity pricing is not likely to last. Markets will break one direction or the other. There are several data points to keep an eye on which should provide some important directional cues for investors – as well as some caution.

From a valuations standpoint, as I have pointed out in recent notes, valuations are stretched. The S&P 500 for example is trading with a P/E ratio of 21.31 – well above historical averages. The Dow Industrials are trading at a less lofty 18.42, but still remain elevated. The Nasdaq is trading at an eye-popping P/E of 32.84. Much of the Nasdaq’s out-performance in regards to its P/E is historically based, but most of it is also a direct result of the large cap tech vertical whose earnings have largely come in better than expected. Given that Q1 earnings results from FANG stocks and their supply chain components have also outperformed in recent earnings results, it is entirely understandable for the Nasdaq to be trading at a premium relative to its major equity market indices even though valuations remain a concern.

Last week’s price action for the major US equity indices did little to embolden investors. Three out of the last trading days saw markets lose ground and each one of those daily loses was accompanied by elevated relative volume. That is a sign that there is a degree of caution in the market. Additionally, in recent weeks volume has clearly been slipping away from news specific trading activity across the entire equity landscape.

An additional factor that has been providing pressure on the broader equity market has been the impact on the energy sector of the S&P 500 due to rising US shale oil production. A theme that has undercut the prospect of a stable petroleum market in the near term – much to the frustration of OPEC and Saudi in particular. Rising US production and leaky production limits by OPEC have driven the price of WTI to a $47/bbl handle, down for $54/bbl in early March. The trend remains lower.

Broadly speaking, the S&P 500’s close last Friday at 2390.90 left the index still above its 50 and 200 DMA but susceptible to a trade lower – particularly in light of our stretched valuations, slowing volume, historically low volatility and a recent stall in price appreciation.

Interestingly, even Emmanuel Macron’s victory in France last week did little to assuage investor apprehension. Global markets did not appear to have much concern over either Marine Le Penn’s resurgence or his eventual victory.

Earnings continue to roll in this week. Retail sales will remain topical while the doomsday narrative framed by some of the largest names in the group, Macy’s for example, continue to put downward pressure on traditional retailing names. Of course the counter narrative comes form those retailers with an e-commerce focus both domestically and globally. This week we hear from one of the largest and most successful global retail giants, Alibaba. Other Chinese companies are likely to muster significant investor attention this week as well. Sina and Weibo are both scheduled to report quarterly results.