The VIX rose above 10 on Wednesday, but the S&P 500 still barely moved. The S&P 500 hasn’t moved more than 0.5% intraday in 14 days which is the longest streak since 1971. As you can see in the chart below, the VIX has had a 13 day streak of closes below 11 which is a new record. The past few days have felt like Christmas holiday trading where this isn’t much movement. Unlike the Christmas holiday, there has been a lot of news coming from earnings reports, macroeconomic data, and politics. The two possible conclusions you can draw is either all the factors are counteracting each other or investors in index funds and algorithmic trading programs are ignoring the news.
Looking at the headlines which could effect the market, I would say earnings surprising to the upside have brought the market to new all-times highs. One would think even more positive momentum would come from these great reports, but some of that may have already been priced in. Speaking of earnings reports, Snap reported a modest miss and the stock got destroyed in the after hours market. It was down about 23%. That’s what happens when you have a stock that’s too expensive. The takeaway from the quarter that Facebook is destroying Snapchat is premature in my opinion.
As I predicted, Snap stock fell because it’s too expensive. It was priced for perfection. Concluding that the most popular app among teenagers is dead would be overzealous. Revenue came in at $150 million which was below expectations for $157 million. Global daily active users came in at 166 million which was below the expectation for 167.3 million. The key takeaway from this quarter is that stock based compensation is out of control. The company lost $2.2 billion and spent $2 billion on stock based compensation. If stock based compensation is lowered and the stock falls to a more reasonable valuation, it may become a good investment.
The other headline besides earnings is the weakness in macroeconomic data. Interestingly, the Eurozone has outperfromed America’s Citi Economic Surprise Index. American equities have been outperforming global equities, so there may be a shift in asset allocation if this trend continues. However, the weaker economic data would have to start hurting earnings, which hasn’t happened yet. Earnings have been boosted by margin increases. If this reverses, then the switch may occur. The one issue that complicates this is that many multinational S&P 500 firms have large European businesses, so what’s good for the European economy is also good for American stocks.
The final headline which is in traders’ heads, but not necessarily causing stock movement is President Trump firing FBI director James Comey. In my opinion, this doesn’t affect stocks. I’ve read that it could help Trump’s economic agenda and that it could hurt his agenda. It’s one of those situations where you must wait and see how it plays out. I’d rather not make an investing decision on a complex political issue. It’s on everyone’s radar screen, but investors must agree with my strategy because it didn’t move the market up or down.
As I was saying, part of the reason stocks may not have moved much in the past two weeks even though the news has been rocky is because of mindless ETF buying. These investors are buying based on past performance instead of doing objective research. Buying based on past performance becomes difficult when there’s a bump in the road. Your entire strategy is ruined if stocks don’t go higher. Mom and pop investors usually get in at the end of the bull market. They start out small and then start to bet the farm right at the peak.
The chart below shows the net equity inflows from 2003 until March 2017. Inflows are up about 40% from the peak in 2015. You’d expect ETF buying to go up over time because of GDP growth and inflation, but those effects are limited if you’re comparing the market of today to how it was less than two years ago. It has been great run after the near recession of early 2016. I would expect the ETF buying to be up slightly in April given the S&P 500’s performance was positive. There have been three mini falls in ETF buying, but now, judging by the sentiment indicators, the next fall will probably be the one that moves stocks into a bear market. This latest ETF buying binge is more important than previous ones to the market because the decline in buybacks.
Even though I have been discussing the recent decline in small caps’ margins, the earnings estimates imply revenue growth will be strong. As you can see, small caps are expected to have the biggest boost in earnings in the next twelve months. Although the Russell 2000 has given up on the Trump trade, analysts still believe the regulation cuts and tax cuts will boost earnings. There hasn’t been any major news on the tax cut front because the healthcare bill is still stuck in the Senate. However, there has been some progress on the regulatory front as an overhaul of Dodd-Frank has cleared the Financial Services Committee and is now headed to the House to be voted on. I expect it pass easily as this will be one case for the GOP’s majority isn’t stymied. Once it passes the House, it will join the healthcare bill in the Senate.
Conclusion
Anecdotally, it feels like the market hasn’t been open in the past few weeks as stocks remain right at their all-time highs and barely move throughout the day. This is an unsustainable trend, but it’s important to not worry too much because it doesn’t imply a crash is coming. It’s much more worrisome that the Shiller PE is at 29.48 because that implies low returns for stocks in the long-run. For ETF investors, it remains smooth sailing as those who barely do any research continue to profit. They probably don’t even know how unprecedented the lack of volatility is.
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