The Unlikely Rally Continues

The unlikely event that stock prices would rise this year given their expensive valuations to start the year is occurring. If you annualize the returns of the S&P 500, the market is on pace to return in the high 20% range for 2017. That goes against what I have been projecting. This is why I have shown the bullish indicators in past articles. They are double digit earnings growth, great labor reports, great ISM PMI manufacturing data, and an improvement in the C&I lending environment.

We received another positive labor report on Thursday which showed only 234,000 claims for state unemployment benefits. This was below the 250,000 jobless claims expected by economists. This was only 1,000 shy of the 233,000 jobless claims in early November which was a 43-year low. Jobless claims have been below 300,000 for 101 weeks which is the longest streak since 1970. On a population adjusted basis, the jobless claims data has never been stronger. Usually it is a good idea to buy stocks when the number starts to decline and sell stocks when the rate of the decline starts to slow. However, in this rare case, if you bought stocks after the jobless claims first went below 300,000, you captured a lot of the gains in this bull market.

The VIX had a very small rally at the end of January when the market fell about 1%. Now it is back at extremely low levels. The chart below shows that the short term VIX’s 8 week moving average has fallen to single digits for the first time ever. The S&P 500 is currently in the longest streak without a 5% correction in this bull market. On a relative basis, the environment for stocks has improved in the past few weeks, but they were starting from an expensive level. It seems like I’m always bearish because the issues the market faces snowball. If it never falls when bad news comes out, I can’t get behind a rally when good news comes out.

The number of short based funds in September fell to 18 from 50 in 2009. Short selling is becoming impossible. It’s not that the number of skeptics declines by the end of bull markets; it’s that they don’t receive any more investor money because their strategies haven’t been working. This ‘what have you done for me lately’ expectance of investment performance is shown in the chart below. The average holding period for stocks has now fallen below 6 months. I think there’s a cultural change with the advancement in technology. People can get instant gratification with the advancement of the internet, so they figure why not get the same with stocks? Patience is no longer part of the lexicon of investors.

This also explains the enormous shift of assets from active investments to passive ones. If an investor has a short time horizon, then he/she will get mad that he/she must pay fees to a manager who isn’t outperforming the market. In theory, the active managers can foresee volatility and help limit losses. It depends on the skill of the manager whether the losses will be avoided. However, passive investing guarantees you’ll experience the full brunt of a correction. Some investors believe stocks will never fall, so this doesn’t concern them.

If you thought I was being facetious writing that some investors don’t think stocks will ever fall, look at the chart below. Stock newsletter providers are the most bullish they’ve been since 2004. No wonder why most of these newsletters are free. They provide exactly the wrong advice. They were bullish in 2007 and bearish in 2009. An important factor to consider is that some newsletters are of the ‘doom and gloom’ variety. They’re always negative. Therefore, I’d say the upper limit to this metric is probably near 70%.

As I mentioned, skeptics still exist, but fund managers who exhibit that skepticism aren’t receiving the money they once were. The fact that skepticism is still prevalent is shown in the two charts below which show the web traffic received by zerohedge.com and offthegridnews.com. Traffic has been increasing in the past year to both sites. Before checking these stats, I was expecting to see declining traffic given the low volatility in the market. I think zerohedge.com received extra traffic because of the election and offthegridnews.com has received more traffic because gold and silver prices have been rallying.

The biggest economic report on Friday was the consumer sentiment data. Consumer sentiment for February was 95.7 which is down from January’s 98.5. It missed economists’ expectations for 98.0. The biggest decline was seen in consumer expectations. It fell from 90.3 in January to 85.7 in February as you can see in the chart below. It’s not surprising to see sentiment fall off a 13-year high. The question is whether this represents a trend or a one-off decline.

A key signal to watch to see where consumer sentiment is headed appears to be the government’s economic policy. Six in ten consumers mentioned government policy in the survey. This means Trump’s performance will determine where the survey goes. The last time this survey has had so much chatter about government policy was in 2013 and 2014 during the debt ceiling crisis. There is a major difference between both situations. During that period, all the Congress had to do was pass an increase in the ceiling with some spending cuts that the GOP was demanding. This time, Trump must pull a rabbit out of his hat and create economic growth while corporate debt is already at the cycle peak and the Fed is expected to raise interest rates. In fact, Trump is expected to pick hawkish Fed officials, making his job harder.

Finally, consumers in the survey projected inflation to be 2.8% next year compared to 2.6% in the last survey. This shows the heightened risk the Fed faces when it lets the economy run hot by not raising interest rates in response to higher inflation.

Conclusion

            Investor sentiment cannot be higher, but consumers aren’t seeing the same picture. They’ve become less excited in the past month even though stocks have hit record highs. More worrisome is the projected inflation is rising way above the Fed’s 2.0% target. Will the Fed raise rates if the CPI rises, even if it doesn’t have enough information on how Trump’s policies will affect the economy? Next week the CPI data is released. I will review it in a future article.