By Gary Stringer, Kim Escue and Chad Keller, Stringer Asset Management
Market volatility tends to be persistent and can continue for a while. The current environment has been devoid of volatility for so long that we are certainly overdue. On average, the U.S. stock market has a sizeable correction roughly every 18 months, and until recently we had not had a corrective move in almost exactly two years. Importantly, volatility also does not end because a new calendar month begins. It can take weeks for the market to work out shifting volatility regimes based on new economic and market information.
As volatility and markets normalize, we will again see their movement reflect the prevailing economic fundamentals. Overall, the indicators that we track suggest optimism for the global economy and risk assets, such as equities and commodities, so we think investors should maintain these exposures consistent with their overall plan. If our signals were to shift, our strategies would follow suit.
The global economy is firing on all cylinders as seen in the following chart of the Leading Economic Indicators (LEIs). We are witnessing “global economic synchronization,” which refers to all major global economies advancing at the same time. This is a rare occurrence and one that should be appreciated. That said, we expect the pace of growth to reduce as some indicators of business confidence and investment are at unsustainable levels. We expect the economy to continue to grow, but some of the recent positive economic reports are likely to come back down to normal levels. While this softening may result in equity and commodity market volatility, fundamentals remain strong, so we remain invested in the business cycle at this time.
For example, the latest ISM Manufacturing Index reading of 59.1 suggests real U.S. GDP growth of approximately 4.0%. This growth rate is roughly double the sustainable rate estimated by the U.S. Federal Reserve. Furthermore, both the ISM New Orders Index, which tends to lead business investment, and the NFIB Small Business Optimism Index are nearing all-time highs (exhibit 2). Based on history, both of those indicators are likely to fall back after crossing new highs rather than remain at lofty levels for long periods of time.
We are seeing economic strength around the world with euro zone economic growth in 2017 at its fastest pace since the global financial crisis. While the euro zone’s growth last year was competitive with the U.S., we think that pace is unsustainable given Europe’s structural headwinds. Also reflective of global economic strength, Japan’s export business has been booming as global demand remains strong. However, their exports should slacken if for no other reason than year-over-year comparisons get more difficult at these high levels.
Major equity market risks tend to come with economic recessions. We see little chance of a recession in the near-term. Global central banks remain supportive of economic growth, monetary conditions continue to look healthy, and though we expect many of our fundamental leading economic indicators to soften in the weeks ahead, these indicators should stabilize at levels supportive of further economic growth. We think investors should be prepared for volatility and either look past it or take advantage of it.
Our strategies are generally overweight the sectors that we think offer attractive valuations compared to the broader market. For example, since the beginning of the year, analysts have increased their forward 12-month earnings expectations for S&P 500 Index companies by nearly 16%, yet earnings expectations for value (the S&P 500 Value Index) and midcap companies (the S&P Midcap 400 Index), two of our favored areas of the U.S. equity market, have increased more than 18%. Additionally, considering the recent equity market declines, the forward price-to-earnings (PE) ratio of the S&P 500 Index has decreased more than 17% since the beginning of the year, while the forward PE ratio for value is down more than 19% and the ratio for midcap stocks has fallen more than 22% based on stronger earnings expectations and lower prices.
THE CASH INDICATOR
The recent rise in the Cash Indicator (CI) level is similar to the volatile market declines of 2011 and 2016. While the CI has experienced a large upward move, especially considering the long period of low volatility we have experienced recently, it is not to a level where we would raise significant amounts of cash.
Please keep in mind that the CI is designed to be intentionally stubborn and avoid the whipsaw effect. That characteristic helps differentiate between periods of high market volatility that are expected from time to time, and a systematic breakdown. We are monitoring the CI closely as well as our other signals, and we will make adjustments accordingly. We expect this market volatility to continue for the next several weeks.
This article was written by Gary Stringer, CIO, Kim Escue, Senior Portfolio Manager, and Chad Keller, COO and CCO at Stringer Asset Management, a participant in the ETF Strategist Channel.
DISCLOSURES
Any forecasts, figures, opinions or investment techniques and strategies explained are Stringer Asset Management, LLC’s as of the date of publication. They are considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect to error or omission is accepted. They are subject to change without reference or notification. The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment and the material should not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested.
Past performance and yield may not be a reliable guide to future performance. Current performance may be higher or lower than the performance quoted.
The securities identified and described may not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable.
Data is provided by various sources and prepared by Stringer Asset Management, LLC and has not been verified or audited by an independent accountant.
Index Definitions:
S&P 500 Index – This Index is a capitalization-weighted index of 500 stocks. The Index is designed to measure performance of a broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
S&P 500 Value Index – This Index is a capitalization-weighted index consisting of those stocks within the S&P 500 Index that exhibit strong value characteristics based on book/price ratio, earnings/price ratio and sales/price ratio.
S&P Midcap 400 Index – This Index is a capitalization-weighted index of 400 stocks. The Index is designed to measure the performance of mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment.