Market Watch

Evidence Supportive of Stocks

Download pdf version – Market Watch – Evidence Supportive of Stocks – November 29, 2020

 

“This is an important development. Global stocks have been in a bear market since Jan 2018. That now is ending. Don’t let the “why” distract from the “what”.”
-Willie Delwiche, CMT, CFA

 

Bottom Line: For now, we remain in wealth building mode. With these high levels of optimism and weakness in our Buying Power Model, we would ordinarily expect consolidation in the market. However, going into the seasonally strong part of the year and given how strong our Primary Trend Index is, a strong finish to the year seems probable.

 

This week:

We lost the client we mentioned last week to cancer. A client that has been with me for over twenty years and has become a friend of the family. Our thoughts go out to her extended family and friends. She’ll be missed and we are diminished for losing her.

‘They’ say that life is not about the ending point, that it’s about the journey. Well the journey is getting odder by the day it seems. Restrictions and economic closures are picking up pace again and if that continues, it could again negatively impact economic activity.

On the other side of things, I still get to coach Anthony’s basketball team and we’ll keep that up so long as we can.

On a finance note, we had an odd development last week that could have some significance with discord between Treasury Secretary Steven Mnuchin and Fed Chairman Jerome Powell.

The expansion of central bank power is a central theme of the world in my view so the disagreement was a bit of a surprise. Mnuchin released a letter to Federal Reserve Chair Jerome Powell demanding the return of money in an unused Covid stimulus lending program. The Fed issued a statement urging that “the full suite” of measures be maintained into 2021.

My sense is that Trump is not too pleased with how Powell acted during the recent nomination to the Fed board of Judy Shelton. She was rejected by the establishment at the Fed. Shelton is an outsider and may be less likely to support insane money printing forever and stimulus spending. The Fed doesn’t like that and did not support her nomination, so Trump had Mnuchin send a message.

Despite folks playing hardball in DC I think it’s little more than political theatre and there is little that will change the path of Federal Reserve Bank expansion of power and money printing in coming years, keeping that support for asset prices alive.

Upward and onward, stay active, stay healthy.

 

In the Markets

Schenk Group Primary Trend Indicator – Measures underlying the health of the stock market – Strongly positive.

Schenk Group Buying Power Indicator – Measures the power behind money flowing into the market – Weakening.

Sentiment – The level of greed or fear among investors – High optimism. 

 

Risk Management Intro.

The best analogy I can think of for risk management is viewing the stock market as a heart patient. Mr. Market can have palpitations (2013, Aug 2015, Jan 2016, Jan 2018), irregular heartbeat (daily and weekly volatility) and outright heart attacks (2008, December 2018, March 2020).

Since Mr. Market’s massive heart attack in 2008, Dr. Federal Reserve has treated Mr. Market with massive experimental medication (“Fed liquidity injections”). He responded in 2009 but has experienced a series of the aforementioned palpitations and follow up attacks every time the medication slowed, or even as the doctor (Federal Reserve) simply discussed reducing said medication. Today, it is likely that Mr. Market is completely dependent on this medication for survival.

This massive medical experiment requires investors to look beyond normal economic relationships (the ‘why’) to explain the current situation (the ‘what’) and to use tools needed to see inside Mr. Market’s innerworkings to see how strong the heart is pumping, how well the market lifeblood is flowing and if any blockages are building in the primary arteries.

That is where our PTI and BPI come in.

 

PRIMARY TREND INDICATOR (PTI) – Measuring market participation:

“Breadth analysis is like quantum mechanics; it does not predict a single definite result. Instead it predicts a number of different possible outcomes and tells us how likely each one will be. Breadth directly represents the market, no matter what the indices are doing. It is the footprint of the market and the best measure of the market’s liquidity.”

~Greg Morris – Market Breadth Indicators

 

An electrocardiogram (ECG) records the electrical signals in your heart. It’s a common and painless test used to quickly detect heart problems and monitor your heart’s health.

Our PTI is a collection of breadth measurements that, like an ECG, can give us a good picture of how strong Mr. Market’s heart is. Each component of the PTI is a measure of market supply and demand in and of itself. When weighted and combined they can give us a good indication of when the balance of supply and demand is shifting, allowing us to make adjustments in our portfolios to increase or reduce equity exposure depending on how the shift is unfolding.

The first place we go to look at “breadth” or market participation, and a main input into our PTI (ECG output),  are the cumulative advance-decline lines for the NYSE, S&P 500, S&P Mid Cap and S&P Small Cap indices.

The Advance-Decline Line (AD Line) is based on Net Advances, which is the number of advancing stocks less the number of declining stocks. The AD Line is a cumulative measure of Net Advances, rising when it is positive and falling when it is negative. We use the AD Line for the index and compare it to the performance of the actual index action. The AD Line should confirm an advance or a decline with similar movements. Bullish or bearish divergences in the AD Line signal a change in participation that could foreshadow a reversal.

Here’s the chart with the S&P500 on the top pane, followed by the AD Lines for the NYSE, S&P500, S&P Mid Caps, and S&P Small caps. Click on the chart to expand it.

After last week we now see all four AD lines breaking to new highs. For now, all of them are in a confirmed bullish trend supporting the advance in stocks.

The strength in these advance-decline lines tell me that equities overall remain in a position of strength. In fact, the market trend strength is expanding beyond the few big tech names which drove the market earlier this year into smaller companies and companies more sensitive to the economy. Another positive for the market.

 

BUYING POWER INDICATOR (BPI) UPDATE

While an Electrocardiogram (ECG) records the electrical signals in your heart to quickly detect heart problems and monitor your heart’s health, an echocardiogram is a test that uses ultrasound to show how your heart muscle and valves are working. The sound waves make moving pictures of your heart so your doctor can get a good look at its size and shape. You might hear them call it “echo” for short.

This is a little like our Buying Power Indicator (BPI) which measures the strength of money flows into or out of the market. Ideally we like to see both the PTI and BPI giving positive signals.

However, since giving a buy signal in September, our BPI has weakened. Our PTI and our BPI usually do not diverge for long so given we are now in the strongest seasonal period for stocks, and the expansion in positive signals given by our PTI, my expectation is that the BPI will again pick up strength. We’ll closely monitor our PTI for weakness and will keep you posted and adjust accordingly.

 

SENTIMENT UPDATE

At the same time as our Buying Power model has weakened there are signs of quantifiable excess optimism in our market sentiment readings. I do not put much stock in investor surveys by themselves but when all of the various surveys and sentiment indicators we monitor are saying the same thing, we take notice. Currently they are reading excessive optimism.

Bernard Baruch said, “Something that everyone knows isn’t worth anything.” Sentiment indicators suggest everyone knows about (& is positioned for) the historical tendency for stocks to rally from here into year-end so this optimism also serves to highlight any negative signals that may come from our PTI. However over-all this week did little to change the breadth picture and overall market health. It still reads solid at this juncture.

 

 

November In Our Portfolios

During the bounce back from the March lows the market was “narrow” meaning very few stocks were actually going up. As late as the end of May, the indices were higher because the five largest stocks in the S&P500 had driven all of the gains and the other 495 stocks were still collectively down by about -10% for 2020.

Since then our Buying Power Indicator (BPI) gave a buy signal in September, which suggested that investor demand was broadening out. This led to a big surge in market participation which guided our portfolio into industrial companies and base metals.

While we saw a big move in those ‘heavy industry’ sectors, the big technology leaders like Microsoft (MSFT) and Amazon (AMZN) went up and down but basically nowhere. On the positive side for Tech, while the sector consolidated (went sideways), they all held support and did not start downtrends. Now, at the end of November these stocks appear ready to resume their uptrends from earlier this year.

As such we have begun the process of trimming profits in metals stocks like Arcelormitel (MT, steel) and Freeport McMorran (FCX, Copper, Nickel) and shored up positions in AMZN and Shopify (SHOP) and Crowdstrike Holdings (CRWD, cyber security).

As we head into the Christmas season the online retail sector could have some tailwinds. In fact, just on Saturday SHOP announced record-setting Black Friday sales of $2.4 billion on the platform worldwide. On November 27, from the start of Black Friday in New Zealand through the end of Black Friday in California, Shopify-powered businesses saw a 75% increase in sales from Black Friday in 2019. In fact, by 8:00am EST, merchants on Shopify collectively had crossed $1 billion in sales.

The Amazon led global change to retail transactions has been transforming the economy for some years now. It would behoove investors today to recognize that the industry revolutions from web-based technology, promised during the internet bubble of the late ‘90s, are largelyl coming true today. Every industry, from manufacturing to education to medicine to finance and everything in between are effectively becoming “tech businesses”. Technology upgrades used to be an option. Today, they are a mandatory matter of course. Those who lag in this area are being left behind.

The complete transformation of retail transactions, which still has many other layers to come (Paypal and Bitcoin’s recent moves for example), is just one example of innovation that will provide investment opportunity for years to come, in many other sectors.

(I hadn’t intended this section to go in this direction but while I’m at it, I should include this article interviewing Wellington Altus Founder and CEO as he discusses the firm’s massive gap over our competitors in technology applications. This is one of the main reasons our team decided to make the move to WA in February of this year. Our technology edge helps us do a better job for clients; in all aspects of the business from portfolio management to communication. Have a read. Click Here)

 

Conclusion

Is Willie’s quote at the top of this update correct? It is starting to seem more likely, yes. Can the market pull back from these levels? Absolutely. In fact, I would argue that the excessive optimism in certain investor surveys discussed in the notes above suggests the odds of that are growing.

However, improving economic data coming in and the broad weight of our indicator evidence suggests November’s success could carry through into the new year and possibly for some time to come. Clearly developments in Covid–19 outcomes could impact that but at this stage, short-term setbacks aside, the data, the charts, and our indicators are telling us to expect more upside.

Still, these are only expectations and we are committed to following the data and making sure your portfolios benefit from change, rather than fall victim to it.

We remain completely open to any eventuality that the markets bring. Our strategies, tactics and tools will help us to successfully navigate whatever happens as we focus on monitoring supply and demand signals that the market provides us.

I hope you had a very good weekend. If you have any questions about this update, or anything else please do not hesitate to reach out.

 

Peter Schenk, CMT, CIM | Portfolio Manager

 

Words we operate by:

“Deliver to the world what you would buy if you were on the other end. There is huge pleasure in life to be obtained from getting deserved trust. The way to get it is to deliver what you would want to see if you were on the other end.”
-Charlie Munger

“Strive not to be a success, but rather to be of value.”
-Albert Einstein

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