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CANEY CREEK REPORT - Getting There

CANEY CREEK REPORT - Getting There

| September 03, 2019
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The short-term outlook for the US stock market is beginning to improve. Sentiment numbers from Investors Intelligence have finally reacted to the increased volatility and pullback in prices that has been going on since mid-July. This week the number of advisors who were Bullish decreased to 44%. Bears increased a bit to 19%. The difference of 25% is the lowest spread in about five months. So, we are correcting the “overbought” situation in the market. I would now say that sentiment is neutral. 

To put that in perspective, when the market peaked in July with the S&P 500 at about 3050, advisors were 58% Bulls and the difference between Bulls and Bears was 40%. That was dangerously high. Last December, when the S&P was trading at 2500, the difference was 0%. That was a great time to buy. 

Now there is a little bit of fear in the market. There is now some cash on the sidelines. One more downdraft with the S&P testing its 200-day moving average at about 2800, would be enough to trigger more Bears and would make a good entry point for a trading rally into year-end. 

If you are a longer-term investor, you can start averaging into the market again. If you are a short-term trader, wait for the last selloff. The S&P could reach an all-time high in a year-end rally. But from today’s level of 2900, that could amount to only 5% - 6%. 

The problem remains in the monetary outlook. US monetary policy is clearly a negative for stocks. The US Treasury bond yield curve is “inverted.” Overnight Fed Funds yield is 2%. Two-year notes yield 1.52% and ten years yield 1.49%. When short-term yields are higher than long-term yields it is a problem for stocks. 

The Federal Reserve will likely lower short-term rates by 0.25% in September, and again in December. That is not likely to correct the inversion. As we have discussed before, our long-term rates are being dragged down by negative yields of -0.71% for ten-year German bonds and -0.27% for similar Japanese bonds. In a world where there is a “shortage” of global sovereign bonds, the central banks in Europe and Japan continue to buy bonds, which pushes their yields to these ridiculous levels. Monetary factors remain negative. 

Valuation is essentially neutral with the price/earnings ratio of the S&P 500 at about 17.5X next twelve months earnings.   I see no reason to think the P/E will break either side of 16-19X in the near term. A trading range of 2600-3100 is indicated for the index. We are right in the middle. Valuation is neutral. 

As for bonds, it is a great time to be a borrower, but a lousy time to be a lender. It was reported last week that Denmark banks were offering mortgages with negative rates. They would be paying you to take out the mortgage. Tell me how that even works! Bonds offer very low current yields and a significant risk of principal loss on longer maturities. 

Eventually, all of this will be solved with higher inflation. Stay in shorter term fixed income securities or buy Treasury Inflation Protected Securities as a hedge. With the yield curve where it is, you don’t give up income by staying short, while you mitigate principal risk.

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Robert C. Davis is a Chartered Financial Analyst and is affiliated with Woodlands Asset Management, Inc. as a consultant.  Founding partner of Davis Hamilton Jackson and Associates, a Houston based investment advisory firm; Bob is now retired and living in Chappell Hill, Texas.  He now lends his expertise and knowledge of the markets to our company and customers.  We hope you find it interesting and insightful. 

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