Saturday, January 13, 2018

A Balancing Oil Market, But Will It Last?

In May 2011 crude oil (WTI) hit $113 per barrel and remained elevated at or near that level until the summer of 2014. Given the high price of crude and the expansion of fracking at that time, crude supply continued to grow until peaking in mid 2017. I wrote about the high crude supply level in mid 2017 and its impact on keeping oil prices down, Higher Oil Prices Contend With Too Much Supply And Higher Energy Efficiency. Today, we are seeing crude oil inventory decline at a fairly rapid rate as can be seen with the green line in the below chart.

Although rig count has increased from its June 2014 low (maroon line above), the rig count has remained relatively stable to down slightly since the summer of last year, which has helped stem the growth in supply. Two additional factors contributing to the decline in supply is the reduction of crude oil imports into the U.S., down almost 2 million barrels per day versus a year ago, along with growth in the demand for petroleum products of about 1 million barrels per day versus the same time last year as seen in the two charts below.

With supply and demand nearing a more reasonable balance, the question becomes whether or not producers can maintain discipline and not over supply the market. As noted in Econoday's report earlier this week after the release of the EIA Weekly Petroleum Status Report (PDF):
"Dampened imports and strong domestic demand have more than offset the impact of increased domestic production and brought bloated inventories down to the middle of the average range for this time of year. But with crude oil prices above $63 per barrel and domestic shale oil breakeven costs far below that price, supply from the nearly inevitable new domestic production may swell inventories again during the new year."
History suggests producer will increase production given the higher price of oil currently. This would potentially lead to increasing oil inventory levels and hence place downward pressure on oil prices. An unknown is the impact on oil demand resulting from a potentially faster economic growth rate in the economy on the back of  Tax Reform legislation recently passed by Congress.

Thursday, January 11, 2018

Investor Sentiment More Actionable At Market Bottoms

Today's weekly AAII Sentiment Survey reports a drop in bullish investor sentiment of 11.1 percentage points to 48.7%. The bullish sentiment reading has been on a steady move higher since November 16 when the bullishness reading was 29.4%. The weekly readings tend to be more volatile and one can look at the 8-week moving average in order to eliminate some of this volatility. As a result, although the sentiment reading fell this week, the longer period average of bullish sentiment increased to 45.6%, largely due to dropping the 29.4% bullishness reading from November 16.

Most of the reported decline in bullish sentiment was reported in the 9.5 percentage point increase in the bearishness reading. The net affect was a decline in the bull/bear spread by 20.6 percentage points to 23.6%.

Given the low level of equity market volatility, the uninterrupted climb in the market for nearly two years and elevated investor sentiment readings, one would expect a market pullback. One reason a pullback is not occurring may be due to the simple fact most investors and strategists are expecting one. The market loves proving the consensus wrong. Secondly, as contrarian indicators, the sentiment measures tend to be most predictive of future market returns at market bottoms versus market tops. Nautilus Investment Research recently released some detail via the firm's Twitter site that provides some detail on this difference and one of their charts is included below. Notable is the fact when the AAII bullish sentiment reading cross above 55 for the first time within six months, which occurred last week, six months later, the market was up 12 out of 12 times with an average return of 8.14%.

A number of sentiment measures continue to note the elevated bullishness readings. As noted in our recent Investor Letter and prior blog posts, an improving fundamental backdrop, both economically and financially, is serving as a tailwind for companies. A large portion of this improvement seems to be driven by the positive expectations around the recent tax reform legislation passed by Congress. Time will certainly be the weighing machine, but some type of market pullback would be healthy if only to reduce any speculative market froth.

Wednesday, January 10, 2018

Winter 2017 Investor Letter: An Uninterrupted Climb

Our Winter 2017 Investor Letter provides commentary on 2017 and our thoughts and observations on the coming year. Many strategists and investors have either commented on or know from first hand experience, in 2017 the equity market saw very little downside market volatility. Our expectation for 2018 is the market will see a more normal level of volatility. As we comment on in our Investor Letter, that normal level of volatility would be a 14.1% decline from peak to trough. A decline of that percentage amount would equal 3,500 Dow points, and that would represent a normal pullback.

For additional insight into our views for the market and economy in the coming year, see our Investor Letter accessible at the below link.

Monday, January 08, 2018

High Beta Stock Outperformance Suggests A Strengthening Economy

For the first part of 2017 low volatility equities were outperforming their high beta counterparts. However, as tax reform talk began to look more a reality in late August, high beta stocks resumed their outperformance that really began in early 2016. As the maroon line in the below chart shows, this high beta outperformance is carrying over into the beginning of 2018.

From a sector weight perspective, the high beta stocks tend to have larger allocations to the more economically sensitive sectors, for example, Industrials, Technology, Energy and Financials. Conversely, the high beta index is under weight the traditionally more defensive sectors like consumer staples and utilities.

The blue line in the first chart at the beginning of the post represents the Conference Board's Leading Economic Indicators Index. Of significance is the fact high beta stocks as a group tend to outperform low volatility ones when the economic data is improving. By its nature, a positive LEI Index is representative of an improving economy and not a recessionary one as can be seen in the below chart by comparing the blue LEI line to the recessionary grey bars.

With the recent passage of the tax reform package in Congress, a stimulative economic impact is anticipated. It is quite possible the economic cycle gets extended as a result of the benefits that accrue to the economy from the tax reform legislation. The fact economically sensitive sectors are once again outperforming indicates the market may be expecting this as well. This week's fourth quarter earnings reports by S&P 500 companies will be weighted towards financial stocks and company comments around their outlook should be a key focus for investors.

Sunday, January 07, 2018

Sentiment: Simply More Buyers Than Sellers

I am re-reading Justin Mamis' book, The Nature of Risk, a worthwhile read by the way, and being reminded of the dissemination of information prior to the internet age, which is difficult for many to believe if they did not work in investments at that time. Simply gauging market sentiment prior to each day's market open at that time was much different than it is today, of course. As he notes in his book, when one inquired about, say, a higher market, the most appropriate answer was there simply were "more buyers than sellers" that day. In today's proliferation of business cable channels, that type of response will not sell many advertisements.

This focus on buyers and sellers is really an evaluation of investor sentiment and is one reason I write about sentiment reports on a fairly regular basis. To that end, the American Association of Individual Investors reported Sentiment Survey results last week and individual investor bullish sentiment jumped 7.1 percentage points to 59.8%. Most of this bullish improvement came from the prior week's bearish survey participants as bearish sentiment decline 5.1 percentage points to 15.6%. This spike in bullish sentiment can be seen in the below chart.

Saturday, January 06, 2018

Dow 30,000 By Year End

The Dow Jones Industrial Average pushed through 25,000 in the first week of 2018. True to form, the President weighed in on this record and indicated 30,000 is the next target, skipping over the 1,000 increment target milestones. His comment was replayed numerous times on television by the financial media Thursday with many commentators spinning his comment as hyperbole, but might a Dow target of 30,000 in 2018 be reasonable?

The below chart displays the calendar year returns for the Dow Jones Industrial Average going back to 1980. Also included on the chart are red dots representing the largest intra-year drawdown or decline. Looking at the mid 1990's returns, there was a five year period, 1995 - 1999, where the Dow returns ranged from 16% to 33%, but with four of the year's return above 20%. So what would it take for the Dow Index to hit 30,000? A 20% return.

The point being, with the Dow Index trading at a large absolute number level, these 1,000 or 5,000 point moves are not out of the realm of even a reasonable possibility. Just as today a 100 or 200 point decline in the Dow is not a significant drop at all, i.e., less than a tenth half of a percent. Importantly for the market and investors though, is the fact the market has not experienced a double digit pullback since February of 2016, nearly a two year period. The market will experience one of these double digit declines as it did 1997 and 1998, but looking at those prior years, the market can recover and generate strong returns for the entire calendar year period.

Tuesday, January 02, 2018

Equal Weighted Equity Performance Lagged In 2017

One equity market phenomenon that played out in 2017 was the fact larger capitalization stocks were larger contributors to market returns. One way to evaluate this is to review the return of the cap weighted S&P 500 Index versus the equal weighted Guggenheim S&P 500 Index (RSP). As the below chart shows, the equal weighted index underperformed the cap weighted S&P 500 Index by more than 300 basis points. Additionally, the largest 50 stocks by capitalization (XLG) outperformed both the the S&P 500 Index and the equal weighted S&P 500 Index.

Monday, January 01, 2018

Is The Glass Half Full Or Half Empty

The end of Friday trading was certainly interesting as the last thirty minutes of the trading day incurred most of the day's half of a percent loss. A few Twitter posts I read were comments in the vain of "this is the selling I have been anticipating." The market is over due for a pullback.

Sunday, December 31, 2017

Most Read Articles From Our Blog In 2017

Below is a list of the most read blog articles in each month during 2017. One interesting commonality for some of the top posts is the fact the ones focusing on investor sentiment tend to gain higher levels of readership. Sentiment is one important market factor we monitor on a fairly regular basis. Secondly, some prior articles seem to remain applicable as 2018 is set to begin. For example, articles like Market Pullbacks Should Be Expected and The S&P 500 Index Is Expensive and Has Been So Since The Early 1990's are certainly timely even today.

Our firm's bullish equity stance in 2016 and 2017 has certainly rewarded our clients. We are in the midst of finalizing our Winter Investor Letter which will contain some of our firm's thoughts on the coming year.

To our clients and readers, we wish all of you a Healthy and Prosperous New Year.

Second Longest S&P 500 Rally Since 1932 - January 25, 2017

Recent Outperformance Of Low Volatility A Sign Of Risk Off Ahead?
- February 12, 2017

Time To Reduce One's Equity Exposure? - March 1, 2017

Widespread Bearishness Indicating Market Nearing A Turning Point? - April 14, 2017

The Unfortunate Rise Of The Misleading 'Scary Chart' Comparisons Again
- May 29, 2017

Market Pullbacks Should Be Expected
- June 26, 2017

Strong Earnings Growth And Favorable Valuations Lead To Weak Stock Returns - July 22, 2017

The S&P 500 Index Is Expensive And Has Mostly Been So Since The Early 1990's
- August 5, 2017

Stocks Need Some Healthy Competition - September 16, 2017

Citgroup Economic Surprise Indices Have Little Bearing On Equity Market Performance
- October 15, 2017

Individual And Investment Manager Sentiment Is Diverging - November 2, 2017

If Cash Is King - December 19, 2017

Thursday, December 28, 2017

Continued Improvement In Bullish Investor Sentiment

In the few weeks after the 2016 presidential election, individual investor bullish sentiment spiked to near 50%. Over the course of the next five months though, bullish sentiment trended lower to a year low of 23.85%. From March through April the market had some volatile periods that may have influenced investor sentiment; however, true to form this year, the market never experienced a prolonged or significant contraction.