4.13.14: Has Character of Stock Market Changed, and More Links to Read

One element to watching the stock market every day is to get a feel for the pattern of the market, and then watch and see if that pattern continues. Every correction for the SP 500 since 2011 has been fairly limited in scope. We did an Excel spreadsheet a few months back on the length and depth of recent corrections, which is attached here: SP500corrections.

We haven’t updated the spreadsheet after the January, 2014 correction since I don’t think we’ve finished the move (or at least the churning) that has signified this year’s stock market action. In other words, the fact that we saw a 6% – 7% correction through the first 5 weeks of the year, the SP 500 then bottomed and rallied through the month of February, but the market still hasn’t decisively moved higher supported by breadth and leadership, likely means this correction isn’t over.

The question we ask then, “has the character of this stock market changed ?” Id say yes, it has. The rally off March, 2009 market lows has been partially lead by small-caps and biotech’s, both of which have broken down of late. The biotech ETF’s (BBH, IBB) are testing testing their respective 200-day moving averages, so the action this week for that sector is critical. q1 ’14 earnings start this week. I don’t think they will be as bad as the current headlines suggest, but yiou can have strong years of SP 500 earnings growth, like 1994 and 2011, and yet the SP 500 does very little in terms of the annual total return.

However, the prospect for a prolonged bear-market that the SP 500 just exited from in May, 2013, when it broke out to an all-time high seems highly, highly unlikely.

Frankly, I’d be greatly surprised at a 20% correction in the SP 500, given its 15(x) forward p.e ratio and the expectation that SP 500 earnings will grow 8% in calendar 2014.


Josh Brown, with his notes from the Jeffrey Gundlach lunch.  Start at the bottom or the summary section first and work your way up. Josh is one of the best and most prolific writers in social media today.

Charlie Bilello, CMT on asset-class returns in 2013 and 2014, and more importantly, found at the bottom, the correlation therein. It is a completely different year in 2014.

Ryan Detrick, a “money” contributor in the financial media if there ever was one, on the action in small caps, and the prospect for positive prospective returns. The Russell 2000 is testing its 200-day moving average, or getting close to it. How the index acts around the 200-day average will speak volumes about its prospects. The Russell 20900 is trading about 70(x) earnings, while the SP 500 is trading at 15(x) forward earnings. The importance of market cap – don’t forget it.

Great tweet by Norm Conley of JA Glynn on the really long-term picture of the market. Stay with large-caps.  Norm also thinks technology will do ok despite its streak of underperforming the Russell 1k Growth index. Here is Norm’s tweet on this topic. The constant cacophony in the financial press about “tech” greatly oversimplifies investing in the sector. Two of our top 5 holdings are Facebook (FB) and Microsoft (MSFT), two tech stocks with completely different valuations. For our clients, it is cheaper “old tech” (PC’s, networkers, software companies) versus, more expensive “new tech” (i.e. social media), etc. (Long FB and MSFT)

Jeff Kleintop, Strategist at LPL Financial, on the cheap Cyclical stocks. Technically, GE is an Industrial, but it is still ruled by GE Capital. GE is down 10% year-to-date (excluding the dividend) and is testing its 200 day moving average. There are better cyclicals to own.

The two big tech heavyweights that will report this coming week are GOOGL and IBM (long both). IBM, one of 2013 underperformers, and still down about 5% for its 1-year return is up 5% year-to-date. GOOGL is just the opposite, with the stock being up 60% in 2013, and now down roughly 8% in 2014.

The average investor and diversification, found on Bloomberg View (@BV). The issue I have with this is the 20-year returns. Distorted by the 13 year SP 500 bear market ? If starting today, given “reversion to the mean”, etc. how would you position a portfolio ?

Ukarlewitz with some good graphs supporting all that was said above.

This Week on Wall Street blog. Note Gray Morrow’s April 11th column. Our sentiments exactly.

Jeff Miller, of A Dash of Insight: always a must-read, but takes a while to get through given his voluminous links. This week’s A Dash is pretty good. Jeff is worried about corporate earnings, which I don’t think he needs to be. As we’ve mentioned many times though, corporate earnings are not correlated directly and immediately to SP 500 returns.

Moody’s recent Leveraged Finance Interest notes that high yield bonds are NOT cheap, although default rates remain low. Moody’s Liquidity Index also signals continue benign conditions for high yield. Frankly, we’d rather own municipal high yield here than taxable. Nuveen’s Muni High Yield Fund has a higher absolute yield at 6.11% versus the HYG’s 5.93% and the JNK’s 5.86% yields, not to mention the US high yield composite index yield of 5.26%. For taxable accounts, muni high yield should be less risk and more reward, as Detroit, Puerto Rico and even Chicago clean up their respective pension and credit messes. As corporate high yield becomes more “covenant lite”, muni high yield, particularly the Chicago GO bonds you would think, which are secured by (my) property taxes, would look relatively much stronger.

Speaking of credit, yesterday, here in Chicago I had a chance to listen to Professor Joel Litman of Valens Credit, a firm which publishes credit default swap spread info relative value opinions on stocks, based on credit analysis. Personally I think this is an excellent analytical framework in which to view the world, and cash-flow and balance sheet analysis is part of our analytical analysis in valuing stocks for clients. It was a great presentation by Professor Litman. Here is the website for Valens-Credit.

So where does that bring us to today ? We will be looking to short the IWM into any earnings rally this week. The SP 500 and the large-cap universe look much better than their smaller-cap brethren. The non-stop Treasury rally has been a killer for balanced accounts this year although Friday’s close for the 10-year Treasury yield is sitting right at long-term resistance. If the 10-year Treasury yield trades through 2.62%, then 2.40% or the March ’12 high yield is the next stop.

The 2-Year Presidential Cycle appears to be the best analog for 2014 thus far as we wrote about in January ’14. Predicting the future is far more complex than analyzing the past, so we are taking a cautious approach, and will likely get more aggressive as we move into the end of the 3rd quarter, and after the mid-term elections.

q1 ’14 earnings will not be as bad as currently expected, per our Weekly Earnings Update published yesterday. Technology, Industrials, Basic Materials, Consumer Discretionary are the sectors we like. Note the positive earnings revisions for tech for q2 ’14.

Just as we were ready to publish this summary on Sunday afternoon, a WSJ headline pops up about Ukranian forces killed by pro-Russian troops in East Ukraine. Putin is Saddam with a brain. He is killing his own capital markets and the chance for his own people to prosper and benefit from global growth. Is it an issue for the markets ? We’ll find out shortly.

Thanks again for reading and stopping in. There are a lot of blogs competing for your eyeballs.

Trinity Asset Management, Inc. by;

Brian Gilmartin, CFA

Portfolio manager






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