WEEKLY MARKET ANALYSIS 01 (04 JAN 2021 - 08 JAN 2021)

Summary

• Nascent geopolitical catalysts, tech and small cap leadership light the way for the bulls.
• PE ratios for the S&P 500 indicate pregnant tropical storm clouds percolating above the bulls' parade.
• What bearish catalyst will trigger the downpour? Should we buy the dip or migrate to higher grounds instead and wait out the coming storm?

S&P 500: PORTION OF S&P 500 STOCKS WITH P/E RATIO ABOVE 17 (OBSERVATION):

66.33%

S&P 500: WEIGHTED P/E RATIO (MEAN/MEDIAN = 17) (OBSERVATION)

27.53

S&P 500: FORWARD P/E RATIO (OBSERVATION) (As at 06 January 2021)

SPX --> 22.7

XLK --> 27.5

XLC --> 23.2

XLY --> 36.3

XLP --> 20.8

XLF --> 14.6

XLV --> 16.2

XLU --> 18.5

XLE --> 30.7

XLI --> 23.9

XLB --> 20.9

XLRE --> Not available

(Source: https://www.yardeni.com/pub/mktbriefsppesecind.pdf)

S&P 500: CAPE RATIO (SHILLER P/E) (OBSERVATION)

Wk 01 = 34.77; mean = 16.78; median = 15.81.

DotCom bubble = 45

GFC = 27

(Source: https://www.multpl.com/shiller-pe)

S&P 500: TOBIN'S Q RATIO (MISESIAN STATIONARITY INDEX (OBSERVATION)

Wk 01 = 2.40; mean = 1.00; median = 1.00.

DotCom bubble = 2.1

GFC = 1.1

(Source: https://www.msindex.net/)

BROAD EQUITY INDEX INDICATIONS (INFERENCE)

The S&P 500 seems to be 60-70% overvalued when comparing its latest weighted P/E against its mean and median weighted P/E. The forward P/E ratio painted a rosier picture for the index, with the forward P/E being slightly more than 10% overvalued compared to its latest median figure, with data collected over the period of 1982 to 2021, according to Yardeni Research. The CAPE ratio and the Tobin's Q ratio however, warned of massive overvaluation, with present levels more than double compared to average figures since the inception of the US stock market. Having more than 80% and 90% of S&P stocks above their 50-day and 200-day EMAs lend a lot of credence to the inference that the S&P 500 is grossly overvalued. But then, we observe that this rally is now being led by small caps and tech - which means that the biggest gainers are companies that form the backbone of the US economy. Together with the VIX, it looks like this bull still has some fight in it.

EARNINGS (INFERENCE)

According to this chart and data from Factset (S&P 500 CY 2021 Earnings Preview: Largest YoY Earnings Growth Since 2010), the Energy sector is expected to record a $24.0 billion in CY 2021 compared to an expected loss of $3.7 billion in CY 2020, which means the expected earnings growth rate cannot be calculated as the base earnings number is negative. However, the energy sector is ecpected to report the highest YoY revenue growth of all 11 sectors due to rising oil prices. The sectors expected to have highest earnings growth next quarter are the Industrials and Consumer Discretionary sectors, led by Aerospace & Defense, Industrial Conglomerates, Automobiles, and Auto Components industries.

The rest of the sectors had been faring better during the pandemic, and thus is expected to experience a lower earnings growth margin. However, these figures are likely to be revised upward if the economic recovery does not experience serious setbacks, as several industries within the Industrial sector like Airlines, as well as the Hotels, Restaurants, & Leisure industry in the Consumer Discretionary sector cannot provide growth estimates as of the time of writing due to projected losses in CY 2020.

We notice here that Energy, Industrials, and Materials the 3 big covid-loser sectors, are expected to recover according to FactSet's higher estimated earnings growth for them. Consumer Discretionary having high estimated earnings growth is definitely a plus in any economic situation because it is as close to a risk-on indicator as a sector can go.

SEASONALS (OBSERVATION & INFERENCE)

Statistically speaking, recent history indicated a bullish performance for January 2021, with both 5 years and 10 years data indicating a 60% chance that the S&P 500 will close at a higher price at the end of the month, with returns averaging between 0.50% and 1.50%. However, if we expand the sample size to 15 years worth of statistical data, January has only slightly better than 50-50 odds of being bullish, with average returns in the negative for the month.

Seasonally speaking, the January effect should begin in mid-December, with small cap stocks typically favored by the institutions after their tax-loss harvesting in the early half of December.

NASCENT CATALYSTS:

1. Look to Biden's policies on EV adoption, clean energy, higher corporate taxes, and more Big Tech antitrust to move stocks.
   • Biden's $2 trillion Build Back Better plan (to be deployed over his first term) would encourage investment in infrastructure, electric vehicles, renewable energy, efficient buildings and in agriculture and conservation. There will of course be renewed focus on tech regulations laws like Net Neutrality and Big Tech antitrust; as well as repeal of corporate tax reductions. But please remember, these are all CAMPAIGN PROMISES. Kindly refer to the "Macroanalysis" tab for further details.
2. Additional fiscal stimulus expected soon - good for SMBs and commerce stocks - both online and offline.
   • With a Democratic control of Congress and a Democratic president, a split Senate with VP Kamal Harris as the deciding voter should give Democrats full control of the government. That being said, the slim majority in the Senate means that passage of bills may still be more difficult than assumed, especially if there is disagreement in the Democratic camp, notably between the far left and the more conservative minds.
3. Covid-19 vaccine developments - Emergency Use Authorization (EUA).
   • There seems to be no major logistical breakdowns in the vaccine distribution in the US so far. See the "Macroanalysis" tab for more details and for actionable data.
4. Belligerent Chinese response to the US Commerce Department's Entity List expansion.
   • The recent blacklisting of SMIC and SZ DJI Technology Co. by the outgoing Trump administration might raise the sceptre of a renewed trade war with an emboldened China. But the NYSE's U-turn in its decision to delist 3 NYSE-listed Chinese telecom companies might mollify the dragon. Based on China's reaction to the Biden Administration so far - which ranged from muted to cautiously optimistic, I'd wager that there are so far no significant trade war-related headwinds coming in the near future.

MACROECONOMIC RISKS (INFERENCE)

	SOURCE & EXPECTATIONS	Dec-20	Nov-20	Oct-20	Sep-20	Aug-20	Jul-20
Inflation Rate YoY	Tradingeconomics // +1.10%		1.20%	1.20%	1.40%	1.30%	1.00%
Core Inflation Rate YoY	Tradingeconomics // +1.60%		1.60%	1.60%	1.70%	1.70%	1.60%
PCE Index YoY	Tradingeconomics // NA			1.20%	1.40%	1.18%	1.00%
Core PCE Index YoY	Tradingeconomics // NA			1.40%	1.50%	1.40%	1.30%
Inflation Expectations YoY	Tradingeconomics // N/A		2.96%	2.84%	2.98%	3.00%	2.90%
PPI YoY (Producer Price Changes)	Tradingeconomics // 0.80%		0.80%	0.50%	0.40%	-0.20%	-0.40%
Core PPI YoY	Tradingeconomics // 1.50%		1.40%	1.10%	1.20%	0.60%	0.30%
Nonfarm Payrolls	Tradingeconomics // 71,000	(140,000)	245,000	610,000	711,000	1,493,000	1,761,000
ADP Employment Change	Tradingeconomics // 88,000	(123,000)	307,000	404,000	754,000	482,000	216,000
Unemployment Rate	Tradingeconomics // 6.80%	6.70%	6.70%	6.90%	7.90%	8.40%	10.20%
Labor Force Participation Rate	Tradingeconomics // NA	61.50%	61.50%	61.70%	61.40%	61.70%	61.40%
Consumer Confidence Index (UoM)	Tradingeconomics // 76.50	81.40	76.90	81.80	80.40	74.10	72.50
Retail Sales YoY	Tradingeconomics // 5.90%		4.10%	5.50%	6.10%	3.60%	2.70%
Retail Sales Ex-Autos MoM	Tradingeconomics // +0.10%		-0.90%	-0.10%	1.40%	1.50%	1.60%
Building Permits	Tradingeconomics // 1550 K		1639	1544	1545	1476	1483
Housing Starts	Tradingeconomics // 1530 K		1547	1528	1437	1373	1487
New Home Sales	Tradingeconomics // 995 K		841	945	965	977	979
Existing Home Sales	Tradingeconomics // 6791 K		6690	6860	6570	5980	5860
ISM Manufacturing PMI (Bus. Conf.)	Tradingeconomics // 56.6	60.7	57.5	59.3	55.4	56.0	54.2
IHS Markit US Manufacturing PMI	Tradingeconomics // NA	57.1	56.7	53.4	-	53.1	50.9
ISM Non-Manufacturing PMI	Tradingeconomics // 54.6	57.2	55.9	56.6	57.8	56.9	58.1
IHS Markit US Services PMI	Tradingeconomics // 55.3	54.8	58.4	56.9	54.6	55.0	50.0
IHS Markit US Composite PMI	Tradingeconomics // 55.7	55.3	58.6	56.3	54.3	54.7	50.3
Industrial Production YoY	Tradingeconomics // NA		-5.50%	-5.00%	-6.30%	-6.50%	-6.60%
Manufacturing Production YoY	Tradingeconomics // NA		-3.70%	-3.50%	-5.10%	-5.80%	-6.60%
Capacity Utilization	Tradingeconomics // 72.90%		73.31%	73.01%	72.31%	72.34%	71.77%

Looking at labor, consumer, and business productivity data, we discern the overall sentiment on productivity:

Labor data is very worrying for the month of December, given the job cuts in the face of expected job creation. Whatever the reason, be it increasing covid infections or other reasons, this is a negative development for the US economy. ISM data is positive, while IHS data skews towards pessimism. New home sales and existing home sales, both of which missed expectations, could negatively impact building permits and housing starts, which in turn means lesser opportunities for the full spectrum of economic activities related to the housing sector.

Looking at price index and housing data, we discern the overall picture on the state of purchasing power:

The Nov data shows that besides the core PPI data, inflation is relatively healthy when compared to estimates. In fact, inflation measures hadn't changed much since Jul 2020. However, given that we are now in January of 2021, we really need the December 2020 numbers in order to update our macroview. The negative new home sales and existing home sales data shows slowing demand in housing, and could negatively impact the "reflation".

Looking at Treasury yields:

The entire term structure of the Treasury yield curve shifted upwards between Wk 51 of 2020 and Wk 01 of 2021, with the exception of the 3 months yield. The 10-year rates however, breached and closed above the 1.0% level for the first time in recent memory. The yield curve continues to steepen, heading into the second week of 2021.

As for the worrying yield curve shape of the shorter-term Treasury securities, I believe that the Fed purchases of Treasuries is the main cause of depressed Treasury yields, which had remained true until the day of this writing. 54.65% of Treasuries issued since March 2020 were bought by the Fed (TREAST/Total Treasury Securities), when the Fed first announced "QE Infinity" on 23 March 2020. With the entire term structure yields starting to tick up - except for for the 3 months Treasuries - this bodes well for a risk-on picture of market sentiment from a Treasury (safe market) perspective. The breakdown below:

• Total Treasury securities (tradingeconomics.com) = US$ 23.75 trillion in Mar 2020;
• Total Treasury securities (tradingeconomics.com) = US$ 27.478 trillion in Dec 2020;
• Total Treasury securities owned by the Fed alone (St Louis Fed ticker: TREAST) = US$2.64 trillion as at 18 Mar 2020;
• Total Treasury securities owned by the Fed alone (St Louis Fed ticker: TREAST) = US$4.70 trillion as at 07 Jan 2021.
• TREAST/Total Treasury Securities = 11.12% in Mar 2020;
• TREAST/Total Treasury Securities = 16.938% on 07 Jan 2021 (slightly down from 16.979% in Dec 2020), owing to the Fed's Treasury purchases as part of the stimulus efforts.

Looking at currencies and commodities price action:

With the safe haven / speculative metals - Gold and Silver - continuing their consolidation into the new year, and the industrial commodities - Copper, Zinc, and Light Sweet Crude Oil - exhibiting bullish breakout patterns (zinc is consolidating sideways) indicating a global ramping up of industrial activity. We can infer that global markets are in a risk-on mode.

The risk-on thesis is supported by the observations of the relative strength of the US Dollar value. The Dow Jones FXCM US Dollar Index consolidated and languished below its 200 week EMA since end of July 2020, and had made new lows since, owing to the relative strength of the EUR, JPY, AUD, and GBP. It could be that the world markets are optimistic again, and funds are seeking higher returns outside the "safe haven" of the US markets.

CONCLUSION

The immediate potential bearish catalyst is the bad jobs report on last Friday - potentially caused by spiking covid cases - which might motivate some knee-jerk selling in the market. Compounding this data will be the below expectations housing numbers. But over the more (relevant) long term, the perceived ease of further stimulus measures due to a Democorat-controlled government could provide a band-aid. More lasting measures like heavier vaccine rollout and actual stimulus disbursement might salve the wound. Fundamental indicators like bullish earnings estimates, foreign currency strength relative to the US dollar, rising industrial commodity demand, as well as tech and small cap leadership bodes well for the longer term buy-side argument. The gross overvaluation of the S&P 500 as shown by the various PE ratios indicate that should a sufficiently strong bearish catalyst comes calling, sufficient cash must be available to buy the dip. Until the fundamental strength of the bull is compromised, there is no need for a 100% downside hedge.