Weekly S&P 500 ChartStorm – Underappreciated Upside Risk

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Those that follow my personal account on Twitter will be familiar with my weekly S&P 500 #ChartStorm in which I pick out 10 charts on the S&P 500 to tweet. Typically I’ll pick a couple of themes to explore with the charts, but sometimes it’s just a selection of charts that will add to your perspective and help inform your own view – whether its bearish, bullish, or something else!

The purpose of this note is to add some extra context and color. It’s worth noting that the aim of the #ChartStorm isn’t necessarily to arrive at a certain view but to highlight charts and themes worth paying attention to. But inevitably if you keep an eye on the charts they tend to help tell the story, as you will see below.

So here’s another S&P 500 #ChartStorm write-up!!

1. About 69% of companies are set to report Q3 earnings over the next two weeks. @LarryAdamsRJ kicks us off with a timely view of earnings season. This week and next carry the bulk of third quarter results from S&P 500 companies. Last week, several big name Financials revealed decent Q3 operations, but now the market turns its eyes to other sectors to get a gauge on just how well corporate America coped with continued economic trouble as a result of COVID-19. The $600 federal unemployment benefitted ended on July 31, so that deadline was thought to have hampered consumer spending.

Nevertheless, the US reported record retail sales last week – which should bode well for the Q3 reporting season. FactSet notes that the S&P 500 is expected to report an earnings decline of 20.5% for the third quarter which would be the second largest year-on-year earnings fall since Q2 2009.

S&P 500 earnings fell more than 30% during the second quarter, but the beat rate was actually the best in the last 20 years. While it was a dreadful economic and business environment, firms were able to top expectations on revenue and earnings (or at least limit net losses). Partly as a result of the strong beat rate, Q3 EPS expectations have been on the rise versus initial estimates during the summer. Looking ahead, the big tech names report later this month with Microsoft’s earnings date being October 28. Apple and Google report October 29. Amazon reports this week on Thursday.

Bottom line: Q2 2020 was dreadful when it came to S&P 500 earnings, but it was much ‘less bad’ than analysts thought. Earnings revisions have been strong for the Q3 reporting season, and now it’s time for corporate American to show its cards. The American consumer has been very resilient, so expectations are likely higher this season than last. Expect volatility.

2. Hulbert Sentiment: sharp gyrations from Sep to Oct. Worth noting that sentiment is better for picking bottoms than tops, but fair to say risk is elevated when indicators move like this. @JesseFelder brings us this chart of sentiment and the DJIA. The Hulbert Newsletter Sentiment Index shows that the average recommended stock market exposure among short-term market timers has climbed to its highest reading since early 2020. The red line surged from falling below zero in mid-late September.

Despite risks that lie ahead like earning season, stimulus uncertainty, and the election, recommended equity exposure is very high. Perhaps seasonality of the market plays a role here – stocks tend to perform well from mid-October through year-end. This time last year, the index was softer in the 40-50% range. Equities rallied impressively in the last few weeks, though gains were largely consolidated last week.

The S&P climbed more than 7% off its September lows, allowing many investors to feel better about dipping their toes back in with any cash on the sidelines. Volatility also eased back into the mid 20s on the VIX. Bulls should always take caution when market timers turn sharply bullish, however. Stocks were not far from short-term peaks earlier this year when the Hulbert index rose above 60%. Now here we are at 75%

Bottom line: The September swoon in stocks was rather quick and orderly. The S&P 500 fell into correction territory only very briefly on an intraday basis. A late-month rebound eased fears that the markets would fall hard into the election, and it has been a solid first half of October, too. Sentiment almost always follows price action, and now there may be just too many bulls roaming around at the moment.

3. Speculative futures positioning has gone from net-short to net-long, not extreme by any means, but certainly a significant turnaround. Continuing the theme, we pulled the chart of total US stock index speculative futures positioning from our vast library of macro views on Topdowncharts.com. Like the Hulbert Index earlier, the red line went from below the 0% mark to back above – indicating a move from net short to net long positioning among spec futures traders. Interestingly, the net aggregate position has not swayed to extremes during 2020 despite high S&P 500 volatility.

In previous years, net open interest would peak near +10% and fall to nearly -10%, but the range has been muted this year on a relative basis. The break above the 0 line recently indicates that there is less fear today versus a month ago – it’s been an impressive reversal in market sentiment over a short period. Our own Twitter sentiment poll last week showed the same bullish reversal. Once again though, sentiment indicators are often used as contrarian signals. It will be fascinating to view these charts a month from now.

Bottom line: Investor sentiment has improved markedly from its nadir last month. September is often a time for the bears to shine and for volatility to spike. And we were witness to that, but it’s been hard to keep stocks down for long since the March low.

4. Sign of things to come? Simply clearing the event risk off the table by getting the election over and done with could itself be a key upside catalyst for equities. @Saburgs shows us a neat chart of equity flows before and following the US presidential election (via Goldman Sachs Global Investment Research). To explain the chart, we are looking at the 12 months before and 12 months after the election on the x-axis and fund flows as a percent of AUM as of November of the pre-election year on the y-axis. 2020 has followed the analog nicely – so far. Equity fund flows have been on the decline (a trend that has been in place for a while now).

The question is, “does money pour into the stock market after November 3, 2020?” We’ll just have to wait and see, but history suggests confidence should build and uncertainty should ease once we find out who will be POTUS come January of next year.

A caveat to the chart & data is that we only have 5 instances to learn from since 2000.. not exactly a vast data set. The elephant in the room from a political standpoint is the expectation among many investors and fund managers that the election will be contested. The latest Bank of America Global Fund Manager Survey showed that more than 60% of those surveyed expect the US election outcome to be contested – the group also felt that was the biggest risk to equities.

Bottom line: Anyone can speculate on the election outcome and the stock market’s reaction to it, but recent history suggests money should return to equity funds following election day 2020. Equity flows have been negative since November last year, much like the five election year analog composite, but a rebound could be in the offing.

5. Will history repeat? Let’s take a broader view of equity fund flows. We also highlighted (appropriately in orange) the 2016 election – which happens to demarcate the turn in flows. Taking a trip back in time 4 years, stocks were struggling to break free from the global bear market of 2014-2016. The commodity crash left energy and materials stocks in shambles while commodity-driven economies suffered weak growth (with many countries enduring a recession). The US held up relatively fine from an economic point of view, though the S&P 500 was sideways from early 2015 through October 2016.

The bright side was that stocks had rather clearly bottomed in January and February of 2016, so it was a nice rebound for much of that year. Still, equity fund flows were decidedly negative from mid-2015 to election day 2016. Perhaps investors grew nervous as to how the markets would perform under either a Trump or Clinton administration. And earlier in 2016, there were thoughts that Bernie Sanders could have become the 45th POTUS.

Election day came & went, and optimism regarding tax cuts & deregulation sent stocks higher, allowing confidence to return to Wall Street. Equity fund flows increased through 2017 with the passage of the Tax Cuts and Jobs Act. But that was the top for flows. Money has been leaving equity funds for nearly 3 straight years now. The global pandemic in 2020 did not help assuage existing election fears this year either.

Bottom line: Will history repeat? Once we know the outcome of the election in about two weeks, does uncertainty leave the room, allowing investors to pour money back into equity funds? Check back with us later this year for the latest data points.

6. Also got seasonality in the mix… Halloween effect and Santa Claus rally and all that

On the side of the bulls is seasonality. We talked about bearish seasonal trends throughout Q3 as we approached the often turbulent month of September. Stocks fell, then rebounded as outlined above.

Now Q4 is upon us – a bullish time of year no matter how you slice it. Since 1990, the S&P 500 has climbed about 5% on average from early October through year-end. Back out the craziness of 2007-2009, and it’s still a similar build. Other studies of history suggest the pattern holds across longer time frames, too. While seasonality is secondary to price-action, this time of year is perhaps the strongest signal.

Bottom line: The bulls may be in charge right now. Bears got what they were looking for in September with a 10.6% intraday peak to trough decline, but equities have since rallied 8.6% from the September 24 low. Look for a break above the all-time high of 3588 for a confirmation that an uptrend is in place.

7. Tend to see positive seasonality in investor sentiment and economic surprises in Q4 also The final quarter of the year brings with it a renewed hope. Investor confidence usually climbs during the October through December timeframe along with a rising Economic Surprise Index. The AAII Investor Sentiment Survey is currently just below zero in bulls minus bears (34.8% to 35.7%) despite the recent rise in stocks from the September low.

If history is a guide, investors should grow more optimistic through the holidays with the net bulls-bears reading rising to between 10-20%. The mood of investors usually grows more jolly as Q4 plays out. Interestingly, AAII reported that pessimism fell to an eight-month low in the latest report, but remained above its historical average.

The Citi Economic Surprise Index is off the highs from earlier this year. But those highs were in the stratosphere given extreme volatility in economic data points. The index hit an all-time high in June (of course, it about matched its all-time low during March). Averaging out history though, data tends to come in better than expectations during the last few months of a given year.

Bottom line: Sentiment improves and economic data usually verifies better than estimates during the final quarter of the year, helping to boost stock prices. Will this year match history? It seems we have a lot on our plate with uncertain stimulus talks and a second wave of COVID-19 sweeping across Europe and the States.

8. S&P500 Dividend Yield @topdowncharts provides this chart of the S&P 500 dividend yield since 1990 – it has dropped to its lowest level since the early 2000s. Often used as a quasi-valuation metric, when the dividend yield drops to low levels, it could suggest an over-valued stock market. Take a look at recent pops on the chart. March 2009 featured a very brief 3.5% yield while the Q4 2018 correction and the 2020 COVID crash featured a 2.5% yield. Today, it sits just above a paltry 1.5%.

On a relative basis though, the S&P 500’s dividend yield is about twice that of the US 10-year Treasury’s current interest rate. Not apples-to-apples at all, but everything is relative in the investment world. The US equity landscape has shifted over the years from income-oriented value stocks like banks and energy firms to more forward-looking growth companies in the tech and health care spaces that reinvest in their businesses instead of paying out cash flow to shareholders. The duration of the stock market is naturally much higher than it used to be, so the trend of lower interest rates has certainly been a tailwind for the US stock market this year.

Bottom line: A chart tells a thousand words. The historical dividend yield of the S&P 500 indicates so many trends we have described this year across various financial markets. Will history mean-revert to a higher dividend yield for stocks, or is the current regime of low yields and buybacks here to stay?

9. Meanwhile, dividend futures market pricing that dividends won’t recover to pre-corona levels until 2027. @davidmoadel continues the dividend payout theme with this Bloomberg charts displaying a rather troubling expectation (if you are a dividend-focused investor). The futures market believes the nominal amount of aggregate dividends paid by S&P 500 companies will not surpass the 2019 all-time high until 2027.

Put this chart on a wall as one that indicates just how hard some areas of the stock market got hit during the COVID crash. Tech and growth firms have largely faired fine this year while industries that usually pay high dividends have gotten smoked. The recovery for those hit hardest will be measured in years, not months.

Looking internally, many consumer discretionary firms, energy stocks, and banks were forced to cut or suspend dividends over the last seven months to shore up capital to remain solvent. Sure, stalwarts like Proctor & Gamble and Johnson & Johnson have kept up their payouts, but less dominant firms are still in rough shape. From a historical perspective, it took just 4 years for S&P 500 dividends to climb above the 2007-2008 peak following the GFC.

Bottom line: It is a new era for dividend investors. High yield stocks were led to the slaughterhouse earlier this year. Many such firms were forced to drastically reduce their dividend payout rate at a time when their equity prices had fallen hard, too. The futures market doesn’t expect a full dividend recovery for many years.

10. Duh, because everyone knows it’s easier for a $1 stock to go to $2 than a $100 stock to go to $200. @GravitasMSN brings us home with a telling graphic of how speculative today’s stock market is. 2020 will be known for many things, and one will undoubtedly be how Robinhood came to prominence. The free trading app is having its day in the sun as federal stimulus, unemployment and social media exacerbate the itch to trade.

People have been sitting around with nothing to do, with a little extra cash in the bank, and wanting to impress their Instagram friends. Of course, there’s no better way to make a quick killing in the stock market than to day-trade low-priced stocks.

More than half of all Robinhood accounts hold at least one sub-$5 stock – which is impressive given how the average share price has been sharply on the rise in recent years. Why trade Amazon when you can buy & sell Hertz?? The chart is also illustrative of the makeup of investors by brokerage firms. More long-term investors are found at Schwab and Fidelity.

Bottom line: 2020 has been a year of volatility and speculation all at once. Usually, bear markets and a high VIX scare away speculators, but 2020 is not your usual year. Everyone is waiting for that moment when these inexperienced traders get what is coming to them, but they keep on trading & swiping.

So where does all this leave us?

1. Earnings season and positioning.

Q3 reporting season is underway. The market is coming off a very interesting Q2 earnings period that was horrendous from a y/y EPS change perspective, but it was also fantastic relative to Wall Street’s expectations. The Q2 beat rate was the best on record at more than 80% and aggregate earnings came in more than 20% above the consensus expectation from before the reporting period began. Of course, much of the gain was driven by the biggest companies. What will Q3 bring? Expectations have been on the rise over the last few months, so the bar has been raised for S&P 500 firms. Banks kicked things off last week, and results were solid for the most part. This week and next feature the bulk of S&P 500 firms reporting and will showcase some of the biggest market cap names. Reporting season comes at a time when money has been exiting equity funds. In terms of short-term sentiment in newsletters, recommendations are quite bullish (but that is a contrarian indicator usually). Futures traders have also flipped back positive in terms of net positioning. We’ll see how all of these stats shake out a month from now.

2. Seasonality and the election.

Q4 is often when the bulls dominate Wall Street. Despite uncertainty around earnings season, stimulus talks, the election, and a second wave of COVID-19, history suggests it’s a good time to put money into the S&P 500 if you have a short time horizon. We have already seen the S&P rally more than 8% from its September 24 low, however. The next three weeks will be particularly interesting with the US Presidential Election on our doorstep. Money usually exits in advance of elections, but then returns after as investors grow more confident post-election. Investor sentiment and economic surprises to the upside are usually on the rise this time of year, too. All of this rosy talk feels inappropriate this year considering the macro environment, but maybe that wall of worry is just what the bulls need to take the S&P 500 to new all-time highs.

3. Dividends and trading trends.

The S&P 500 dividend yield has nearly fallen to its lowest level in 20 years. High-yielders were beaten down in February & March, and those stocks have failed to recover in aggregate. The futures market doesn’t expect a new high in nominal dividends paid to investors for many years to come – that’s indicative of just how nasty the COVID crash was to value stocks. Growth equities focused in Information Technology and Health Care tend to pay lower dividends. Another feature of the current market is the rise of the Robinhood trader. Gen Z and Millennials keep buying and selling on a whim – and they seem to love their low-priced names. 2020 has brought us interesting times.

Summary

The S&P 500 was about flat last week as gains from the late September low were consolidated. There is ample day-to-day volatility with several apparent risks we outlined above. Will history repeat? (and will it be 2000 or 2016?) Will positive seasonality kick in? Will stimulus save the day? Will there be a contested election? There are many known unknowns ahead of us right now, but on the bright side, I see just as much, if not more, upside risks as there are downside risks. For now, all we can do is focus on what we can know, and this week’s set of charts provided a little more visibility on some key issues.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.