March markets were like a rollercoaster…
And if you don’t like rollercoasters, the month of March was not much fun for you. In fact, the whole first quarter of the year wasn’t a lot of fun if you don’t enjoy ups and downs in the market. There’s not many who do.
We finished the quarter on a positive note. As of today, April 2nd, 2018, it was a bad day in the markets. We had losses ranging from 1.75% – 2.0% depending upon the index that you looked at, and every major index (with the exception of the NASDAQ) is now in negative territory for the year and all well off their highs in January. Additionally, the NASDAQ is flirting with negative territory for the year for what we saw happening in the market today.
So, we’re going to take a deep dive into not just the indices and what they’re doing, we’re also going to review what the interest rates are doing, what’s causing market volatility, and valuations.
Let’s look at what’s happened recently in the major indices. Above is a year-to-date chart that’s looking at the Dow Jones Industrial Average, which is negative by 2.36%. This chart does not include the first trading day of April which was down another 1.75 percent. Combined that puts us down around negative 4.0% year-to-date. The S&P 500 was down 1.39% year-to-date, and the NASDAQ Composite (through the end of March) was the only major index in positive territory for the year. Today, the NASDAQ was off nearly 2% so that will put it flirting with negative territory on the year.
You can see by the chart above that we had some really nice gains, up in the 7% range in both S&P 500 and Russell 3000, and we had the Russell 2000 peak out.
If we add in the NASDAQ (See chart above), you can see that it had some pretty high peaks earlier in the year, up nearly 12% through early February. You can also see that the NASDAQ has been all over the place with volatility and even leaked into negative territory in late January. This just goes to show you that there really hasn’t been anything in the broad markets that hasn’t been affected by the market volatility.
Let’s take a look at just the last month. The NASDAQ wound up being the lowest performer for the month of March, off 3.5% for the month, and the S&P 500 comes in down 2.2% on the month. The only positive index was the Small Cap Index which was positive by .25%, and if you look at it on a year-to-date basis, (previous chart) it is down by .01%. So, you’ll see that the second-best performer was a negative number.
From an economic perspective, real estate looks really positive. Interest rates are still low, they peaked out, but they’re on their way down again. Wages are increasing, taxes are going down, and the overall health of the economy is strong. If it wasn’t strong I might believe that we were in the beginning stages of a Bear Market. The reason I might say that is because this Bull Market is the second longest Bull Market in history and valuations are really through the roof.
Before we discuss the valuations, let’s take a look at interest rates. Below is a look at the 10 Year Treasury and as of the end of March, it is yielding 2.73%. It did leak up a bit in March but have since come back down. If you look back a year ago, it was 2.35%. So compared to today, we are higher by about 0.4%. What’s crucial in this chart is what’s called, “The Flattening of the Yield Curve.” If you notice the blue line, that is the yield curve from a year ago. You’ll see that it goes from the one-month treasury at .73% and up to 2.98% on the 30-year treasury. If you look at it today, the one-month has jumped to 1.68% but the 30-year has not moved. This is a steep yield curve. Typically when we see this, it is a sign that the markets don’t necessarily buy into a longer term economic growth and if we ever get a yield curve that’s inverted where the short term yields are higher than the long term yields, then that’s typically a sign of an impending recession.
We don’t think the yield curve is inverted anytime in the near future. However, I did mention back in 2005 that I thought this 10 Year Treasury would finish this decade somewhere between 2.5 – 3.0%. I still think that there’s a really strong possibility that it stays in that 2.5 – 3.0% range.
Even though, we’re going to see the Fed raise rates. They are raising rates because the economy is doing well. Therein lies the dilemma for the stock market. Equity valuations are so far overblown right now but they are supported by ultra-low interest rates. As those interest rates rise you will see pressure on stocks. So even the “talk” of wage inflation starts causing us to want to pull out of the market and creates panic.
Let’s take a look at valuations and what some of our concerns may be surrounding those. The first valuation we’re going to look at is Crestmont. We’re running all the way back to 1870 and you’ll see two pieces to this chart. The top part is the S&P 500, the red line is the regression and the gray line is the S&P 500 and you can see that when it rises above the regression that it eventually comes back down to it. I’d like to point out that the price to earnings ratio on the Crestmont PE back in 1929 was 26.4%. During the dot-com bubble we were at 33.8% and just before the great recession we were at 24.7%.
Where we are today is very close to where we were just before the dot-com bubble. There’s no way you can look at this chart and not come to the same conclusion that we’re coming to right now which is that equity valuations are at the higher end of long-term norms and when they get this high, they typically come back down. They come down in one of two ways, either the stock price comes down or the earnings accelerate rapidly. Now, the good news is that the earnings on the S&P 500 are projected to grow somewhere around 15-20% this year, but these are based on forward-looking earnings. If those earnings happen to disappoint us that could mean more trouble for the stock market ahead.
Let’s now look at a different way to look at the Price Earnings Ratio. This view comes from Shiller’s Price Earnings Ratio, but he comes to almost the same conclusion as the Crestmont PE. You can see it from the regression here and from the price to earnings ratio here at 31%. Now it did peak out at 44% at the dot-com bubble. We were down here roughly at 26-27% just before the Great Recession. We are sitting at 31.7% today. Back before the Great Depression in 1929, we were at 32.6%. So once again, it’s just a second method of valuing stocks that show us that equity valuations are high. It’s been a slow and tedious ride up. We don’t want to take volatility and panic over volatility, but any time that we start seeing days in the market where we have huge upswings and huge downswings, that is a time for caution.
We have three indicators that we watch on a regular basis. In fact, we watch it daily. We also have a short-term indicator that tells us what the overall health of the market will look like in the next few weeks and months. We also have a quarterly trend indicator that tells us what the health of the markets are over the next quarter and then we have a long-term indicator that tells us the health of the markets over the next year.
Our long-term trend indicator is the only one of those three which is currently positive and that puts us in a neutral mindset saying that we need to think about things in a more cautious factor. It doesn’t necessarily mean that the next bear market is around the corner but I can tell you that over the last two decades there are have been four occasions where all three of those indicators turned red or negative at the same time and two of those were the great recession and the dot-com bubble. They caught those very early on and we don’t currently have all three of those in the red and that may tell us we have a little bit more potential and that’s a positive sign.
One last thing I’d like to mention is that when we look at the year-to-date charts of the different indices, you can see in the chart above that the Dow Jones Industrial Average has five stocks that are showing Bear territory. We have 24 of the Dow stocks that are showing neutral and zero that are showing bullish. When you look down at the S&P 500, 39 of them are bullish, 341 are neutral, and 113 have turned bearish. You can kind of see how the bearish number of stocks outweigh the bullish stocks. Of course, this can change next week or next month.
No one has a crystal ball and nobody can predict the future. What I can tell you now is this: we pay attention to every bit of this data on a daily basis. We look at our clients’ portfolios as they’re designed for their personal situations. By no means is this monthly commentary meant to give you investment advice as we always encourage you to sit down with your advisor to talk about your portfolio, all of the options they have for you, and how they can help you position your portfolio to weather the volatility and potential downturns that could be ahead.
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The views expressed represent the opinion of Barber Financial Group an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Barber Financial Group does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.