Financial Thinking

Last week, the market was not kind to stocks. It may be nothing worse than trading closing positions before leaving on vacation, but it seems that people are more reluctant to own stocks. At the same time, interest rates rose, reflecting lower demand for bonds. It’s not a very fun time to be in the markets.

Only US stocks, large cap and small cap, have positive momentum, but it is declining after a negative week. Last week, I decided to sell my ETF of European stocks (XIN), since it was no longer working. Because no other asset class seems poised to rise, I instead bought an individual stock (MG) and I’m really glad about that.

It’s hard to get excited about the economic outlook. Interest rates remain low, debt remains high, governments seem intent on creating more debt and corporations seem hesitant to spend. At the same time, it’s been five years (just about) since the last market crash… which seem to happen every 4-7 years. It’s hard to imagine what could happen in the next year or two to improve the fortunes of stocks and, by extension, investors who “buy & hold” broad market indices (or mutual funds).

I was about to write that the last week wasn’t very good. Every investment type except US stocks appears to have dropped in price. But let’s be honest: the stock market was markedly higher two years ago, and the past two years haven’t been very good. But I remind myself that if the market always went up, we’d all look like geniuses all the time.

Stocks only maintain slightly better momentum than bonds. Given the time of year, the economic environment and the lack of momentum, it appears that the stock market is running out of steam. I will watch very closely, expecting to move out of stocks very soon.

As I mentioned, only US stocks (IWM, then SPY) appear to have positive momentum. Every other asset class has turned negative. Strangely, this includes stocks, bonds and gold. It might just be time to cash out for the summer, but I’m going to wait one more week.

Volatility has risen, with the VIX going from 13.99 to 16.30. This is not a predictor of anything, but it reflects fluctuations in the market. The TSX ended the week near where it began, but it bounced around in between. That is sometimes the result of nervousness. It appears that more people are trading stock, as reflected by increased volumes, however there is a buyer for every seller, so changes in volume don’t necessarily result in price movement.

Interest rates have continued to rise, resulting in losses for bondholders. By comparison, stocks appear attractive, even if they lost a little ground over the week. The point being that stocks don’t look very good, but there doesn’t appear to be anywhere better at the moment.

Further, this pause isn’t restricted to North American markets. The Brazilian, Chinese and now Hong Kong and emerging markets have all lost their positive momentum. Of the asset classes in my model, the European (XIN) and American (SPY, IWM) markets look the most attractive at the moment. But since even they are pulling back, it’s really difficult to say that it’s a good place to be. Cash might be just as good at the moment.

As they say: Sell in May and go away.

The stock market movement wasn’t anything to get excited about last week, although it was better than the weather here in Calgary. It was like one step forward, followed by one step back. Still, it did make some upward progress, and outpaced bonds where interest rates are rising (and prices are falling). There’s really very little to indicate that the market is poised for anything exciting over the coming few weeks.

Stocks continue to present better momentum compared to bonds, so a balanced portfolio would still do well to overweight equities. Looking more broadly at a variety of asset classes and markets, European stocks (XIN) continue to outpace the others (despite weakness last week). US stocks (SPY and IWM) both have even better momentum, but since they also fell over the past week, they didn’t tip the model in their favour.

When the market spends a long time going nowhere, as has been the case for the past four months, it becomes a stock picker’s game. I saw an article that referred to some research (I wish I could find it again) that showed that the majority of stock market returns come from a very small number of stocks. That is to say, most stocks go nowhere (slightly up or slightly down), while only a small number go way up (or way down). That’s why it’s so difficult to beat the market average, since the average is skewed by a very small number of stocks, and it’s easy to miss them if you don’t own everything. So when I say that it’s a stock picker’s game, I mean that it would be easy to outperform if you could tell in advance which stocks will lead. My momentum model seems to do that for individual stocks. I’ll review that on Wednesday.

The TSX is closed today for Victoria Day. But with uncooperative weather (in Calgary), I’m spending the day indoors. The stock market seemed to take a pause a couple weeks back, but the last four weeks have been positive. The past week saw interest rates rise and stocks pull further ahead of bonds. It’s clear that, for the present, the smart money is moving into stocks.

The big news last week was how very weak the inflation reading was. The economy has certainly not been surging and it looks as though spending has been slow. This makes it difficult for businesses to increase prices and pass along increased costs (if there are any), although the headlines blamed the low inflation on reduced gas prices. It’s Victoria Day, and just before the long weekend gas prices jumped to their “summer level.” I’m not calling the newspapers liars, I wouldn’t do that, but it seems ironic. I wonder who is experiencing lower gas prices?

As for my asset rotation model, European stocks continue to shine. I enjoy watching the price rise, and I’ll continue to own XIN over the coming week. Elsewhere, US stocks (especially IWM) surprised to the upside. That may be the next asset to own.

Stocks were higher two months ago, in March. For a couple weeks, it looked as though they might lose their momentum and begin to slide in earnest. There was a week or two where I was watching very closely. However, sentiment seems to have resolved positively, and the past month looks like a line “from the lower left to the upper right,” to steal a phrase from Dennis Gartman.

Over the past week, interest rates have risen, so bond values have fallen, which has been consistent over the past month. In comparison, stocks have better momentum. A portfolio that is divided between stocks and bonds should be overweight stocks at this point. Despite the market dictum “sell in May and go away,” it looks like stocks might do alright over the coming weeks. Or maybe it’s just the last two weeks of May.

Looking at the various asset classes that I follow in my asset rotation model, I see that European stocks (XIN) continue to outperform and maintain the best outlook. Hong Kong and American stocks remain virtually tied in second place, though fairly far behind European stocks. I’m still not sure why they’re performing so well, but looking in two of my accounts, I see +21% and +17% (over a three or four month period?) and I’m not complaining.

After a couple weeks of uncertainty, stocks have pushed ahead. They again show a clear advantage over bonds. Looking at the economy, interest rates and inflation remain subdued, which is generally supportive of economic growth. These are the conditions that help generate profits in business.

In turning my attention to the various asset classes in my rotation model, European stocks (XIN) maintain the lead. That pleases me, since I’ve owned it since February 1st. In the ensuing three months, it has risen in value almost 10%. By contrast, the TSX has fallen almost 2%. American stocks (SPY, IWM) also look attractive, followed by Hong Kong stocks (EWH).

The TSX group (Standard & Poors, a division of McGraw-Hill) has changed their website AGAIN, and no longer shows the average P/E of the TSX index. The result is that I haven’t yet found a way to calculate a fair market value. It was nice to see, but it didn’t inform my investment decisions anyway.

Last week I was concerned because stocks had lost momentum and been surpassed by bonds. The past week has been more favourable to stocks, and they now are showing equal momentum to bonds. When neither asset class has a clear advantage, it’s a time of uncertain outlook. Interest rates are low, inflation is low and economic news is not particularly optimistic. There’s an old stock market dictum that says, “Sell in May and go away.” If I had to guess, I’d say it seems likely to hold true again for this year.

Looking deeper, at the various assets in my asset rotation model, I see that European stocks (XIN) continue to dominate. In second place, for anyone investing in USD, is the S&P 500 (SPY). I continue to own XIN and remain very pleased with the performance.

Ewwwwww. The stock market has been volatile. It hasn’t been outrageous, as it would pending a crash, but it has been rocky. Gold has particularly negative momentum at the moment, small caps in Canada and the United States have turned negative and even emerging markets are looking down.

I’m not entirely sure why European stocks, followed by US large caps and real estate, have the best momentum. I wonder if some of the reason lies in the fact that the ETF is currency hedged, and perhaps the Euro is falling in value compared to the CDN$. Whatever the reason, I will continue to own XIN.

The momentum of Canadian stocks, compared to bonds, has turned negative. This could just be a momentary lapse, but bonds appear safer than stocks at the moment. This moment is a risky time and I will continue to watch the market movement very closely.

I’m somewhat reassured. A week ago, investor sentiment seemed to be teetering on the edge. The past week has been volatile, but only because the stock market rose before falling back to near where it began the week. That’s not the type of action I would expect from a market that’s beginning a multi-week decline. In fact, it appears that even though some nervous money was scared out of stocks, most investors have remained calm.

I am pretty annoyed, but not at the market. Rather, the TMX website has been reorganized again, and I can no longer find the average P/E or the average dividend yield of the market as a whole. I suspect that the company prefers people not have have this type of information (for free). I’ll get over it, though, since my fair market value estimate doesn’t really inform my investment decisions. Still, it was a nice barometer to have.

European stocks (XIN) are again leading the pack in momentum. IWM is not far behind, but the broader US market (SPY) has edged ahead. I’m not sure why the American markets are outperforming the Canadian market to this degree, but it probably makes up for years where the Canadian market led the way, benefitting from increasing commodity prices. Those days appear to have passed.