/perspectives/weekly-viewpoint/markets-rally-but-jump-in-sentiment-is-a-yellow-fl

Markets Rally but Jump in Sentiment is a Yellow Flag

The Dow Jones Industrial Average (Dow) added 2.03%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) gained 1.70%, the Standard & Poor’s 500® Index (S&P 500) finished up 1.71% and the NASDAQ Composite Index (NASDAQ) tacked on 1.65%.

August 25, 2014    |    By Mike Schwager

Performance for Week Ending 8/22/2014:

The Dow Jones Industrial Average (Dow) added 2.03%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) gained 1.70%, the Standard & Poor’s 500® Index (S&P 500) finished up 1.71% and the NASDAQ Composite Index (NASDAQ) tacked on 1.65%. Sector breadth was positive with 9 of the 10 S&P sector groups finishing higher. The Industrials sector (+2.31%) led the way higher followed by Financials (+2.30%) and Technology (+2.29%).

Index* Closing Price 8/22/2014 Percentage Change for Week Ending 8/22/2014 Year-to-Date Percentage Change Through 8/22/2014

Dow

17001.22

+2.03%

+2.56%

Wilshire 5000

20613.04

+1.70%

+7.06%

S&P 500

1988.40

+1.71%

+7.58%

NASDAQ

4538.55

+1.65%

+8.67%

*See below for Index Definitions
 

MARKET OBSERVATIONS: 8/18/2014-8/22/2014

The major market indices finished higher for a second straight week reflecting fading geopolitical concerns and growing signs the U.S. economy is gaining momentum. The much hyped presentation by Federal Reserve (Fed) Chair Janet Yellen in Jackson Hole, WY turned out to be a nonevent as Yellen generally steered clear of committing to any stance on the future direction of monetary policy.

While the recent move in the markets has been impressive, it has also occurred on relatively light volume, a potential sign that “buyer’s exhaustion” may be starting to set in.  Another sign the market may be ripe for a pause is the sharp uptick in investor sentiment.  According to the American Association of Individual Investors (AAII), the percent of investors who are bullish on the markets outlook jumped to 46.1%, the highest level this year.  Keep in mind that 4-weeks ago, sentiment was at a very depressed 29.6%. Sentiment tends to be contrarian in nature as investors tend to be the greediest (bullish) at/near market tops and the most fearful (bearish) at/near market bottoms.  The current bullish reading, while not at extreme levels yet, should still be viewed as a yellow caution flag.

The spring back in sentiment, in light of the recent market gains is not surprising; however it is occurring at a time when the CBOE Volatility Index (aka the fear index) is nearing its recent lows. The lack of fear and rising sentiment, suggest that investors may not be positioned for news flow that goes against the bullish grain. This in turn could result in investors heading for the exits in the case of an adverse event.  As boxer Mike Tyson once said “everyone has a plan until they get punched in the face.” While there are no obvious “haymakers” on the horizon, an escalation in geopolitical tensions, a “hawkish” tone out of the Fed and/or a setback on the economic front could all do the trick.

With that said, the broader narrative is still intact and the macro environment remains supportive of further gains over the remainder of the year. In other words, if the markets were to pullback, the weakness would be seen as a “pause to refresh” that likely sets the stage for the next leg higher. The U.S. economy looks poised to gather momentum over the next few quarters, the labor markets continue to recover, corporate earnings are likely to post solid gains both this year and next, inflationary pressure should remain muted, and monetary policy is expected to remain loose through most of 2015. In addition, corporate balance sheets are in very good shape, confidence among corporate CEO’s continues to improve and should result in a pickup in investment spending during the second half of the year.  In addition, the housing market should continue to benefit from a pickup in household formations as well as falling mortgage rates. On the valuation front, the S&P is selling at 15-times the 2015 consensus estimate; while not cheap, the market is certainly not ‘bubbly’ either. Stay tuned.

Data Wrap Up:
Last week’s batch of economic data continued to confirm that the U.S. economy remains on firm footing. On the manufacturing front, the Markit manufacturing PMI jumped to the highest level since April 2010 while a report from the Philadelphia Federal Reserve showed manufacturing activity in the greater-Philadelphia region surged during the month of August. Housing markets continued to rebound as existing home sale rose at a stronger than expected pace in July while housing starts surged by +15.7%. Meanwhile, building permits—which tend to be a leading indicator of future construction—rose by a solid +8.1%.  Initial jobless claims during the latest week fell 14K to 298K, slightly better than the 303K expected by economists The 4-week moving average—which helps smooth the week to week volatility—came in at 300.8K, just off the lowest level in over eight years.

The Week Ahead:
The week before the Labor Day holiday is typically one of the slowest of the year as many Wall Streeters head out to the sandy shores of the Hampton’s to close out the remaining days of summer. While attendance will likely be light, the economic calendar is relatively full. Economic reports of note include July new home sales, July durable goods orders, the June S&P Case-Shiller home price index, the August Conference Board consumer sentiment survey, the first revision to second-quarter GDP,  July pending home sale index, July personal income and spending, the August Chicago purchasing managers index and the University of Michigan’s August consumer sentiment survey. Earnings season continues to wind down with just a handful of S&P 500 members scheduled to report results.


Definitions

The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.

Wilshire 5000 Total Market IndexSM represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm’s headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.

Standard and Poor’s 500® Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.

American Association Of Individual Investors - AAII is a non-profit, membership-driven investor education organization. The American Association Of Individual Investors (AAII) was founded in 1978 by James Cloonan. The AAII's mission is to teach individuals to manage their own portfolios and to beat average S&P 500 returns, while taking on lower-than-average levels of risk. AAII also publishes the results of its weekly investor confidence surveys that are based on its members' feelings about where the stock market is headed.

VIX - CBOE Volatility Index - The ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge."

Indices do not include any expenses, fees, or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

Past performance is no guarantee of future results. Indices do not include any expenses, fees, or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

The individual companies mentioned in this piece were for informational purposes only and should not be viewed as recommendations.

The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes. This document contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Information in this report does not pertain to any investment product and is not a solicitation for any product. This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy.

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