Quite a rally in the S&P

January 11, 2018 10:27 AM

We began last week by wishing everyone the obligatory Happy New Year. And as it turned out, it has already been very happy for the U.S. equities bulls. This is also true for their international counterparts, even if politically challenged Germany is lagging a bit. Yet the degree of leadership emanating from the United States remains very impressive, almost to the point of straining credulity if it were not an actual market where independent operators come together to "discover" the current values. It has indeed been a jaw-dropping rally, especially on the further acceleration into the beginning of this year.

And possibly for the first time in the lengthy rally from the 2009 lows there is a sense of euphoria. While we will discuss the issues that might bring below, for now it seems most folks are content to just marvel at the overall market progress since Trump’s election.

That is even true of many of his acolytes, and especially his detractors. The latter camp includes those who were convinced a Trump victory would result in the destruction of the U.S. equities rally. While some are still saying it is only a matter of time prior to the market waking up to some sort of ‘Trump trouble’ that will collapse the U.S. equities, that is not likely. Consider all of his peccadillos to date. None of even his more mindless and offensive proclamations or actions (like Charlottesville and firing FBI Director Comey) have created anything more than limited corrections in the inexorable equities rise.

Trump’s doing?

How much of this is fully Trump’s doing, versus other factors which are predisposing the United States (and global) equities and economies greater strength, is highly problematic. Yet, for the first time in more than a decade there is a coordinated global economic expansion underway. And regardless of his extensive encouragement since the promises made during his 2016 election campaign, the passage of U.S. tax reform remains more of a Congressional success than an isolated Trump action.

That said, Trump’s rollback of Obama executive order regulatory expansions has been an explicit and implicit benefit. In addition to specific lower costs associated with less regulation, there is a sense the "friend to business" Trump administration has replaced a hostile Obama administration. That includes guidelines to agencies along with specific regulatory rollback. This was already building confidence prior to market euphoria.


We will return to the specifics of the U.S. equities taking on a euphoric tone and the technical trend indications implications for its Evolutionary Trend View. In the meantime, there was a very insightful analysis from the Financial Times’ estimable John Authers in this past weekend’s FTWeekend Long View. His Signs of euphoria suggest equity bulls are on borrowed time included some longer-term cyclical views that are very useful perspective if not currently actionable market insight. 

And in the first instance, it is not like anyone necessarily needed third-party analysis to infer that the U.S. equities might be developing a euphoric psychology. The front-month S&P 500 future began its long climb after the 2008-2009 Crisis at the roughly 666 (they always say the devil is in the details) low in March 2009. After more than a 1,500 point climb into mid-2016 it would have been reasonable for the market to put in a cyclical top after a seven-year bull run.

Instead, it was reinvigorated by Donald Trump’s election and its promise of more pro-business policies. Even in that context the subsequent rally extension has been striking, gaining more than another 600 points so far. That includes the 76 point gain last week just since the beginning of the year. And that was in spite of last Friday’s weaker than expected U.S. Nonfarm Payrolls at just up 148,000 versus 180,000 or more expected. Even on the day, it managed to shake off that normally weak indication to rally 20 points.

The ‘higher retained earnings’ bubble?

Yet, as Authers points out in his assessment, the initial signs of euphoria setting in are never the precursor to an immediate major top. He also cites the respected market analyst Jeremy Grantham that “…the melt-up (seen in the acceleration since the tax cut plan was unveiled a few months ago) was only just beginning.”

This is very consistent with the market developments in previous euphoric phases. The 1997-2000 Dot.Com Bubble was obviously driven by initial public offering funding with not much sign of any business models that could sustain enduring higher profits. And the 2006-2208 Housing and Credit Bubble was equally based on the assumption that already elevated U.S. housing prices could never come back down. Yet while it was apparent to informed observers well ahead of any crisis in each case, the bubbles continued to develop, with higher equities prices, for a couple of years before the crunch.

Indeterminate future earnings strength

That is why we suspect the equities being driven by a strong, yet still indeterminate, sense of higher U.S. retained corporate earnings due to tax reform is entering at least a quasi-bubble phase. This is much as it was when U.S. housing prices were expected to increase forever, or on assumptions that the Dot.Com phenomenon was a ‘new era’.

It is a guessing game. Investors are expected to accept the idea of a major, yet still undetermined, increase in corporate profits means one cannot afford to miss the opportunity. And under those sorts of circumstances, it is easy to interpret even negative news as positive, like last Friday’s U.S. Nonfarm Payrolls number. In that case, it was likely due to the reinforcement it provided for last Wednesday’s somewhat more dovish than expected minutes from December’s FOMC meeting.

Note: For anyone who has never read it, we suggest George Soros’ 1987 The Alchemy of Finance. His explanation of his theory of market ‘reflexivity’ should have been a warning for all participants on the degree to which extended false assumptions can support extended trends to a degree that is not rational. It is disconcerting that both the Dot.Com and Housing and Credit Bubbles occurred after Soros had shared this telling insight.

‘Normal’ economic cycle not repealed

And in any event, across time market euphoria and extensive corporate confidence create the conditions for the end of the psychological bubble and equity market rally. Yet that is only after the extensive corporate capital investment drives better economic performance for a while (like expanded U.S. home building into 2007-2008.) In the longer run that creates a bit of over-investment due to the need to compete with also expansive competitors.

This leads to higher wages the Fed (and many others) have been longing for, and the higher general overheads with a lack of further income gains in the more aggressively competitive environment. That eventually leads to lower profits and weaker share prices. However, this is only across a multi-quarter (and possibly multi-year) cycle that allows the initial euphoric surge from the ‘reflexive’ assumptions on higher retained corporate earnings to support the equities for a good deal of time. There may also be pressure on the equities if the highly anticipated major surge in corporate profits fails to materialize. 

Key S&P 500 Trend Metrics

All of which gets us back to just how distended the S&P 500 Stock Index has become, using the front month future as our guide. In the first instance, we are using the weekly chart out of early 2016 up until last Friday’s U.S. close because it both illustrates the extent of the rally discussed above, and also lends itself to a clear weekly Oscillator indication discussion that is an important part of what to look for from here.

As our regular readers know, one of the ways we address the issue of the key price thresholds to monitor is by assessing how the current market activity compares to long-term underlying (or overhanging in the case of bear trends) momentum. Our long established views include a very simple Difference Oscillator comparing the current weekly close to the 41-week moving average (MA-41), and using the history of difference to ascertain the key differentials.

As to why MA-41, there are two answers. The first is that when we initially performed these studies on a diverse group of markets many years ago, some moving average differentials showed more obviously useful, consistent key thresholds. For the weekly data that was MA-41 for the major trend decision levels. Considering why that might be, we also note that for the daily data it was MA-60.

Both of those seemed to make philosophical sense as well regarding some of the standard measures analysts tend to utilize. The 60-day moving average is also roughly the same as comparing the current market value to the average daily Close of the past calendar quarter. And weekly MA-41 relates back to the widely observed 200-day moving average translated into weekly form. It all seemed to fit, and they have been reinforced by the success of those Oscillator levels in each case across the ensuing decades.

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About the Author

Alan Rohrbach is Lead Analyst and President of Rohr International, Inc.  He is an international equity index, interest rate and foreign exchange trend advisor. His forte is ‘macro-technical’ analysis of how fundamental influences blend with technical aspects to drive trend psychology. Clients include international banks, hedge funds, other portfolio managers and individual traders.