Making a Right Turn

Originally posted at

The S&P 500 is up 3.5% year-to-date.* Over the last three months, however, it is up 6.3%. Simply put, three months and a day ago, things didn't look as good as they appear to look now.

Lately, it seems as if the stock market does nothing but go up. Why that is the case is open for debate, yet one compelling factor seems to be that a lot of people have been expecting the stock market to go down or, at best, sideways. Accordingly, they have been "squeezed into the action" so to speak, fearful of missing out on the next up leg.

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There was a lot wrong with the stock market earlier in the year, and even though it has made a huge comeback, we can't say that everything is now right again. It isn't. There are things going on inside the stock market, however, that are forcing a careful re-think of our market view.

I plan to publish an updated market view next week.

This week I am going to highlight for readers a number of developments that have contributed to the stock market taking a right turn that has the S&P 500 at the intersection of a new all-time high.

Right On!

1) The S&P 500 Equal-Weighted Price Index has outperformed the S&P 500 Price Index

  • The S&P 500 is market-cap weighted, which means stocks with a larger market capitalization have an outsized influence on the performance of the price index. Apple (AAPL), which has the largest market capitalization of them all, is down 5.3% year-to-date and has acted as a major drag on the price index.
  • An equal-weighted index gives the same weight to each stock, so a 1% move in a stock with a $20 billion market capitalization counts the same as a 1% move in a stock with a $500 billion market capitalization.
  • It is constructive to see the S&P 500 Equal-Weighted Price Index outperform the S&P 500 Price Index because it reflects a broader base of participation in the move upward and lends more credibility to the rally effort

2) Small-cap and mid-cap stocks are outperforming the large-cap stocks

  • Over the last three months, the Russell 2000 and S&P Midcap 400 are up 11.0% and 10.1%, respectively
  • These stocks typically do well when market participants believe there is a constructive outlook for the US economy

3) Cyclical sectors are leading the rebound in the S&P 500

  • While all sectors have increased over the last three months, the strongest gains have been seen predominately in the cyclical sectors
  • The outperformance of the cyclical sectors corroborates the outperformance of the Russell 2000 and S&P Midcap 400
  • The outperformance of the cyclical sectors also reflects improved attitudes about the economic outlook and most likely reflects an effort by underinvested money managers to increase their exposure to these areas

4) Earnings estimate revisions are turning up

  • The earnings outlook for the S&P 500 this year still isn't great, but it is no longer getting worse—and that's important
  • According to S&P Capital IQ, second quarter earnings were expected to decline 4.6% as of June 9 versus a 5.0% decline expected on May 31. Calendar 2016 earnings are now expected to be up 0.33% versus up 0.11% as of May 31.
  • The trend here, if it can persist, is apt to resonate more than the actual level since it will help to temper rising valuation concerns in the face of declining earnings estimates; it also supports the market's underlying belief that earnings prospects are going to be better in the second half of the year

5) The dollar is weakening

  • A weaker dollar is a key development feeding the expectation for an improved earnings environment since it is helping to lift dollar-denominated commodity prices, bolstering the prospects for US exporters, and aiding the earnings growth potential for US multinationals
  • The weaker dollar reflects the market's belief that the Fed is going to be less divergent than previously thought with its monetary policy versus other major central banks

6) Interest rates remain low and have been grinding lower

  • Treasury yields have come down along with expectations for the timing of the Fed's next rate hike
  • Market rates aren't just low in the US. They are low—and even negative in some cases—in developed economies around the globe.
  • Japan's government bond yield is -0.14%; Germany's bund yield is just 0.04%; the yield on the French OAT is 0.40%; Spain's 10-yr yield is just 1.42%; and the 10-yr Treasury note yields 1.68%.
  • In real terms, sovereign bonds aren't measuring up as income generators and that is working to the advantage of stock markets as investors have been forced to seek higher returns elsewhere

7) Average hourly earnings growth is improving

  • Increased income growth is the key to increased consumer spending. It has been well documented that income growth has been weak in this recovery, which has certainly contributed to the weak recovery from the Great Recession.
  • With the May employment report, it was shown that average hourly earnings growth was up 2.5% year-over-year. That was in-line with the average for December through April and near the best levels seen since late-2009.
  • Higher wage growth and an increased feeling of job security should support stronger economic growth.

What It All Means

There are other factors that could be highlighted here. We simply wanted to capture a cadre of developments across the capital markets that have helped the stock market drive along the bullish road it has been driving in recent months.

The road out there still isn't smooth. Potholes can still be seen. I'm not going to spend time this week pointing out the potholes nor paving over them.

Those potholes will be as relevant in driving our updated market view as the right turns the stock market has been making of late will be.

The S&P 500 now sits at the intersection of an all-time high.

It's really a T-intersection and which way it now turns will depend a lot on what—or who—is doing the driving. Based on the noise from the backseat about interest rates, the economy, monetary policy, currency volatility, valuation, politics, and earnings, there isn't going to be a shortage of drivers either.

Be sure to check back next week to see how it all—the right turns and the wrong turns—factors into our updated market view.

*Returns through June 9

About the Author

Chief Market Analyst