The State of The Economy, Market Trends, Valuation, And Internals

Jan 23, 2024 | Economy & markets, Inflation, Investing, Investment Portfolios, Investments, Markets, Newsletter

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The State of The Economy, Market Trends, Valuation, And Internals

With financial markets undergoing volatility in the first two weeks of this year, it’s an opportune moment to examine the condition of the U.S. economy. We then will proceed to analyze current market trends and internals.

The US Economy

There has been an ongoing debate about whether the U.S. economy will enter a recession this year. Let’s begin by reviewing several key economic indicators.

Labor markets

The labor markets are surprisingly robust, with the unemployment rate standing at 3.7 as of December 2023—a notably low figure.

Consumer spending

Consumer spending or consumption is most accurately reflected through retail sales growth, and up to now, it has shown positive year-over-year growth.

Industrial output

Industrial production has demonstrated year-over-year growth.

Housing start

Nevertheless, housing starts have shown relative weakness, although they have not entered a consistent decline. The impact of high-interest rates is increasingly evident, and it is notably contributing to the weakening of the housing markets.

Inflation

Inflation has been on a downward trend. Specifically, in December 2023, the CORE CPI (Consumer Price Index Excluding Food and Energy) has exhibited a consistent decline. However, it’s worth noting that the overall CPI has experienced fluctuations in recent months, primarily influenced by the volatility in energy prices.

In summary, the current state of the economy appears relatively stable. However, markets usually focus on future economic growth, where the strength of the current economy might compel the Federal Reserve to extend high interest rates, potentially affecting economic growth adversely. Whether this will impede growth to the extent of pushing the economy into a recession remains uncertain. At present, we maintain a cautious stance.

Market trends and valuation

Currently, major asset price trends show a lack of uniformity. Upon examining the 360-degree market page, the following trends in major asset prices are shown on the 360-degree market page:

Major asset price trends as of 01/19/2024:

Description Symbol 1 Week 4 Weeks 52 Weeks Trend Score
US Stocks VTI 1.02% 1.23% 22.96% 9.72%
US Equity REITs VNQ -1.92% -2.63% 2.95% 4.37%
International Developed Stks VEA -1.66% -1.54% 7.98% 4.18%
US Credit Bonds IGIB -1.04% -0.77% 4.7% 3.47%
Treasury Bills SHV 0.07% 0.37% 6.03% 2.48%
Total US Bonds BND -1.08% -0.94% 1.82% 2.02%
Gold GLD -0.94% -1.23% 4.82% 1.63%
Emerging Market Stks VWO -1.93% -1.56% -3.36% -0.26%
Commodities DBC -0.54% -1.3% -3.55% -1.73%

Treasury Bills (considered the safest asset and categorized as Cash) exhibit higher trend scores compared to Total US Bonds, Gold, Emerging Market Stocks, and Commodities. The current market dynamics are predominantly influenced by factors such as economic growth and interest rates.

Upon closer examination of trend scores within major U.S. stock sectors, it is evident that the top-performing sectors include technology, consumer discretionary, and financial. These sectors are generally associated with a more risk-on mode from investors. The strong performance of these sectors typically serves as an indication during an economic expansion period.

Sector trend scores as of 01/19/2024

Description Symbol 1 Week 4 Weeks 52 Weeks Trend Score
Technology XLK 4.13% 4.23% 54.07% 19.89%
Consumer Discretionary XLY 0.53% -2.56% 27.16% 8.74%
Financial XLF 0.88% 1.58% 10.43% 8.42%
Industries XLI 0.3% -0.6% 16.25% 7.07%
Telecom IYZ 1.28% 2.63% 0.46% 4.62%
Healthcare XLV -0.75% 3.29% 6.36% 4.5%
Consumer Staples XLP -1.03% 1.17% 2.62% 1.77%
Materials XLB -1.46% -3.94% 2.16% 1.51%
Utilities XLU -3.7% -2.62% -8.11% -3.17%
Energy XLE -3.04% -5.66% -7.25% -5.55%

Valuation-wise, stock valuation remains excessively high. Specifically, the Shiller CAPE (Cyclical Adjusted Price Earnings ratio), calculated as the ratio of the current S&P 500 index price to the average of the past 10 years’ earnings (adjusted for inflation), has been at a level surpassing even the peak observed in 1929, just before the Great Depression.

We would like to emphasize that stock market valuations can remain elevated for an extended period. Relying on it as a primary factor for making intermediate-term allocation decisions may not be a good idea. Instead, one should view it as a confidence indicator. In other words, if the valuation stays significantly above its average, greater attention should be given to potential weaknesses in other indicators such as economic indicators and market trends. Conversely, if the Shiller CAPE is below the average, there may be more flexibility in tolerating weaknesses in other indicators.

Market Internals

To better understand the internals of the U.S. stocks, we compare the returns of the equal-weight S&P 500 ETF (RSP) and the S&P 500 cap-weight index SPY. The equal-weight ETF more accurately shows how the 500 stocks in the index have performed on average than SPY, which has been much more impacted by the several stocks with the largest capitalization.

We are indeed observing a considerably weaker performance of RSP in recent years, including year-to-date, the past one year, and the last three years. Once again, the bulk of returns for the S&P 500 (SPY) are originating from large stocks.

The second indicator we examine involves determining the percentage of stocks in the S&P 500 that are above their 200-day moving averages. A high percentage of these stocks indicates that most stocks are in an upward trend.

Presently, the SPXA200R, representing the percentage of stocks above their 200-day moving averages, is at a healthy level, standing at 71.8%.

From the above two indicators, we can deduce that a majority of stocks in the S&P 500 index are in upward trends, albeit with smaller market capitalization stocks exhibiting comparatively weaker upward trends.

The key takeaway from the above data is that, currently, the economy and financial markets appear to be relatively healthy. Nevertheless, it is crucial to monitor various economic indicators and the trajectory of interest rates. This can aid in better assessing the potential for a recession this year.

Market Overview

According to Factset, as of December 31, analysts anticipated a 1.6% year-over-year earnings growth rate for the S&P 500 in Q4 2023. However, by the end of last Friday, with 10% of S&P 500 companies reporting actual results, the blended (year-over-year) earnings decline for Q4 2023 stands at -1.7%. It’s important to note that we are still early in the earnings reporting season, and we will closely monitor the reports.

Despite an uneven performance, stocks staged a strong recovery in the past weeks. The sector trend table above indicates that half of the sectors had negative returns last week. Nevertheless, the substantial gain in the tech sector significantly lifted the S&P 500 index, reaching an all-time high at the close of last Friday.

As always, we claim no crystal ball and we call for staying the course which is guided by the well defined and sound strategic and tactical strategies:

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as we have emphasized numerous times when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years, preferably much longer, given the current high valuation. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later and preferably many more years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially during this time. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This is true time and time again.

Stock valuation has dropped, and now valuation is becoming less hostile. However, it is still not cheap by historical standards. For the moment, we believe it’s prudent to be extra cautious. However, how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of market is through dollar cost average (DCA), i.e., invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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