Is the Rally Running Out of Gas? (4 Reasons)

The problem with macro research is that most of it isn’t actionable.

A lot of the macro research I read tells me obscure things about foreign central banks and complicated economic reports, but it doesn’t answer the question of:

“What Do I Do Now?”

And, in the money management business, that’s really the only question you need answered.

Case in point, look at the markets right now:

  • Two months ago the S&P 500 was down nearly 10% YTD and there was legitimate concern it could get worse.
  • Now, the S&P 500 is up 1% YTD, and it seems like money managers are much more worried about missing a year-end-rally than they are locking in gains and ensuring a modestly positive year.

So, it’s completely normal that even experienced money managers are feeling confused and wondering “What Do I Do Now?”

The Sevens Report was created because actionable macro analysis can answer that question and help advisors and investors:

  • Be more knowledgeable about the markets and in turn impress current clients and prospects
  • Identify tactical opportunities than can help them outperform.

And, despite being in business just under 4 years, thousands of financial advisors, both at wire houses and independent firms, now use our fundamentals based, independent macro research to save research time, stay focused on what’s really moving markets, help their clients outperform and get more AUM!

Back to the question at hand:  “What do I do now?

We told our paid subscribers Monday morning we think now is a time to get defensive in stock portfolio allocations and move towards lower volatility names and sectors, because the fundamentals don’t support this rally. 

And, as always, we explained the reasoning behind that call so our paid subscribers could decide, on their own, whether they agree.

We’ve included an excerpt of that research below, which was sent to subscribers Monday morning at 7 AM.

4 Reasons We Think This Rally is Almost Out of Gas (Sevens Report Excerpt)

Stocks surged in October (the S&P 500 was up nearly 8% for the month), but despite erasing the entire August/September swoon, we remain broadly cautious on stocks and think near-term risks are to the downside. The move higher in October was very impressive, and while much of it was the result of underinvested managers having to add long exposure after dumping it in late August and September (thereby chasing stocks higher), there were real, positive fundamental improvements.

First, China stabilized, and fears of a true hard landing have (for now) been dialed back. Second, the market was reminded that globally the world’s central banks remain very accommodative: The PBOC cut rates in October and the ECB strongly hinted at more QE in December. Even the Riksbank (Sweden’s central bank) increased its QE program late last week.

But, these fundamental improvements are already priced into stocks at these levels, and as a result it is hard to find a positive catalyst to move markets materially higher.

Reason #1:  The rally has occurred thanks mostly to positioning and “chasing” and that’s largely over. 

The 11% rally in the S&P 500 has been driven by short term positioning (investors were too bearish at the end of September), and experience has taught us not to buy positioning driven rallies.

Part of the reason we know this is because of which groups have outperformed:  Up until this week the sectors that have outperformed were 1) Energy and 2) Basic Materials, which would have been the beneficiaries of the most amount of short covering.

Also, with the exception of those “China related” sectors, other cyclicals have lagged during this rebound, with the Russell 2000 significantly underperforming the S&P 500.  That implies the buying has been broad and generalized, not targeted, which is anecdotal of money managers just “slapping on” long exposure.

These are not the internal signs of a sustainable rally.

Reason #2:  The Central Bank Tailwind is Exhausted in the Near Term

  • The Chinese Central Bank rate-cutting cycle is likely over for the rest of 2016 and already priced in.
  • ECB QE, which we have been alerting subscribers to since early October, is also basically priced in following the recent ECB meeting.
  • The Bank of Japan chose not to do more QE last Friday and as a result that’s off the table until 2016.
  • The Fed is now more likely to raise rates in December, and in the short term that could prove to be a headwind on stocks.

Bottom line, central bank accommodation was a big part of the October rally, but that’s over and already priced into stocks at these levels.

Reason #3:  Market Valuation is NOT Cheap (it’s actually close to expensive). 

Third quarter earnings are coming in not as bad as feared, and that’s helped stocks over the past two weeks.

But, as we’ve been telling our paid subscribers for over two months now, full year S&P 500 EPS need to be over $125/share to support stocks at these levels, and that’s not happening. 

We are hearing 2016 full-year EPS is shifting to somewhere between $123-$125, which puts the S&P 500 at 17X current year earnings, a high multiple for this environment.

If you are buying the broad market up here, you are buying a relatively “expensive” market – plain and simple.

Reason #4:  Stocks Are Above Pre-August Levels but Fundamentals Are Actually Worse

  • Most US economic data has gotten worse since August including:  Jobs Data, Durable Goods, ISM Manufacturing PMIs, Retail Sales.
  • Corporate Earnings have declined and expected 2016 FY EPS have dropped from around $130 in August to the $123-$125 level.
  • The fear of a Chinese economic collapse has subsided, but that’s already priced into stocks and the absolute state of the global economy has gotten worse since August.

All of our analysis has actionable takeaways, so in the paid edition of the Sevens Report we provide a “Near Term Stock Market Outlook” where we give our opinion on the outlook for markets over the next 1-3 months.

Monday we shifted that outlook from “Neutral” to “Defensive” and provided a broad asset allocation using liquid ETFs that we think can:  1) Protect against downside volatility in stocks while 2) Still having positive upside exposure to the market should stocks continue this momentum rally. 

Helping advisors turn macro analysis into actionable strategies for their clients is an important part of what we do, and it’s one of the reasons our retention rate is over 90%.

We provide our subscribers with:  1) Daily macro analysis, 2) Suggested asset allocation profiles and 3) Tactical investment strategies that can outperform markets, all for less than one client lunch per month.

Click this link to start your quarterly subscription and receive the market intelligence you need to finish 2015 strong. 

We Make Macro Research Actionable

We watch stocks, bonds, commodities, currencies and important economic data each and every trading day because doing that research allows us to identify fundamentals driven, tactical investment opportunities that have helped our subscribers outperform the market.

We focus on “medium term” strategies that provide opportunities over a 1-3 month period and beyond (our longest tenured tactical idea, “Long Japan” is now a 3 year old trade and has been massively profitable).

Over the past few weeks our fundamentals based research has produced market beating results:

More ECB QE Leads to Our Favorite Europe ETF Outperforming

  • In early October we alerted subscribers that due to low European inflation data and slowing incremental growth, the prospects for more ECB QE in December were rising.  We again alerted them to our favorite Europe ETFs as a strong tactical play.
  • Since early October that ETF has risen 12.4%, handily outperforming the S&P 500.

Strong Fundamentals in Banks Resulted in an Undervalued Opportunity

  • Two weeks ago, as bank earnings were on going, we provided subscribers with four reasons we though banks could outperform:  1) Strong Fundamentals (earnings were good), 2) Relative Value to the Market (banks had underperformed thanks to low rates) and 3) Additional Upside potential with little additional risk (low rates were already priced into banks and they couldn’t get much lower, so that represented a potential tailwind that turned out to come true).
  • Since then, our preferred bank ETF has rallied 7.3%, outperforming the S&P 500 by 3% in just over two weeks.

More Tactical Opportunities Ahead

Despite our overall defensive outlook on US stocks, that doesn’t mean there aren’t select tactical opportunities to consider.

Specifically, we are looking at Biotechs and Industrials as two areas of potential future outperformance. 

Biotechs have gotten pounded on drug price concerns and the Valeant saga, but good earnings last week have re-focused investors back on still positive fundamentals.

Industrials are offering some potential value after yesterday’s ISM Manufacturing Report contained a sub-index that we think could be forecasting a potential bottom in exports and industrial stocks.

If US exports have bottomed, then that will be a significant tailwind on industrials and they can outperform going forward.

We will be completing our research on both potential strategies this week and will alert subscribers as to whether we are adding either to our “Seven Best Ideas” portfolio.

That is how we turn macro research into actionable strategies that have helped our clients outperform markets, and our subscribers will be provided with specific, liquid ETFs that will help them execute these and other tactical strategies, and they know we will consistently update them including when to exit (because we all know when to sell is as important as when to buy).

Click this link to start your quarterly subscription today for less than the cost on a single client lunch.  And, with no penalty to cancel, you are not locked in to a long term commitment.  

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In three years of doing this the absolute best feedback I’ve ever received was when a client (an FA from a wire house firm based in Florida) called me late last year and said our Report helped him land a 25 Million dollar client!

But, while obviously not as monetarily impressive, we continue to get strong feedback that our report is: Providing value, Helping our clients outperform markets, and Helping them build their business:

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Best,
Tom

Tom Essaye,
Editor of The 7:00’s Report

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