Markets have a long history of rising with rising lending spread – Bullish!

Markets have a long history of rising with rising lending spread – Bullish!

“Davidson” submits:

Lot of economic data supporting existing trends, big shift in US$ underway

Employment trends in place since 2009 continue with May 2017 reports. Vehicle sales remain historically high as the avg age of vehicles remains in 11yr-12yr range. Reports by CAT, DE, UTX, XOM, PX and the Chemical Activity Barometer reflect recovery in industrial, energy and chemical industry sectors which should report additional high wage employment in the months ahead.

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The US Dollar is beginning to drop back to the long-term trend which is ~30% lower than current levels in the Trade Weighted US$ Index Major Currencies. This is correlated to the rise in the EFA(iShares MSCI EAFE ETF) which was recently priced at 64.87. Even though the EFA and US$ tend to correlate, which shifts first does not have a simple relationship. History shows that the US Dollar shifts based on investor perception of where returns are best. How this is executed and what were the precise drivers are more often than not seen only in hindsight. The most recent US Dollar strengthening showed a marked correlation with the Russian invasion of Ukraine and was tied by Momentum Investor algorithms inversely to $WTI(West Texas Oil Price) and other commodities priced in US Dollar.

Even without a significant shift having not yet developed in the US Dollar from recent peaks, there has been a sizable improvement in Intl Equity returns since Feb 2016. In my experience, the US$ should continue to drift lower and Intl Equities should continue to stregthen relative for US investors.

Economic Trends Dollar S&P 500

US Dollar

Dallas Fed reports 12mo Trimmed Mean PCE of 1.8%

Markets can be simply viewed as Value or Momentum Investor driven. The SP500 Value Investor Index is designed to mimic the market level which has been attractive to Value Investors. Value Investors are responsible for significant market cycle lows. Momentum Investors are responsible for high valuation levels at market cycle peaks.

The 12mo Trimmed Mean PCE(inflation measure) is part of the Value Investor Index construction. Lower inflation equates to justifiably higher stock prices. Higher inflation has a long market history of forcing earnings to be priced at lower PEs. This is due to Value Investors making inflation part of their mental market capitalization calculation. Higher inflation makes anticipated earnings worth less than when inflation is lower. Today’s Dallas Fed report saw a drop of 0.1% vs the past 3mos and the SP500 Value Index reflected a rise to $2,125. The SP500 at $2,390 sits ~12% higher. The major market peaks 2000 and 2007 registered ~100% and ~60% premiums respectively. Today’s market is not overly speculative by comparison.

Economic Trends Dollar S&P 500

Markets have a long history of rising with rising lending spreads. The current T-Bill/10yr Treasury rate spread, a proxy for lending spreads is currently 1.55% and rising after a brief pull-back from Jan 2017 level of 2.00%. Markets peak when this rate spread falls to 0.2%. An excessively priced SP500 relative to the SP500 Value Investor Index with the rate spread falling to 0.2%-0.0% range is a signal that a market top and significant  correction is at hand. There is no sign of this occurring anytime soon.

I expect economic expansion to continue for 3yrs-5yrs. Economic indicators tend to signal 24mos to 8mos ahead of market tops. I encourage investors to add to equity positions.

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Todd Sullivan is a Massachusetts-based value investor and a General Partner in Rand Strategic Partners. He looks for investments he believes are selling for a discount to their intrinsic value given their current situation and future prospects. He holds them until that value is realized or the fundamentals change in a way that no longer support his thesis. His blog features his various ideas and commentary and he updates readers on their progress in a timely fashion. His commentary has been seen in the online versions of the Wall St. Journal, New York Times, CNN Money, Business Week, Crain’s NY, Kiplingers and other publications. He has also appeared on Fox Business News & Fox News and is a contributor. His commentary on Starbucks during 2008 was recently quoted by its Founder Howard Schultz in his recent book “Onward”. In 2011 he was asked to present an investment idea at Bill Ackman’s “Harbor Investment Conference”.
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