The Means to a Trend Market Update - Grindstone Intelligence

May 20, 2019

It’s Getting Harder to Be a Day Trader

Full Disclosure: I’ve never actually been a day trader. It might be the golden age of day trading for all I know, but I do know a major change has taken place since 2016. No, I’m not talking about a certain Twitter addict. I’m talking about futures markets.

The CME launched the E-mini S&P 500 futures contract in 1997, and they can be traded nearly around the clock. If Russia declared war on the United States at 2:30 tomorrow morning, you could instantly sell some futures contracts rather than waiting for the cash market open (that’s not a recommendation for what you should do if Russia declares war tonight. In fact, you should probably find shelter). Transactions in the overnight futures market have an impact on where stocks open for trading every morning, and gaps (differences between opening and closing prices) are accounting for more and more equity market gains.

To gauge the impact of after-hours trading on market returns, I created two performance indexes: Daylight and Overnight. The first ‘buys’ the S&P 500 cash open at 9:30 ET and ‘sells’ the closing print at 4:30 ET. The second ‘buys’ the S&P 500 cash close and ‘sells’ the open on the following morning.

There was a time when the overnight session barely mattered. (Click charts to view them full screen)

The Daylight index (Red), excluding its superior performance during the financial crisis, tracked the S&P 500 (Black) with near perfection from 1998 to 2013. Unsurprisingly, the two had a near perfect positive correlation. Even through the first half of 2016, 3 years after the Overnight index (Blue) began to show consistent signs of life, the correlation held steady.

But the winds changed in the middle of 2016.

The correlation between the Daylight index and the S&P 500, while still high, has notably deteriorated since then. More importantly, the Overnight index has outperformed the Daylight index from that point in August 2016 to now. In fact, it’s accounted for about 70% of the S&P 500 gains over that time. If you’ve been day trading, maybe it’s time you took up night trading instead.

Another perplexing trend is a divergence in performance over the past few weeks.

Since early May, the S&P 500 has fallen more than 4% in the overnight trading sessions but has been up over 2% between the opening and closing bells. I can’t find a comparable period of such sustained and conflicting movement in after-hours trading. Even if I could, with only 3 years of relevant data, I wouldn’t have much confidence in assessing what it’s meant in the past. I certainly don’t know what it means for the future.

What I do know is this:

Gone are the days when markets truly closed. More than ever, being a money manager is a 24-hour gig.

Questions or Comments? Let me know

Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.

May 13, 2019

Sector Review: Industrials

In college, they taught me to value stocks using the present value of future cash flows. You take dozens of fundamental inputs – from company specific metrics to interest rates to the macroeconomic environment – and determine which businesses are the most undervalued. Having a grasp on these indicators is a crucial part of my job, but equally important is understanding that nobody cares what I think. A company may, in fact, be undervalued, but if no one else thinks so, then no one else will buy it. Sentiment around a stock has value too, and there’s no better way to track sentiment than the price of the stock itself.

Every week, I scan through hundreds (but who’s counting?) of individual stock charts. It can be tough to keep things in perspective, so I find a lot of value in looking at charts of sectors and industries. Trends in these larger groups often reveal the biggest and baddest trends in the underlying constituents. We don’t necessarily have to agree with the trend in sentiment and prices, but as investors we need to know it and understand it.

Here’s a high-level view of the trends in the Industrials sector over the last 5 years. (Click charts to view them full-screen)

S&P Industrials Sector GICS Level 1

The broad sector lacks a trend, hovering near a flat 200-day moving average. It back-tested a couple of long-term Fibonacci extensions in December 2018, then rallied back to the midpoint of its 18-month range. Momentum has weakened over the last few months, and a break below December lows would put the longer-term trend in question. On the other hand, a rally above the highs at 680 puts the next cluster of extensions (near 800) within reach.

The Industrials sector has 12 industries. Of those, 2 are in uptrends, 1 is in a downtrend, and 9, like the overall sector, are struggling to establish a trend. Let’s take a look at each.

Uptrends – Price above a rising 200-day moving average

Commercial Services and Supplies

The group broke above the 2018 highs in March and just kept going. The next long-term extension is up near 420, with a closer level of interest just above 350. The decline in momentum is a potential cause for concern, and it will be important to hold 320 on any pullback.

Road and Rail

The same story here. Momentum is starting to weaken and getting below 1650 would be a problem, but 2180 and 2600 are the levels to watch on the upside.

Downtrends – Price below a falling 200-day moving average

Air Freight and Logistics

It’s been the clear underperformer, but holding above 600 on this decline would be constructive in establishing a bottom. On a retest of the 550 level, I’d be watching for momentum improvement versus the December lows.

Sideways – Price near a flat 200-day moving average

Charts without a trend are messy by nature. Until we get a break out of these ranges, whether it’s up or down, they’re just going to stay messy. With each chart, I’ve identified some levels that could indicate the beginning of a new trend. Of course, at the end of the day they’re just lines on a chart drawn by some analyst. They might not mean anything.

Aerospace and Defense

Levels to watch: Upside 1370. Downside 1180.

Airlines

Levels to watch: Upside 380. Downside 300.

Building Products

Levels to watch: Upside 390. Downside 340.

Construction and Engineering

Levels to watch: Upside 300. Downside 240.

Electrical Equipment

Levels to watch: Upside 800. Downside 680.

Industrial Conglomerates

Levels to watch: Upside 350. Downside 300.

Machinery

Levels to watch: Upside 1115. Downside 930.

Professional Services

Levels to watch: Upside 200. Downside 150.

Trading Companies and Distributors

Levels to watch: Upside 600. Downside 450.

Takeaway

I’ll be watching these underlying industries for a clue as to which way the broad sector will resolve. If more start to break up than down, or vice versa, Industrials as a whole will probably do the same. We’ll see how it plays out.

That’s it for this week. I’m always interested to hear your thoughts.

May 6, 2019

Do rising wages lead to higher stock prices?

Real wages growth is higher than it’s been in years. Higher real wages should lead to more consumption and higher investment, and, without too much extrapolation, it follows that such actions should result in higher revenues and valuations. But do they? And how does that relate to earnings? Do increased wage pressures weigh on the bottom line? In this week’s post, I look at the historical relationship between real Average Hourly Earnings and some fundamental equity metrics.

The charts below compare the Z-score of real wage growth (I’m using Average Hourly Earnings for Production and Non-Supervisory Workers less Core Personal Consumption Expenditures Price Index) to S&P 500 revenues, earnings, and valuation.

First, let’s look at revenues. Despite a weak positive correlation over the entire period, the relationship has varied greatly. Note the most obvious breakdowns during recessions in the chart below. Moreover, the relationship changes quite a bit depending on the measure of inflation used. I would be wary of drawing any conclusions about revenues based on this series of wage data.

When it comes to earnings, there’s been a somewhat negative relationship. In the chart below, I’ve inverted the y-axis on the earnings data to more clearly show the correlation.

Valuation appears to have had the strongest link to changes in real wages. The two have been positively correlated, with only the period from 2006-2008 raising some questions.

On the whole, it looks like a toss-up for the impact on the S&P 500. I’ve inverted the y-axis again (this time on S&P prices) below. The relationship has been pretty negative since 2000 but was decidedly positive for much of the 1990s.

The bearing on stock prices may be uncertain, but there is still good information to take away. In the short-term, rising wage pressures have outweighed any concurrent growth in consumer spending and had a negative impact on earnings. At the same time, perhaps due to increased discretionary income and changes in inflation and growth expectations, equities have gotten more expensive with rising pay.

Rising wages are good for consumers. We’ll see how they play out for the markets.

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