An Inverted VIX Curve and the S&P 500

Demand for increasing protection against stock losses increased yesterday, as the price of the VIX jumped relative to the price of its own futures.  In the past, an inversion between the spot and 3-month prices has signaled a decline in the S&P 500.



Just one more in a long line of indicators that would seem to signal the need for a more defensive stance.

Middle Eastern Stocks Leading Stock Indices Higher Around The World YTD

Looking at MSCI All-Country World Index, which is a combination of the MSCI Developed Markets Index (23 countries)and the MSCI Emerging Markets Index (23 countries), we find impressive breadth in the global stock market. However, this quarter has started off on weaker footing. As usual, all data shown is on an equal-weighted basis.

The top seven performing countries year-to-date are all emerging market economies and are all from the Middle East or the Asia-Pacific region. The top performer is the United Arab Emirates which is up over 40% year-to-date with Qatar, India, Indonesia, Thailand, and Turkey the only other countries up over 20% so far this year. As usual, it is important to remember that many of these individual companies only have a handful of stocks that are in the MSCI index. For example, the United Arab Emirates includes only 9 stocks and Qatar includes only 10. On the other hand, India has 69 stocks in their MSCI country index which is more than Germany (54).

The average stock in the world is up a little over 7% year-to-date and 37 out of a possible 46 countries have positive performance. Only two countries, Hungary and Portugal, are down over 10% so far this year. In Portugal's case, that decline has all happened in July. It is down 14.5% month-to-date. Keep in mind there are only 4 countries in the Portugal in the MSCI Emerging Market Index.

The best performing developed market country is Denmark which is up almost 16% year-to-date. Other than portugal, the worst performing countries are, in order of worst to best, Netherlands, Austria, Sweden and Germany.

Decomposing the S&P 500 PE Ratio by Market Cap: Most Stocks Look Expensive

Back in December we wrote a piece entitled, "Decomposing the S&P 500 PE Ratio: How Can the Market PE be "Low" and Stocks be Expensive at the Same Time?" in which we showed how the market capitalization of the S&P 500, and many other indexes for that matter, is dominated by a few mega-cap companies which distorts index level valuation statistics. It's been a few months so we thought we'd provide an update on that analysis.

In the first below table we breakdown the S&P 500 into three market capitalization categories: top 10, top 50 and bottom 450. From there we show various statistics describing each category including each category's market cap as a percent of the total and each category's forward P/E ratio. What we find is that the top 10 companies by market cap account for 19% of the total index market cap, 20% of the total index earnings and also have the lowest P/E ratio of the three categories. The top 50 companies account for about 50% of the index market cap and earnings and have a slightly higher P/E ratio than the top 10 group. Finally, the bottom 450 companies account for about 50% of the index market cap and earnings and have a much higher P/E ratio than the first two groups. 



From here it's easy to see how the largest companies in the index can distort index level statistics like P/E and give the impression that stocks are in general fairly valued. In fact, stocks, in general, appear to be richly valued, while some stocks (the largest 10 percent to be precise) are the cheapest of the bunch. In the second table below we group each company in the S&P 500 into declie bins based on market capitalization (i.e. each bin contains 50 companies with bin 1 containing the largest companies by market cap and bin 10 containing the smallest companies by market cap). Companies in decile 1 are far cheaper, at least according to forward P/E ratio, than companies in any other decile.    



In conclusion, it may be true that the market P/E ratio is average based on only the last 15 years of history (chart below), but this statistic is greatly skewed by a few mega-cap companies sporting by far the lowest P/E ratios of any other group of companies. In fact, the smallest 450 companies in the S&P 500 that makeup only 50% of the market capitalization of the index have a forward P/E ratio that is more than 4 points higher than the largest 50 companies in the index. Furthermore, while the current market forward P/E ratio is average, we must remember that included in that average is a long period in which valuation levels were by any standard in "bubble" territory.  

Treasury Bond Yields Following Perfectly the Reduction of QE with New 1-Year Lows

Last weekend we wrote that The Flow of QE Suggests Lower Bond Yields and Stock Prices and it appears that is just what we are getting. Putting the stock part aside for now, we simply would like to point out that long-dated US government bonds are following the reduction in QE nearly perfectly so far. Today's decline in yields certainly helps keep this model intact as we note that 30-year and 10-year yields are now down by 8bps in after hours trading. Whether today's move in yields was a flight to safety on geopolitical grounds or simply a reflection of slower growth expectations is questionable, but the correlation with our model of the projected flow of Fed asset purchases is uncanny.

Also of note is that both the 30-year and 10-year treasury bonds made new 1-year lows today.

S&P 500 Posts 1st 1% Down Day Since Apr 10th as Bonds, Gold Rally

Ending a 66-day streak of consecutive days without a 1% down finish, the S&P500 finally succumbed to statistics as it lost about 1.2% today. Bonds and gold, on the other hand, rallied as the US 10-year treasury yield lost 7bps, the 30-year lost 6bps, and gold gained 1.5%. The VIX gained 35% to finish at 14.88 and lumber appears to have stated another leg down as it lost 2.3% on the day following weak housing related data.

Decent Gains in European Car Registrations Obscure Underlying Slowdown in Momentum

In June, new vehicle registrations in Europe maintained a positive year-over-year growth rate for the tenth month in a row-- a trend not seen since before the global financial crisis.



Though registrations fell nearly 2% in Germany, trends remained more positive in the four other largest European economies.  Notably, vehicle registrations in Spain have experienced double-digit growth versus a year ago in each of the last four months.



Renault continues to lead other auto manufacturers (as we discussed a while back, here), with registrations growing more than 20%yoy in June.



Whether these positive trends can continue remains to be seen, however.  Sales in July and August are usually the weakest of the year.  In addition, a number of uptrends in our relative strength point-and-figure charts seem to be easing and/or encountering resistance more recently.









As the charts illustrate, the average daily percent change for the group has declined from +0.13% over the longer-term (252 days) to -0.02% for the most recent 31 day period.



On a relative basis, the average daily percent change has gone from a +0.7% to a -0.7% when comparing the longer-term to more recent moves in prices.

Housing Starts Tumble In June

Even though builders are increasingly becoming more optimistic according to the latest NAHB release yesterday, housing starts are showing major signs of weakness similar to what mortgage applications have been signaling.

Housing starts came in well below expectations in June as they posted 893K annualize units started compared to expectations of 1.02 million. Single family housing starts are actually negative on a year-over-year basis now (-4.33%).







Regionally, we have seen a major fall off in the South which is the largest housing market in the US. Units started have fallen from 533k annually in  April to 375K annually in June. The good news is the the Midwest, which has now become the second largest housing market, has increased nicely this year form only 62K units annually in January to 219K units annually in June. On a year-over-year basis the South is down over 10% while the Midwest is up an astounding 79.5%.



Unfortunately, building permits did not provide a silver lining this time as they too came in below expectations (963K vs 1.038 million). Single family permits are just barely positive on a year-over-year basis. Continued weakness in lumber suggests that building permits may continue to underwhelm in the near future.

What Does The Breakdown In Small-Caps Suggest?

Beginning in March of this year, the relative performance of small cap stocks began to break down.  After a brief recovery from June to July, small caps have recently experienced another leg down and are making new relative lows for the year.

What effects might we expect from this underperformance of small cap stocks?  While there are many, there are two we would like to highlight:

1) It would seem to suggest a stronger Yen, and

2) It would seem to suggest the continued relative outperformance of counter-cyclical stocks (companies from the utility, telecom, health care and consumer staple companies).

In the first chart, we overlay the relative performance of small-caps vs. the S&P 500 and the Yen/USD exchange rate.  Perhaps the Yen reverts into a stronger trend rising into the 90s vs. the USD.

In the second chart, we overlay the relative performance of the S&P 500 vs. the S&P 600 compared the relative outperformance of counter-cyclical sectors to cyclicals sectors in the MSCI World index.  Because of the 92% correlation between these variables, the new leg down in small-caps potentially telegraphs the continued outperformance of counter-cyclical sectors.

Stock Prices Just Aren't Moving Like Normal

Here is yet another indicator highlighting the absolute lack of volatility in the stock market. The below chart measures the cumulative number of stock price moves of 5% or more over the last 65 days for all stocks in the MSCI World Index. The indicator doesn't differentiate between 5% up moves or 5% down moves as it is intended to be a neutral measure of aggregate volatility.

Let's put the current reading of 825 into perspective. Since the indicator sums up all the 5% stock price changes over a rolling 65 day period, this translates to about 13 stocks per day experiencing price changes to 5% or more. There are about 1610 stocks in the MSCI World Index, so this means that on average less than 1% of stocks had a price change of 5% or more on any given day over the last 65 days.

New Highs in Individual Stocks Continue to Lag Headline Prices

After a modest surge in June in which the percent of stocks in the MSCI World Index making new 52-week highs rose to 23%, new highs have languished. Currently the percent of stocks at new one year highs stands at just 7% for the World Index, 9% for North American stocks, just 3% for Europe stocks and 10% for Pacific stocks. We've belabored the point on this blog that we generally like to see expanding breadth during bull markets and since the middle of 2013 we've seen precisely the opposite. Only time will tell if breadth catches up to stock prices or if stock prices catch down to breadth.

ForEx in Point-and-Figure

While we mostly use our point-and-figure charts to gauge the relative strength of a stock versus a benchmark, we also look at things like currencies-- albeit on an absolute basis-- in order to get a better picture, with less noise.

Asia-Pacific





Europe





North America