September 5, 2018
We are nearing the 10th anniversary of the September 2008 crash. September is also the market’s worst month, historically. Despite that, we are seeing the best GDP growth since 2000 and the best consumer confidence since 2000. Does this euphoria or complacency indicate a crash or market peak may be near?
I don’t think so. In 2000, 54% of the S&P 500 was in seven giant technology stocks and the 10 largest companies in the S&P 500 traded an average of 62 times trailing 12-month earnings. Interestingly, due to a “free float” adjustment to the S&P 500, this bellwether index should not get that concentrated in just a few mega cap stocks ever again. There is no doubt that the FAANG stocks continue to benefit from index investing, but it’s not like the top 10 in 2000. When the S&P 500 burst back in March of 2000, the “tail end” of the S&P 500 did better than the mega-cap stocks for several years thereafter. Likewise, today the tail end of the S&P 500, especially the smallest 100 stocks, are posting the best performance this year.
The tail end of the S&P 500 consists of mid- and small-capitalization companies that are more domestic, so they are not impeded by the strong headwind from a strong U.S. dollar. As the index and ETF industry shifts their focus from international, emerging markets, and multinational companies, the amount of index and ETF money now being dumped into the tail end of the S&P 500 (bottom 100) and the Russell 2000 stocks is causing the “melt up” we have witnessed in the past few days. What is even more promising is that there has been minimal trading volume in the past few days, so if the buying pressure picks up, then even more explosive appreciation potential is possible in the upcoming months as trading volume rises.
We could see “flash crashes” at any time, but they are temporary. Last week, I wrote about the third anniversary of the August 24, 2015 Flash Crash and how the stock market can be rigged during market hours, including how stop-loss orders may not provide sufficient protection, and how it is better to buy at the end of the day. In that regard, The Wall Street Journal published a great article last week on how Goldman Sachs now specializes in end-of-day trading for index funds, ETFs, and other passive vehicles.
End-of-day trading has soared in the past several years as passive investing has become more dominant;so I find it a bit ironic that while around-the-clock trading was promoted in the past several years, many professionals have now decided to trade predominantly at the end of the day, when liquidity is much better, when buy and sell orders can be more effectively matched. So if you see the stock market continue to “melt up” at the end of the day and then “gap up” in the aftermarket, that is a great sign that the buying pressure that we have been recently witnessing may be getting even stronger, supporting a bull market.
Consumer Confidence Soars, Reflecting a Healthy Economy
Back in 2000 and 2008, we were entering a recession after a frothy bubble in tech stocks and real estate, respectively. That is not happening today. The economy is strong, earnings are strong, and the market is not in bubble (high P/E) condition. Here is a rundown of the latest run of positive economic statistics.
The best news last week was that the Conference Board announced that consumer confidence rose to 133.4 in August, up from 127.9 in July, reaching an 18-year high, just shy of the all-time record of 135.8 from October 2000. Consumer spending is strong in all income groups, which is why low-end retailer Wal-Mart posted its strongest same-store sales in a decade and high-end Tiffany & Co. last week announced surprisingly strong 12% annual sales growth in the second quarter for its affluent client base.
The Commerce Department last week revised its second-quarter GDP estimate to a 4.2% annual pace, up from 4.1% previously estimated. One of the interesting details is that corporate profits are up 7.7% in the past 12 months, the strongest annual pace in four years. Exports surged at a 9.1% annual pace while imports declined by 0.4%, so a shrinking trade deficit has also helped to boost overall GDP growth. Overall, 2018 is now shaping up to be the strongest year for GDP growth since 2000’s 4.1% growth rate.
The outlier is the housing market. The National Association of Realtors on Wednesday announced that pending home sales declined 0.7% in July, the fourth time in the first seven months of 2018 that pending home sales declined. In the past 12 months, pending home sales have declined 2.3%, so I suspect the Fed will telegraph in its September FOMC statement that it will be slowing its future interest rate increases, since it does not want to kill the housing market or invert the yield curve.
Furthermore, after its September 26 rate hike, the Fed will likely move from “accommodative” to “neutral” and then congratulate itself for hitting its 2% inflation target based on the core PCE.