Market Insights: No Drama
American culture seems to be increasingly addicted to drama. The proliferation of reality T.V. shows like Keeping Up with the Kardashians, Real Housewives, Cops, Here Comes Honey Boo Boo, Bad Girls Club, My 600-lb Life, 90 Day Fiancé, etc. is a measure of this.
At US Capital Wealth Management, we seek to keep the drama and emotions out of the investment process. Drama and emotions often inspire action which is not well thought through.
We rely on quantitative data with stable relationships to stock market activity. Weekly, we publish the status of the Delta Market Sentiment Indicator (MSI) which provides an intermediate term outlook on the stock market. We believe the Leading Economic Index (LEI) and treasury yield curve provide advance indications of recessions and potential major market declines.
We are always looking at data to evaluate the risk/reward balance of stock ownership. This week, we examine the Misery Index. The Misery Index adds the unemployment rate to inflation (core PCE deflator). High inflation and high unemployment makes investors miserable and stocks sell-off. Low inflation and low unemployment reflect a healthy investment environment and rising stock prices.
Shown below is a graph of the Misery Index from 1960 through September, 2017. Major bearish stock market periods occur when the Misery Index is rising.
The next two charts show the stock bull market run from 1982 through 2000. The Bull market was fueled by a falling Misery Index.
Since 2000, we have experienced two major bear markets. The chart below shows the relationship between the Misery Index and stock price in the 21st Century.
The Misery Index is 5.5% today. Historically, when the Misery Index has been this low, the S&P 500 P/E has ranged from about 15x to 35x with many instances of 25x and above. The all-time low of the Misery Index from 1960 through September 2017 was February 1966 at 5.28%. The all-time high was in 1975 at 18.56%.
A year ago, the Misery Index was 6.74%. The index is down roughly -18% in the past twelve months and the S&P 500 is up 21%. For now, the index is low and continues to decline which is constructive for further stock price advances. In the coming months, it will be interesting to see if the Misery Index is able to drop to new all-time lows.
Kyler’s Report —
What I’m Reading This Week
In my portion of the newsletter, I will be writing weekly about whatever I’m looking at for the week. It could be about a specific company, specific industry, the macroeconomy, or something not even directly related to investing.
This week, we’ll look at the state of the US oil and gas market. Over the past couple of years, oil prices have stayed lower than recent averages largely because of expectations of continued strong US production even in the face of weak prices. The recipe for strong production has been cheap capital, productivity improvements, and pricing concessions from service providers.
Some cracks in each area are emerging. In this Bloomberg article, an analyst noted a different narrative from lenders:
“Lenders are tiring of supporting negative cash flows, particularly because of the relatively flat commodity prices,” said Harvey. “If this weariness leads lenders to stem their support by requiring more restrictive covenants or indentures that would limit negative cash flow, it would be a rude awakening for an industry that has typically put growth before positive cash flow.”
Furthermore, drilling productivity has started to decline, and drilling prices have increased across most US drilling basins. Those three important factors that led to strong production at low prices are starting to show signs of weakness, and as a result the US rig count has rolled over in the past few weeks even in the face of relatively higher oil prices:
CEOs of major drilling companies are telling investors that they should expect less growth, and stocks of some of the drilling companies tied to the hottest US shale play, the Permian Basin, have struggled as investors expect less growth.
A difficult few months doesn’t mean the end of the US energy story, but a slowdown in the biggest US shale plays does question the narrative that US production will cover any oil shortfall down the line. For any investors with energy exposure, this is a trend worth following.
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Delta Market Sentiment Indicator (MSI) is published weekly in Barron’s