Zeller Kern’s Investment Monitor

A Market Mania in a Rapidly Changing World

January 24, 2018

By Steve Zeller

Even while we had a temporary government shutdown, the equity markets continue an upward march. Additionally, the economy appears to be gaining steam and positive investor sentiment has grown to extreme levels. Year-to-date, as of the market close on Friday, January 19th, 2018, the Dow Jones Industrial Average closed up +5.56%, the S&P 500 closed up +5.20%, and the NASDAQ closed up +6.27%. The International Indexes are up as well, with the Hang Seng Hong Kong Composite up +7.87%, and the MSCI EAFE International Index up +4.97% (source: Morningstar.com). However, some indexes are under pressure, particularly the Morningstar U.S. Utilities Index down –4.93%, and the U.S. Real Estate Index is down –4.42% year-to-date. More interestingly, investors should keep their eyes on the bond market, as we may be on the verge of a longer-term reversal downward in bond values and rising yields. So far, the year-to-date performance for bonds has the Morningstar U.S. Long Government Index down -2.53%, the U.S. Long Term Corporate Bond Index down -1.59%, and the U.S. Core Bond Index down -1%, year-to-date. The 10 year Treasury yield is at 2.66%, its highest level since March of 2014.

Meanwhile, politicians in Washington, grapple with the budget and their political differences, causing a government shutdown. But so far, investors don’t’ seem to really care, as they pay attention to more relevant issues such as the coming earnings season, the ramification of the tax cut, the repatriation of corporate cash from overseas, and the likely uptick in economic growth.

But, as we regularly point out, either positive or negative investor mood extremes, can be a signal to what may lie ahead, in that, when investor sentiment reaches a positive extreme, it usually does so towards the end of a rising cycle. Conversely, when investor sentiment reaches a negative extreme, it typically does so near the bottom of a declining cycle. During these mood extremes, the media tends to express these extremes by publishing it on the cover of major publications. Here is a recent example issued by the New York Post on January 18th, 2018.

Although we welcome a rising market and a booming economy, when the media publishes these kinds of statements on magazine covers and in newspapers, it is an indication that a trend may be coming to an end. Sometimes this behavior within the media happens shortly before a major reversal, and sometimes the reversal takes a while, but there is accuracy to it. What also exists, are very high equity valuations, margin debt, and a period of record low volatility. First Trust recently pointed out on their website with their Factoid that data from Goldman Sachs indicates that the S&P 500 Index has gone 394 days without a 5% pullback, tying for the longest period in history of the index, according to MarketWatch. They also pointed out that the Wall Street Journal Market Data Group reported that the average daily percentage change for the S&P 500 Index was 0.3% in 2017, the smallest absolute daily parentage since 1964. This is a potentially dangerous condition for investors down the road because it leads them into a mindset of extreme complacency and encourages them to take on more risk than they can tolerate, and makes their reaction to a market downturn that much more dramatic – It arguably magnifies the panic.

The positive sentiment appears to be building with more declarations of stating “that this time it’s different.” Yahoo Finance just posted a headline that mentions Goldman Sachs proclaims that “stocks are not in a bubble and will continue to go higher.” Fortunately,it does appear that stocks are likely to continue to rise. But we are not pointing these conditions out to call a market top, but rather, these are the type of statements that are made towards the end of a bull market cycle.

That being said, there are truly amazing things taking place within the economy that are revolutionary, mainly due to the application of technology within retail commerce, medicine, and other product development. But these are developments that will eat the weak and vulnerable providers within these areas if they don’t adapt. The more visible example is the brick and mortar retail store outlet model. The application of online technology is quickly wiping out the major shopping mall hubs such as Macy’s, Sears and J.C. Penny, producing a spiral effect on other store failures within the malls. A reinvention of the shopping mall will likely have to be implemented in the near future. Of course, Amazon is the culprit, as they have applied technology that greatly increased the convenience for the retail shopper and crushing the old retail model. Amazon continues to expand their application of technology to transform the grocery business that will likely cause destruction to those grocery retailers who do not adapt.

A January 21st article by Nick Wingfield in the New York Times, titled: “Inside Amazon Go, a Store of the Future”, discusses the store concept of the consumer experience with no check-out lines and seamless payment for purchases.


The article describes the experience starting with the entrance to the store, as it feels as if you are entering a subway station. A row of gates guard the entrance to the store, known as “Amazon Go”, allowing in only people with the store’s smartphone app. It is a 1,800-square foot mini-store packed with shelves of food that you can find in a lot of other convenience stores. But it also includes some food usually found at Whole Foods, which Amazon owns. The catch is, cashiers and registers are absent. Shoppers leave the store through the same gates, without pause, to pull out a debit or credit card. This is an example of how this revolutionary concept will rock the traditional grocery store concept and it also gives insight on the future trend for labor positions such as cashiers.

These developments are ushering in even faster change within the economy – some good and some bad, of course. But it will cause economic disruption, and it is producing rapid change - it is likely deflationary, though arguably good deflation. However, it may cause destruction for the retailers that are running on the old model. The results may cause bankruptcies and risk for the shareholders and bondholders of these companies.

We certainly are living in interesting times. On one hand, we have an economy that appears to be more promising than it was a few years ago, with favorable tax cuts, and mega companies, such as Apple announcing a massive $330 billion commitment of capital expenditures, here in the U.S. We have evidence that manufacturing is continuing its return to the U.S. with Chrysler Fiat announcing that it is moving its manufacturing plant back to the U.S. from Mexico. On the other hand, we still have an unimaginable level of debt throughout government, corporations, and the consumer, and it is that way throughout the world. We also have a Federal Reserve that still has a $4.4 trillion + balance sheet that it can’t seem to figure out how to unwind. Even though it has announced a cycle of un-easing, the Feds balance sheet hasn’t really contracted and the policy of easy money doesn’t seem to be going away. Click to enlarge chart.

In the meantime, this week is a kick off to the first earnings season of the 2018 calendar, with 339 releases starting on Monday and the heaviest reporting on Thursday. Expectations are for earnings to be fairly positive, in our opinion, which should provide support for current levels in the market. Economic releases will be significant this week, too, with GDP and other key economic indicators will be reported. Wednesday, we have flash PMI and then on Thursday we have the leading economic indicators. Also, we will see the release of existing home sales as well as new home sales be released this week. It does appear that the major impact on sentiment will be circled around earnings and forward-looking statements.
Although we point out that many indications that exist suggest a maturing bull-market cycle, we still expect the market to remain strong for a little while longer, at least. Our latest guess is for this to continue for another 8 to 12 weeks, perhaps not as wild of a climb, though.

Best Wishes,

Zeller Kern Investment Committee