Zeller Kern’s Investment Monitor

Let's Party On...

May 9, 2017

By Steve Zeller

In our last issue of the Investment Monitor, we discussed whether or not the equity markets could achieve new highs. That took all but a week to accomplish as new market highs have been reached and future highs appear to be probable.

Year to date, as of the market close on Friday of last week, the Dow Jones Industrial Average closed up 7.06%. The S&P 500 Index closed up 7.86% year to date, while the Russell 2000 Index was up 3.36%, and the NASDAQ closed up 13.33%. The MSCI EAFE International Index closed up 11.98%, while the Hang Seng HIS Index closed up 11.25%. The Morningstar US Core Bond Index remains anemic, just up 1.44% year to date.

Over the years, we have pointed out some tremendous headwinds that are in place that have the potential of placing the financial system in serious peril. Countless times, we have wondered whether or not a market high for the current bull market cycle had been reached. The market spoiler that we have expected in recent years has been record debt levels and a pension fund crisis that will likely be the culprit that ends this current bull market. What has been missing all along though, was a level of optimism that usually drives investors into“buy everything” hysteria.

But now, if you look at several indicators, it appears we are finally heading into that direction. The good news is we should see further market highs this year. Aside from a “.com” mania that we encountered in 1999, many of the conditions from that period are falling into place. Recently, I attended a conference in Florida and listened to a presentation by the Chief Investment Officer, Brad McMillan of Commonwealth Financial Network. Many great points were made, points that I very much agree with, indicate that this current bull market cycle, now eight years in length, is lining up to form a major top sometime this year or possibly early next year.  Many of the conditions that were in place in 1999 are being seen now.


We’ll get into some of those indicators, but even though the market has been in a long bull market cycle and valuations are very expensive, what has been missing is the mass hysteria of optimism that finally sets the market up for the final grand top. That appears, arguably, to be setting into place.

The current bull market cycle, a period of overall rising prices, is now eight years in length. Cyclical bull markets typically last five to seven years and sometimes as long as ten years in length, so the current market cycle is a little long in the tooth.

Now granted, the tech stock bubble is nowhere near being into the condition that it was in 1999, causing equity valuations to head into the stratosphere, but if you subtract that out of the equation, valuations and many other indicators are now reflecting similarities.

First off, Consumer Confidence, as measured by the Conference Board, is at a market cycle high, and is at or higher than it was at the market peak in 2007.


We may have a bit more room for confidence to rise even higher, but that would add to the argument that we haven’t seen the ultimate market high yet in this current market cycle. The point is, consumer confidence certainly isn’t in the dumpster, and is at or is approaching the levels when other market peaks have occurred. Furthermore, if you look at the second consumer confidence chart, you see many parallels compared to 18 years ago, with consumer confidence spiking recently.

The service sector, as measured by the ISM Non-Manufacturing Service Sector Index, is going strong and is at higher level seen during or nearing market peaks. The service sector is going strong, though within a sluggish growth economy, and according to the chart for the ISM Non-Manufacturing Business Activity Index, provided by Doug Short at dshort.com, is slightly stronger than it was in the 1998/1999 period.



The recent numbers released for the April Non-Manufacturing Purchasing Managers’ Index (the ISM Services PMI), came out at 57.5 percent, up 2.3 from 55.2 the prior month.

The recent headlines on the subject of jobs have been very favorable. Although there are criticisms to point out such as the overall real wage growth over the last 10 years and the quality of jobs, as well as the number of part time jobs versus full time jobs. But April’s Jobs report released better than expected numbers, with nonfarm payrolls growing by 211,000 while the unemployment rate fell to 4.4 percent, its lowest level since May 2007. Although the labor force participation rate fell lower to 62.9 percent, the employment-to-population ratio increased to 60.2 percent, which is at the highest level so far for 2017, and is at the highest level since February 2009, according to a recent report on cnbc.com. Job creation, although in a rapidly changing world, appears to be maintaining steam and is at levels that occur prior to market peaks. A good perspective to look at is the current jobs growth trends versus where it was 18 years ago and where it went after that time which was a downward spiral, but not until a number of months later.

The stock market is now in all time high territory and continues to suggest that it will print even higher highs. But as we have pointed out in the past, the Shiller P/E ratio is at expensive levels, at 29.7, higher than where it was at the prior 2007 peak, and nearing levels posted at the 1929 peak. The Shiller P/E ratio is nowhere where it was at the 2000 peak, but that’s because you had all kinds of tech stock outliers with price to earnings ratios well north of 100.

Source: https://www.gurufocus.com/shiller-PE.php

The point is, we will likely see new market highs, and all of the indicators that we have pointed out could still improve from here, which would make for a favorable 2017 year in the economy and the stock market. However, lining everything up, you begin to see a major storm possibly coming to fruition in the first or second quarter of next year, but possibly even sooner. It appears, that based on the recent jobs report that the Fed will continue to increase interest rates which will increase the likelihood of a market peak, or put further pressure on the cycle. But, this time around the issue of debt loads and pensions will be the clincher for a turbulent time ahead, in our view.

Looking back on last week
Monday’s action was very flat but with a positive tone for most of the session, finishing slightly higher basis the S&P 500 +0.17%. The stability in the markets on Monday were generated by the technology and the financial sectors.

On Tuesday, the market started on a downtick and traded in sideways range just to close slightly higher, up 0.12% basis the S&P 500. All market participants were focused on the political front as Congress reached an agreement to keep the government funded through September. This kept the markets flat lined all the way into Friday’s release of the unemployment situation.

Friday’s action started higher than faded for the first two hours. The market then found new legs as market participants were covering shorts prior to the French elections and after the positive employment report showed 211,000 new jobs and the unemployment rate at 4.4%.

In Europe, the major bourses finished higher across the board with France's CAC (+1.1%) leading the advance ahead of Sunday’s French presidential run-off. Final polling gave Emmanuel Macron a 62-38 advantage over Marine Le Pen. This turned out to be understated as Macron won with 66.06% of the vote. This has been construed as a positive for equity markets due to Le Pen's anti-EU rhetoric. Germany's DAX and the UK's FTSE settled higher by 0.6% and 0.7%, respectively.

The U.S. Dollar Index (98.44, -0.17) slipped 0.2% as the greenback lost 0.1% and 0.4%, respectively, against the euro (1.0994) and the pound (1.2978).

Market action on Friday was very choppy in the morning session as it started on an upswing and then fading for the next two hours. Finally, the market was able to get some traction and start to move up toward the key pivot number of 2400.98 which is also the historical highs. The S&P 500 was also able to render an all-time new high close but still fell short of penetrating the 2400.98 level.

The configuration suggests that there is a 60% probability that the 2400.98 level will be penetrated in the next two sessions. A close above this level will suggest that the market will rally toward the 2405/2412 levels. Should the market manage to remain above 2400 for the first three days of the week, then we are likely see a further rally toward the 2419/2425 levels.

However, a failure to do this and a close below 2386.40 will indicate a pattern failure and suggest further declines toward the 2373/2368 levels.

While the intermediate and longer-term charts remain in a positive mode, it is critical on a short-term basis that we get above the levels mentioned above or risk further consolidation and a possible signaling of a minor top. At this time all probabilities continue to point toward higher prices moving toward the ultimate long-term objective of 2489.     

*Last week’s market recap provided by VPM Partners

Best Wishes,

Zeller Kern Investment Committee