Market Outlook - February 2021

Welcome to the first market note of the year!  Lots of things have happened in the world since our last note, but has the market environment changed?  Let us take a look at the most recent data and see where the evidence takes us.

One of the most important charts that we study to determine whether we are in a risk on or risk off environment is the ratio between Consumer Discretionary Stocks (things we want to buy – cars, cell phones anything on Amazon) and Consumer Staple Stocks (things we need – toilet paper, food etc).If the slope of the curve is positive, Consumer Discretionary is in control and that typically indicates that the stock market is doing well. If the slope is downward, then Consumer Staples are in control and that usually means that market participants are getting more defensive. So, what is the chart telling us?

As you can see, the ratio is in a strong uptrend.  Check one box for the bulls.

One of the key tenants of how we approach asset allocation is through the use of relative strength, especially comparing asset classes to one and another.  Here are two ratio charts comparing both the S&P500 (SPY ETF) and the Nasdaq 100 (QQQ ETF) to the TLT (20-year Bond ETF).  Again, positive slopes are good for equities and negative slopes are good for bonds. 

Again, the slopes being positive signifies equities over bonds.  In our monthly rankings – US Equities and International Equities still rank 1 &2 from a relative strength perspective therefore meriting overweight vs other asset classes (of course that overweight is only relative to your risk model).

Looking at the TLT chart on its own, you can see the overall weakness in bonds, which means interest rates could continue to go higher.

This is also confirmed across the entire US and International Equity markets as the depth and breadth of the rally over the last few months has been impressive.  This tends to occur at the beginning of bull markets not at the end. 

For those who think the market is overheated, here are some data points that show that we might just be getting started.  First, is the chart of the XLF which is an ETF replicating major US financial institutions.  This index, which is one of the most important sectors in the country, is still below its 2007 highs.  So, this means that these stocks have gone NO WHERE for close to 14 years.  If the XLF breaks out above its highs, it would be hard to imagine equities breaking down.

Another major sector that has gone nowhere for over 10 years is emerging markets.  These are the riskiest of equity asset classes to own.  Again, if EEM breaks out, it would be hard to be bearish.

One other data point that we found interesting this month is the AAII Survey.  Despite markets hitting all time highs, the percentage of bulls is below historic norms.  This means that there is a high degree of pessimism out there.  There is little euphoria to be found according to this sentiment survey.  Markets love a wall of worry to climb.

To recap, the data seems to be overwhelmingly positive at this time.  This does not mean that we cannot have a correction during an uptrend.  Corrections are normal and healthy.  Historically, February tends to be one of the worse market months.  Whether the next 10% in the market is up or down, if the data continues to point positive in the intermediate to longer term, we like equities over other asset classes.

If you have any questions, please let us know.