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IQ Trends: Market Sentiment and the Timely Eight

10/12/2018 5:00 am EST

Focus: STRATEGIES

Kelley Wright

Managing Editor, Investment Quality Trends

In my experience there is no such thing as a single indicator that catches exact bottoms and tops in a market cycle, asserts Kelley Wright, dividend expert and editor of Investment Quality Trends.

After thirty-plus years of studying the markets I have come to believe that the single most important driver of the primary trend is investor sentiment. When investors feel confident they “buy” risk and the markets rise. When investors become fearful they “sell” risk and the markets decline.

In hindsight many will point to measures and indicators as their rationalization for turning bullish or bearish, but I believe the truth lies with emotion. Fear and greed are still the two most powerful forces in the human psyche.

A study of investment history over the last century does reveal that valuations were respected sufficiently that they were at least a part of investment considerations. By example, prior to the Quantitative Easing or QE era, extreme valuations would keep a lid on excessive speculation, and the markets would break to the downside.

This is to say that investors could recognize from measures and indicators that valuations had reached extreme levels, and therefore led them to become risk-adverse and begin selling to lock in gains. This of course all changed with the advent of the activist Fed and the use of extraordinary measures such as QE.

When interest rates were at zero and the Fed supplied a backstop to anything that looked even remotely like a downturn in stock prices, valuations and fundamental internals such as leadership, market breadth and the quality of bonds being purchased became irrelevant.

Of course, today QE is over, and interest rates probably bottomed in June/July 2016. The Fed is not only systematically increasing the rate on Fed Funds, but also withdrawing liquidity from the market at a rate of $70 billion per month. The dividend yield on the Dow and the S&P is lower than the yield on any Treasury with a maturity of two years or longer.

Yes, the economy is doing quite well. Yes, in terms of employment and rising wages and robust GDP numbers you get no argument from me there. What I would remind readers though is that the market is not the economy and the economy is not the market.

What has gone unreported, or under-reported, however, is the S&P 500 recently recorded valuation extremes that exceeded those of the 1929 and 2000 market peaks respectively. That’s a pretty scary thought.

It doesn’t matter until it does, and when it does I suspect there will be plenty of Monday morning quarterbacking from those who “saw” it coming. That day is not today though, and my thought is it won’t be until some point next year. That isn’t to suggest you shouldn’t remain vigilant, however.

Given that our Undervalued category has declined to just over twelve percent of our Select Blue Chip universe, our Overvalued category is now twice as large as our Undervalued category.

As a result, there is an insufficient number of stocks that meet our requirements for inclusion in the Timely Ten — which represents our current top ten recommendations. Due to the lack of viable candidates, our Timely Ten list of stocks has been reduced — for now — to the Timely Eight.

1) Franklin Resources (BEN) — yielding 2.94%
2) Omnicom Group (OMC) — yielding  3.46%
3) Philip Morris Int’l (PM) — yielding 5.72%
4) PepsiCo (PEP) — yielding 3.23%
5) Int’l Business Machines (IBM) — yielding 4.22%
6) Walt Disney (DIS) — yielding 1.52%
7) Cummins, Inc. (CMI) — yielding 3.21%
8) Unum Group (UNM) — yielding 2.88%

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