The S&P 500 gained 0.72% this week with Friday's close at 3,397.16. Friday's close is a new all-time high weekly (and daily) close for the index.
The S&P 500 has now increased four weeks in a row, and seven of the last eight, and the last five trading sessions recorded as yet another trading week that illustrated eager buying interest into lower prices (and a total lack of selling pressure).
The index traded up to a new all-time high at 3,399.54 on Wednesday, only to then trade down to 3,369.66, before closing at 3,374.85. This marked a reversal day somewhat similar to last Tuesday's price action that we discussed in last week's Update. The index was once again "ripe for further downside continuation" on Thursday, but just like last week the S&P 500 reversed to the upside and closed right next to the highs of the week. The price action for the S&P 500 has been analogous to holding a beach ball underwater; it's impossible to keep it down for long.
We remain face-to-face with our last hurdle. After sprinting for virtually all of the last eight weeks, we can't help but wonder if we're going to hit the last hurdle on our first attempt.
In last week's Update we wrote about the rotation we saw with the role player sectors chipping in to help carry the S&P 500 higher. Well, this week was the exact opposite; there was nothing but rotation back into the technology (SPT) and consumer discretionary sectors (SPCC).
SPT gained 3.48% this week and SPCC gained 2.42%. In the exchange-traded fund world, the SPDR's Consumer Discretionary Select Sector ETF (ticker symbol XLY) increased for the ninth week in a row for just the third time since its inception (April 2010 and May 2009 are priors). Put it together, and it's a decent team performance in a sense - from one game to the next, someone's always hitting their shots!
However, the best and most durable of advances tend to come when everyone is contributing, from the stars on down to the role players. With the NBA playoffs in full swing, the team that wins the title is never going to win it with two guys beating five. They'll need their top two players, or sectors, to eventually find positive contributions from the guys coming off the bench (sectors other than technology and consumer discretionary contributing consistently). Without broad contributions from the majority of sectors, the foundation of the advance is always presumed to be shaky.
To this point, the S&P 500's foundation was beyond shaky this week, and its breadth was negative each and every single trading day (i.e., of the stocks that comprise the S&P 500, more declined than advanced each of last five days).
While the S&P 500 gained 0.72% this week, more than half of it was attributable to the price action in Apple (AAPL). AAPL gained a whopping 8.23% this week, and with AAPL being nearly 7% of the S&P 500 it almost accounted for the entire weekly advance!
This sort of narrow leadership has almost always been an ominous sign, and the degree of narrowness we saw this past week is virtually unprecedented. If we quantify this past week as a trailing five-day period where the S&P 500 was higher in price with its breadth being negative each and every day, we're left with just one single five-day period that matches over the last twenty-plus years: 06/21/2000.
As we wrote last week, we remain skeptical about the index's staying power at the 3,400 level over the short term. This is not necessarily a "bearish" perspective, but it is more the recognition that a lot has gone right for the S&P 500 the last two months. Broadly speaking, after a lot goes right for the index, a little bit tends to go wrong (sometimes a lot tends to go wrong, but that's never the most probable outcome). The financial jargon refers to this as "mean reversion". We'll just call it a normal, healthy pullback in price since prices don't move linearly forever.
Taking the last four weeks as an example, the S&P 500 has increased four weeks in a row, while gaining 5% or more, and closing at a new all-time high. Dating back to 1990, we've seen this four-week pattern happen thirteen prior times. The last time this happened the S&P 500 lost more than -8% over the next two weeks. The last eight times this has happened the S&P 500's forward four-week return has been negative seven of them. And the average four-week return over all 13 prior samples is -0.88%.
As always, thirteen instances over the past thirty years isn't consistently predictive of the future, but the entire history of the S&P 500 provides enough evidence to solidify the idea that prices don't move linearly forever. We can't help but feel like we're in the "escalator up, elevator down" portion of the advance, at least over the short term. In other words, any further drawup from here will ultimately find a retracement back toward Friday's close.
S&P 500 Primary Trend - Up
The S&P 500 is presently higher by 3.85% here in the month of August. The index is now just six trading days away from putting a five-month winning streak on the board. Five-month winning streaks have a nearly unblemished track record of preceding higher prices of the S&P 500 over the forward one year following the five-month winning streak (we'll write about them in much more detail in two weeks if it records). The past five months are the epitome of an uptrend; there are higher highs, higher lows, and higher closes on the board for each of the past five months. We never imagined this as of March's monthly close, and that's sort of the beauty of it all.
It sure looks like the S&P 500 is breaking out higher after two years of wild (and we mean wild) consolidation - it's still difficult to believe.
Naturally, this leads us to label the primary trend for the S&P 500 as up or "bullish". During uptrends, long-term investors are best served investing in the most traditional sense of the word. It isn't until the primary trend can be labeled as "down" or "bearish" that long-term investors are best served rebalancing their portfolio in an effort to trot their defense out on to the field. With the S&P 500 at fresh new all-time highs, we're certainly not there yet. The offense has the ball and is piling up the points.
As a reminder, the primary trend is the most important trend for long-term investors as it speaks to the most likely path the S&P 500 will travel over the coming months, rather than days or weeks.
For example, while there's evidence mounting that the S&P 500 will take a breather in the short term (see the first section above), there's also evidence mounting that the S&P 500 will be higher in 6-12 months. For mortal long-term investors, the more actionable point is the latter.
Many of us like to think we can time the market over the short term, such as selling stock here in late August and striving to buy the dip in September, but that game is 1,000 times easier said than done (trust us, we've tried). More often than not, long-term investors are best served aligning their portfolio with the primary trend, sitting on their hands, and taking the good with the bad, rather than trying to shorten their time frame and emphasize trading both alongside and against the primary trend. Investing for success over the long term is a lot like baseball; you can't swing at too many pitches if you ever want a decent batting average.
However, analyzing the primary trend for stocks doesn't speak to what stocks long-term investors should buy within the equity asset class. A decade ago it may have been thought that a "rising tide lifts all boats", but that's most certainly not been the case the last decade. 2020's bifurcation across sectors is the latest example of the need for long-term investors to not only have a rules-based, systematic approach to asset allocation decisions, but also a rules-based, systematic approach to security selection.
Take the common question long-term investors face when deciding what equities to buy across their portfolio: What percentage of my portfolio should I allocate toward international stocks?
The chart below illustrates the performance of the iShares S&P 500 Index Fund (ticker symbol IVV) and the performance of both the iShares MSCI EAFE Index Fund (ticker symbol EFA) and the iShares MSCI Emerging Markets Index Fund (ticker symbol EEM). EFA and EEM combined cover virtually the entire international equity universe, and over the last 13 years EEM has generated total returns of just 42.46% while EFA has gained 28.59%. Over this exact same time period, IVV has gained 207.95%.
Did a rising tide life all boats? Absolutely not. Answering that question correctly, or incorrectly, has had massive implications on portfolio returns, even if we hold the asset allocation constant.
We share this not to write off the prospects for EFA and EEM. We do believe it's as certain as death and taxes that international stocks will have their day in the sun at some point into the future.
However, we believe sharing this illustrates that long-term investors always have two important decisions to make, two important questions to answer: What is the optimal asset allocation for my portfolio given the prevailing trends across asset classes and my investor attributes, and what securities should I invest in to fill, or execute, my asset allocation? The days of being agnostic re: what securities to invest in are over.
As we head into the final straightaway of 2020, it's a great time to revisit not only what asset classes you're investing in, but also the securities you've selected to carry out your asset allocation. All stocks (and bonds) are not crated equal, and a rising tide isn't lifting all boats...just ask value investors.
The Curious Case of Lumber Prices
2020 is going to record as one of the strangest and craziest years we've ever witnessed, and the most recent example is the price action in lumber.
Lumber prices have increased 16 days in a row and gained 51.60%...and that's not a typo.
And this comes after lumber climbed from ~$350 to $564 from early June to mid-July! All said, lumber has climbed from a close of $348.10 on June 3rd to Friday's close at $762.70, a gain of 119% over just shy of three months. Lumber futures are easily the top performing asset across the entire investable universe over the trailing one month and one quarter.
There are economic implications to skyrocketing lumber prices, specifically the role it plays in the housing sector. Like lumber, housing has been on an absolute tear of late, as measured by the SPDR S&P Homebuilders Index Fund (ticker symbol XHB). XHB closed Friday at 53.71, a new all-time high daily and weekly close, and has now gained 117% off the March closing low at $24.66. XHB is higher by ~28.55% since late June's low at $41.78. Consider this another example of a lot going right for the market the last two months...
Home sales in July spiked to a record high, supply remains limited, and prices are skyrocketing in certain areas (click here). The average price per home in San Diego climbed to $634,000, a year-over-year increase of 9.3% (click here). The economic implications of rising home prices are somewhat of a gift and a curse.
From a confidence and wealth effect perspective in the near term, rising home prices are nothing but a gift We've often stated that the recession hasn't started yet (in a tongue-in-cheek manner), and given the rise in both the stock market and housing prices, many consumers and households are better off today than prior to the start of the pandemic, monetarily speaking. In any scenario where confidence across our quality of life returns (i.e., we get back to some sort of normalcy) consumption will return. That creates a plausible scenario of a substantial economic expansion in 2021.
However, the curse of everything being more expensive is the impact to returns on a forward-looking basis. Saying the recession hasn't started yet is one thing, saying it's never going to start is another.
Skyrocketing lumber prices will increase the cost of building a new home, which in turn will reduce supply, which then further limits homeownership affordability. This then exacerbates the bifurcation between those who have (homeowners) and those who have not (renters), and limits the prospects for social mobility associated with homeownership.
Housing's economic impact on a forward-looking basis is then muted, and skewed to the downside. In other words, supply can only increase over time, demand can seemingly only wane (unless interest rates move even lower), forbearance programs can only end over time, and eviction moratoriums can only end over time. Remember, the future for the price of anything is always the darkest when its price in the present is the brightest. Lumber and housing have shined remarkably brightly during this "recession", and it will be interesting to see whether or not these returns prove durable.
The final full trading week in August has arrived. Maybe lumber will actually close red for a day.
As always, another exciting week awaits.
Happy Sunday!
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