Top Stock Market Drivers - Continued
These factors are not necessarily causes of stock market movements. They are correlated with stock market movements.
In our opinion, a few of them significantly influence stock market attractiveness for new capital, and we will highlight those in bold.
This is a continuation and evolution of our original Top 10 Stock Market Drivers story. Here are the current pressures impacting US stock prices.
We would suggest tracking these ten factors each day that you have an active investment with significant capital at risk, and to see where the market forces are leading the market (if at all).
We see many views on these metrics in the popular media, so we publish BETA values where possible so you can see where the correlations historically have been, not where they should or could be.
The details...(from October 4, 2023)
Factors that put pressure on stock prices when they move.
- Volatility of stock prices: Historical stock price volatility (down). 4.00 x 10-5 (our proprietary calculation) on Sept 25, market close. The CBOE Volatility Index (VIX) Futures (down, was up earlier today), and still at 18 handles, up from 13 handles a week ago. The VIXY ETF, ProShares VIX Short-Term Futures ETF, has a BETA of -2.0, which is significantly and materially negative casual relationship.
- Share prices falling (momentum): Fell yesterday by $800B to $49.2T (total equity market capitalization for all stocks that pass data validation in our model). The S&P 500 appears to be completing a head and shoulders pattern today.
- High Yield Corporate Bonds: Down today. The ETF HYG, iShares iBoxx $ High Yield Corporate Bond ETF, has a 5-year BETA of 102% and has been falling since September 14, 2023. These move opposite to High Yield Corporate Bond Yields. Intuitively, it makes sense that increases in corporate bond yields and interest expense are negative for U.S. stock prices, especially those with the greatest debt leverage.
- Real estate values: Down today. These move with stock prices, and the USRT, iShares Core U.S. REIT ETF, has a BETA of 95% with the SPY. Real estate has fallen significantly in the past week, likely due to higher interest rates for commercial and personal loans and both commercial and residential mortgages. Those rates move with the 7-year and 10-year US Treasury bonds and borrower credit risk spreads.
- Silver, Platinum and Copper: All down today. Both silver and platinum are both a physical store of value (e.g., jewelry and bars) and are metals with industrial uses. The ETF SLV, or iShares Silver Trust, has a BETA of 59% against the SPY (higher than gold) and PPLT, or Aberdeen Physical Platinum Shares, has a BETA of 60% against the SPY. The ETF CPER, U.S. Copper Index Fund, LP, with a 5-year BETA of 72%, has declined for the past week, and still in a 10% trading range since June.
- Energy prices: Up today. Oil, gas and electricity prices and consumption: Continuing to rise, with the West Texas Intermediate futures contract trading above $90 per barrel. Natural gas has recently risen a bit after being flat for quite a while. Electricity (total expenditure) was up 6% in a single month from June to July 2023. Rising energy prices limit overall, U.S. discretionary spending power, but a rise in energy prices moves together with US equities indexes. The ETF USO, United States Oil Fund is an ETF that maintains exposure to barrels of oil has a BETA of 58% with the SPY. The ETF DBO, Invesco DB Oil Fund which focuses on WTI only, has a 56% BETA against the SPY. The ETF UNG, United States Natural Gas Fund, has a BETA of 89% against the SPY.
- US Dollar (vs. other currencies): Up today. The UUP Invesco DB US Dollar Index Bullish Fund, and has a BETA of -24% against the SPY. This is up significantly over the past few weeks on Federal Reserve Bank hawkishness. We saw a few days of downturn before Fed FOMC. Been rising for the past two months.
- Gold: Down today. Gold has been relatively flat since June with a recent choppiness. Gold has been moving with stocks this past year. AAAU Goldman Sachs Physical Gold ETF has a BETA of 22% against the SPY, and is moving in the same direction with stocks. This might be a place to 'park' stock market gains for financial investors.
- Long-term interest rates: Up today and up sharply over the past week. In a significant upward trend for the past few months. The TLT iShares 20+ Year Treasury Bond ETF rises when yields fall. It has an 18% BETA against the SPY.
- Government net cash intake (a.k.a. Quantitative Tightening or removing liquidity): Tightening, after being flat. A net two-week reduction of $258B in liquidity (over a quarter of a trillion dollars). The Total Assets of the Fed are down $77B. The Treasury General Account is up $181B. FRED: Sept 26, 2023.
- Bitcoin: Flat. Might have an influence on U.S. stock prices overall, and definitely impacts bitcoin miners and companies that store their Cash, Cash Equivalents, and Marketable Securities. The data is too new to draw conclusions.
Longer-term effects and forces on stock prices. These are very important, but change infrequently.
- Uncertainty in US Government policies and procedures: Much higher due to possible October 1, 2023 shutdown. President Biden joined the UAW picket-line vs. General Motors, and stated he supports a 40% raise.
- Consumer theft and credit delinquency: Credit delinquency rose into August 21 FRED reading, and theft and shrinkage is up in a more broad set of companies. Yesterday we heard from a wholesale foods company UNFI. In the past four weeks, retail has been reporting a significant and material increase in shrinkage.
- Inflation: CPI-U rose 3.7% (NSA) YoY and 0.4% (NSA) or 0.6% (SA) in August MoM, based on Sept 13 BLS data. By category: Food: +0.2%, Energy +5.6%, Commodities -0.1%, Services +0.4%. Chairman Powell's favorite measurement of inflation is the Personal Consumption Expenditures (PCE) Price Index (excluding food and energy), called the Core PCE. The FRB Cleveland Nowcast today has Core PCE rising 4.0% in August and 3.8% in September and a monthly gain of around 0.3% for the next two months. Core PCE is down slightly. Oil futures are up significantly.
- The threat of war: In our opinion, this is getting a little worse with Russia, China, Iran and North Korea. China naval actions East of Taiwan and North Korea meetings with Russia have us more concerned. The U.S. is giving Iran access to $6B in frozen funds, so that probably reduces bilateral conflict there.
- Corporate Income Tax (CIT) rates: The CIT is currently 21%. A new Alternative Minimum Tax rate of 15% passed in the 2022 Inflation Reduction Act on companies with revenues of $100mm annually, or a billion dollars in one year. In May 2022, the Biden Administration proposed to raise CIT to 28%. The Global Intangible Low-Tax Income GILTI tax would also be raised from 10.5%–13.25% to 20%. No change.
- Capital Gains & Dividend Taxes (investment tax on individuals): No change.
- Tariffs and Trade restrictions (reducing the international flow of goods): Trade restrictions are also called Non-Tariff Measures (April 28, 2023, by Fernando Leibovici and Jason Dunn, Reserve Bank of St. Louis). We did see the US put trade restrictions on Russia (for the Ukraine war) and China (for the cold war in technology). This past week China made some adjustments and applied some stimulus to their domestic economy after China's stock market was said to be 'uninvestable.'
- Labor cost increases: However, recent wage hikes are minimal (softening economy) but headline organized labor actions are proving successful in trucking, acting, writing and now automaking is asking for a 46% raise over four years. This past year, compensation costs are up 4.5% for the year ending June 2023 (latest data from BLS). September 1, 2023 data from BLS showing August average wages up $0.08/hour, or 0.2%, to $33.82 / hour. Those wages are up 4.3% for the past 12 months. Production and non-supervisory average wages had the same growth rates, and are $29.00/hour. This equates to an increase of $6.13/week in August and $44.57/week for the past year. New BLS data yesterday shows non-farm business sector labor productivity up 3.5% in Q2, and hourly compensation was up 5.7%, for a rise in unit labor costs of 2.2%. US manufacturing was significantly worse, with labor productivity up 2.9% and hourly compensation up 8.0%.
- Bankruptcy filings: If more firms suddenly cease operations, this is bad for stock market valuation. This eliminates jobs and can freeze business operations and money flows.
- Current estimate of Gross Domestic Product by the Federal Reserve Bank of Atlanta (GDPNow): This is a current quarter estimate of current economic growth as measured by the GDP. This is down to 4.9% growth on September 14 from 5.6% on September 8.
- Short-term interest rates: Flat. They are in Fed policy range and have stayed at 5.3% for months. The SHY iShares 1-3 Year Treasury Bond ETF is an ETF that tracks short-term US Treasury Bonds with 1-3 years to maturity. It has a beta close to zero (1.4%) so we can intuit that daily changes in short term interest rates are unrelated to US equity prices (on that day).
How These Factors Affect Our Firm and Investment Strategy
We run a quantitative model. It searches for portfolios that have the largest gap between expected returns and historical price risk. There are around 3,000 US-listed common stocks that trade each day, and we look at all of them and all the combinations possible.
Here is what we see:
- The risk premium, or expected return of stocks on top of interest you can earn is 8.4% for the next year, including dividends. This is the new normal, between 7.0% and 8.5%. It is up from 1.2% two weeks ago.
- Our model is finding much smaller long portfolios (now 5 to 7 stocks) of very risky stocks (eCommerce, used cars, subprime lender and advertising). The edge rose to 31 ticks for Tuesday's market open, after fluctuating from 18 to 28 ticks last week. The model has more 'confidence' in the best portfolios as high-flying stocks rebuilt their market correlations. Last week, the market blinked on high-risk, new-age top stocks, but this week it feels better. Funny how that is...the model doesn't even read Bloomberg. Today's portfolio pick is very risky and the edge is growing, so this suggests risk is getting significantly lower in those names. Could be they are falling, consolidating, and building a base for future advances while still maintaining their strategic power (or BETA). This works explosively some of the time, typically when markets advance overall, so we consider shorting a few stocks to hedge our market-based long investments.
- The model finds many stocks to short, or to borrow and sell, and not just in unprofitable stocks. Their risk-return trade-off is significantly worse than holding the indices. There are small cap stocks with a negative edge to be reviewed, however most have a very small equity market capitalization.
- Profitable stocks with positive common equity trade today at an average Price to Earnings (PE) ratio of 32x, and a Price to Book (P/B) ratio of 5x. A flight to quality in profitable companies occurred leading up to August, and our hypothesis that investors should prefer profitable firms with low debt levels has been proven. Those stocks carry a premium.
- We don't see this in market stock prices yet, but we intuit that as high yield bonds fall further, this will be a drag on U.S. equity prices for companies with significant debt leverage. There will be a firesale in bankruptcy court, or a line 'out the door' of the courthouse to file bankruptcy motions, if rates continue to rise, credit spreads continue to widen, and the economy continues to soften due to Federal Reserve Bank interest rate 'hawkishness.'
So, what are we doing with this information?
Today, we are net short the model. We purchased and held two 'CQNS stock picks' on Friday and sold them today (Tuesday) for a profit. Those stocks were left for dead, roadkill, with lower valuations. One rallied and reversed while one fell further. The model says they can run hard in an upturn. We like the asymmetric risk-return profile. However, we also cut our losses to avoid a large drawdown.
We hope you find this article interesting, informative, thought provoking and ultimately profitable in your investing journey. For more information, or to learn about becoming a client, please visit our website at https://www.chicagoquantum.com or email me, the author, at Jeffrey@quantum-usaci.com.
Note: to avoid excessive detail, we do not include the dozens of data points, sources, and images, charts and graphs that prove out the current state of the fourteen points. We can point interested readers in the right direction to learn about each one of those data points if they are too difficult to find.