More Bad News For Active Managers?
Stocks posted strong weekly gains, led by tech shares, as investors cheered renewed optimism on the U.S.-China trade front on Friday.Bob Pisani of CNBC also reports, Now that the market has broken through key resistance, here’s what’s next:
The Dow Jones Industrial Average climbed 138.93 points to 25,848.87 as Boeing shares turned around to close 1.5 percent higher. Boeing’s turnaround was sparked by a report saying the company planned to roll out a software upgrade for its 737 Max aircraft. The stock had been under pressure all week after an Ethiopian Airlines flight using a 737 Max plane crashed on Sunday, which prompted several countries to ground flights involving the plane.
Gains in the tech and consumer discretionary sectors pushed the S&P 500 up 0.5 percent to 2,822.48. Tech shares also bolstered the Nasdaq Composite, which climbed 0.8 percent to 7,688.53.
The S&P 500 and Nasdaq Composite both rose at least 2.9 percent, though the laggard Dow gained only 1.7 percent amid Boeing’s troubles. The S&P 500 also posted its biggest one-week gain since November.
Stocks have been on a tear this year, with the three major indexes rising more than 10 percent each in 2019.
“Coming off the lows in December, we thought that was a volatility event. We thought we could get back to those all-time highs by about late March to early April,” said Craig Callahan, president at Icon Funds. Valuations “still backs up that view.”
This week’s gains were largely led by tech shares, as the sector surged 4.9 percent. The tech sector also became the best-performer of 2019. Nvidia was the best-performing stock in the sector, rising more than 12 percent while fellow semiconductor stocks like Broadcom and Lam Research also rose sharply this week.
Semiconductor shares rose broadly on Friday, as the VanEck Vectors Semiconductor ETF (SMH) climbed 2.7 percent. Broadcom shares led the gains, rising more than 8 percent after the company reported better-than-expected quarterly earnings.
“There’s less of a reason to sell; it’s more of a reason to just sit tight and see which way things go,” said Michael Katz, managing partner at Seven Points Capital. “Everybody is looking for a dip that’s not really coming.”
“Barring any macroeconomic news, any North Korea-related news, any negative news coming out of the China trade deal, I think the momentum is still just holding,” Katz said. “At the same time, [the market] is getting up there.”
Chinese Vice Premier Liu He spoke via telephone with U.S. Treasury Secretary Steven Mnuchin and U.S. Trade Representative Robert Lighthizer, Xinhua news agency reported Friday. The report, according to The South China Morning Post, said: “The two sides have further made concrete progress on the text of the trade agreement between the two sides.”
The news comes after CNBC reported Thursday that Chinese negotiators suggest combining a state visit to the U.S. with the signing of a trade deal. Beijing wants a deal to be fully ironed out before President Xi Jinping meets with U.S. President Donald Trump.
“US-China trade negotiations will likely reach a temporary deal, transforming future negotiations into a framework to monitor China’s compliance with trade and intellectual property policies,” Alberto Gallo, head of macro strategies at Algebris Investments, wrote in a note. He added, however, that “binary events” like this “may not translate into tail risks.”
AT&T shares rose 1.3 percent after Raymond James upgraded the telecommunications giant to outperform from market perform, citing an attractive valuation relative to rival Verizon. “We believe that the combination of positive earnings growth and delivering over the course of the year will being investors back to AT&T,” analyst Frank Louthan said in a note.
Ulta Beauty surged 8.3 percent on the back of better-than-expected quarterly earnings. The company’s same-store sales also rose 9.4 percent, topping an estimate of 7.9 percent.
Tesla shares fell 5 percent after investors were left disappointed with the unveiling of the Model Y, the car company’s latest electric vehicle.
The S&P 500 closed up 2.9 percent for the week, its best so far this year. It’s now at the highest level since early October, after breaking through key resistance levels near 2815, where it failed several times.I agree, the key to a further rally is signs of global growth which is why I'm tracking Global M-PMIs and other manufacturing indexes and emerging market stocks (EEM) very closely (click on images):
The S&P is now less than 4 percent from the old historic closing high (2,930 on September 20).
Key observations:
1) Traders increasingly believe global central banks have their backs.
2) With the CBOE Volatility Index at 12, its lowest level since October, strategies driven by volatility would likely add to stock exposure.
3) Bond yields continue to drop, remaining near the lows of the year. The new-high list this week was littered with interest-rate sensitive stocks (utilities, REITs) that rally when rates remain low.
4) Quadruple witching (quarterly expiration of index options and futures, and stock options and futures) has added a lot of volume this week and likely contributed to the upside rally. But the question is whether the expiration exhaust near term demand. The S&P 500 tends to be lower in the week after quadruple witching.
5) Europe (and the U.K.) have outperformed the U.S. this month. There are some hopes for a bottom in the recent poor economic data.
6) Downward earnings revisions are slowing to a crawl. The rate of downward earnings revision for the first quarter was intense from January into mid-February, slowed in the next several weeks and has essentially stopped this week. First-quarter earnings are now expected to be down 1.5 percent for the S&P 500, according to Refinitiv. If it stays in that range, there is a good chance earnings will be positive for the first quarter (companies tend to beat analyst estimates), and we will avoid an earnings “recession,” at least one that began in the first quarter.
7) The key to a further rally: positive comments on global growth. The two key names next week are Micron and Federal Express, which are both scheduled to report earnings. Both had big drops last quarter and saw lower earnings estimates on concerns over China and (for Micron) increasing competition.
As you can see, Global M-PMIs are still deteriorating for developed markets but improving for emerging markets. The Emerging Markets ETF just broke above its 50-week moving average which is good news for global growth, as long as it continues. And with the Fed out of the way for now, it should continue.
Nevertheless, looking at the Purchasing Managers Indexes, you see there is weakness in some developed markets (Eurozone, Japan) and the US and UK are decelerating. Among the BRICS, India and Brazil are doing well but Russia and China are weak (click on image):
That's why everyone is looking for a confirmation that global growth is picking up, it will give investors a sigh of relief.
It's too early to tell but one thing which is encouraging is the absence of inflation, allowing bond yields to go lower and long bond prices (TLT) to go higher (click on image):
In turn, lower bond yields have helped push the S&P 500 (SPY) higher (click on image):
The breakout in stocks has been nothing short of spectacular which is why at the beginning of the month, I said don't discount the possibility of another bubble, especially if the Fed stays on the sidelines longer than anticipated.
Sure, stocks have entered March madness, it will be volatile especially after quadruple witching, but if stocks keep grinding higher, it could cause all sorts of problems for active fund managers who trail the S&P 500 for the ninth year in a row:
It’s the triumph of indexing: Fund managers continue to trail their benchmarks.Unless we see a prolonged bear market, and even then, I just don't see what is going to change US active managers' fortunes.
Active managers who claim that they would do better during periods of heightened volatility are going to have to find another argument.
This week, S&P Dow Jones Indices released its annual report on how actively managed funds performed against their benchmarks. The conclusion is that active managers continue to show dismal performance against their passive benchmarks. For the ninth consecutive year, the majority (64.49 percent) of large-cap funds lagged the S&P 500 last year (click on image).
“The figures highlight that heightened market volatility does not necessarily result in better relative performance for active investing,” the report said.
“What’s different about 2018 was the fourth quarter volatility,” Aye M. Soe, a managing director at S&P and one of the authors of the report, told CNBC. “Active managers claimed that they would outperform during volatility, and it didn’t happen.”
The study will bolster the claims of many financial advisors, who say that investing in low-cost, passive funds remains the soundest long-term investment.
This is not a one-year phenomenon. S&P has been doing this study for 16 years, and the long-term results only strengthen the claims for index investing. Indeed, while a fund manager may outperform for a year or two, the outperformance does not persist. After 10 years, 85 percent of large cap funds underperformed the S&P 500, and after 15 years, nearly 92 percent are trailing the index (click on image).
Long-term, the numbers were not much better in other categories like small-cap stocks or fixed income: “Over long-term horizons, 80 percent or more of active managers across all categories underperformed their respective benchmarks,” the report concluded.
Looking at managers’ overall record last year versus the broader S&P 1500 Composite, 2018 was the fourth-worst year for stock managers since 2001 (click on image).
Critically, the study adjusts for “survivorship bias.” Many funds are liquidated because of poor performance, so the survivors give the appearance the overall group is doing better than it really is.
“The disappearance of funds remains meaningful,” the report notes. Over 15 years, 57 percent of domestic equity funds and 52 percent of all fixed income funds were merged or liquidated.
Picking stocks is a very, very, very difficult game. Very few managers have a long-term stellar track record, and if stocks continue melting up, a lot of active managers worried about career risk are going to jump on the bandwagon or risk underperforming for another year.
Let me end with some US stock market data.
Have a look at the how the S&P sectors performed this week, courtesy of barchart (click on image):
As you can see, all the major sectors were up this week with Technology (XLK), Healthcare (XLV), Energy (XLE) and Financials (XLF) leading the way. Industrials (XLI) were the weakest sector but that was because of Boeing (BA) which got hit hard this week following concerns with its 737 Max planes.
And here are the top-performing US stocks for this past week, courtesy of barchart (click on image):
Once again, small cap biotechs led the way, with incredible action on some of these stocks, like Atossa Genetics (ATOS) which was up over 300% yesterday and down 50% today but still managed to clinch top spot for the week following an FDA special approval for its breast cancer drug Endoxifen.
Also, here are the top large cap stocks year-to-date, courtesy of barchart (click on image):
No wonder active managers are having a very hard time beating the S&P 500 and why most large global asset allocators are indexing their large cap US exposure.
Below, CNBC's Rick Santelli and David Bailin, Chief Investment Officer at Citi Private Bank discuss the future path of the markets. I agree with Santelli, if rates keep going lower for bad reasons, it will hit stocks hard.
Second, Chief U.S. Economist at J.P. Morgan Michael Feroli discusses why he believe the Fed will not raise interest rates this year. Again, if yields keep going lower for all the wrong reasons, the Fed might cut rates this year.
Third, is a Fed rate cut looming, and what does that say about the economy? With CNBC's Melissa Lee and the Fast Money traders, Steve Grasso, Brian Kelly, Steve Chiavarone and Guy Adami.
Lastly, ECRI's Lakshman Achuthan builds his bearish case on a chart of falling semiconductor shipment demand. If he's right, get ready for a second half global slowdown.
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