C.J. Lawrence Weekly Market Comment – Healthy Corporate Fundamentals and Stalled Bond Yields Keep the CJL Market Monitor in BUY Territory
The C.J. Lawrence Market Monitor was created in the early 1980s to measure the attractiveness of the stock market. It calibrates the relative appeal of stocks versus fixed income, and tests the internal technical health of the stock and bond markets. Over the Market Monitor’s 38-year history, it has been a useful asset allocation tool. While not developed as a timing model, the SELL signals generated prior to the stock market crash of 1987, and again in the period leading up to the bursting of the internet bubble in 2000, are two of the Market Monitor’s more notable measurements. It went to a HOLD reading pre-financial crisis in 2007 but became more positive when the Federal Reserve instituted their 0% interest rate policy in 2008-2009 during the credit crisis. The Market Monitor’s current reading is “BUY”, with a numerical score of +1, the lowest reading in BUY territory, on a scale of -6 to +6. As the Fed has lifted the Fed Funds target rate, the year-over-year interest rate rate-of-change models have weighed on the Monitor score. But despite rising rates, the cash flow and earnings yields on stocks continue to outshine the relative appeal of bond yields.
The Market Monitor consists of six components. Each is constructed to generate individual BUY, HOLD, and SELL signals. Two of the components are driven by equity fundamentals, two by the direction and rate-of-change in short and long interest rates, and two by technical and market breadth indicators. The interest rate signals were less useful post financial crisis, as rates fell to historically low levels and even small basis point changes had a meaningful rate of change impact. But the interest rate models are beginning to come back into balance as rates are normalized. At this point in the business cycle one might expect that interest rate models would be solidly negative for stocks. But interestingly the Long Bond Model is in neutral territory. The current yield on the benchmark U.S. 30-Year Treasury bond is 2.93%. In May of this year, the yield reached 3.21%. Historically, during rate tightening cycles, this component has generated a negative signal.
The Market Monitor’s positive stance on stocks is understandable given the strength in equity earnings and cash flow generation. As 2Q18 earnings results are recorded, the related Monitor components are likely to strengthen further. Thus, the ongoing battle being waged in the markets, as reflected in our Market Monitor reading, is between the strength of equity fundamentals relative to changes in the risk-free rate of U.S. Treasury bonds. Asset allocators, increasingly worried about the veracity and length of the current bull market in stocks, may find comfort in the CJL Market Monitor’s positive stance. A breakdown in equity market technical metrics and breadth would certainly weaken its conviction, but the improving fundamental backdrop will likely keep the Market Monitor favoring stocks for the balance of 2018. We continue to overweight equities in balanced portfolios.
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