Beware – The Shadow Bear Market

2/1/2016 – What a wild ride to begin 2016. The S&P 500 ended the month down -5.0%, though the index was down -9% on Jan 20th before bouncing back somewhat.

YTD S&P500

Here are the results of the 3 Bull Oak portfolios for the month of January 2016:

Jan 2016 Bull Oak returns

As most of you already know, I have been keeping a close eye on the recent selloff. The all-time high of the S&P 500 was on May 21st, 2015 at a level of 2131.52, which makes the drawdown from that point -8.8% ( the current index price is 1939.38). In May 2015, I became cautious and my portfolios defensive when economic indicators signaled tremendous headwinds. I still hold this viewpoint and believe we are somewhere near the midpoint of the selloff. In this market environment when market pundits and experts differ on where we go from here, I have decided to be patiently opportunistic. I am waiting for a suitable entry point where I can reallocate my three strategies to take advantage of lower equity prices. I do not know when that will be, but I am fairly confident that we have not yet bottomed out. Yes, stock prices are 9% cheaper than they were last May. Yes, I suppose you can call this a “sale.” Though, I do not believe stocks are cheap. There is a difference.

This brings me to the point of this post: is the S&P 500 price level telling the whole story? Is the U.S. large-cap stock market really down 9% from their peak? Well, it all depends on how you look at the index. As a quick recap, the S&P 500 is a capitalization-weighted index. This means that the 500 (or so) stocks in the index are not weighted the same. Apple Inc. (AAPL) is not represented the same way as, say, Ford Motor Co. (F). Because Apple is a larger company, as defined by it’s market capitalization (share price times the number of shares outstanding), it receives a larger weighting within the index. The larger the company, the larger the representation.

So, when we look at the index and it’s price movement, is it telling us an accurate story of how all of the 500 companies are performing? What if we wanted to know how the average company within the index is performing. Isn’t this what we really want to know if we are trying to figure out whether or not the market is healthy? In order to achieve this, we can look at an equal-weighted benchmark where all of the companies within the index are represented equitably. By comparing this index to the S&P 500, we can see that the average U.S. large-cap stock is not holding up as well as we originally thought.

Screen Shot 2016-02-01 at 8.08.14 PM

The blue line (RSP) represents the equal-weight S&P 500 ETF (down -12.6%). The red line is the ordinary market-cap weighted S&P 500 (down -8.8%). To answer our previous question,  the answer is no. The average U.S. large-cap stock is not as healthy as the headline number would suggest (“healthy” is a subjective term in this case). The 380 bps difference between the two tells quite a story!

So, what does this mean? This means that the index is being propped up by a few companies (e.g. GOOGL, FB, NFLX, etc.). The narrow breadth of the market shows that the index is not strong as most would believe. This is one among many economic and market indicators that keep my market enthusiasm dampened. Along with the high yield selloff (that has yet to subside) and a slowing global economy (among others), I remain patient and defensive. No need to catch a falling knife. Or to get mauled by a bear.

 

Ryan Hughes
Bull Oak Capital
Bull Oak Newsletter
2/1/2016


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While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.