Weekly Note - May 29, 2024

Current MRI Conditions for the DJIA

If you are unfamiliar with the terminology we use to discuss market resilience please see this link: https://focused15investing.com/language.

As you may recall, the MRI are measures of current market conditions based on the price changes of the index. The MRI are responsive to changes in market conditions but do not allow us to see how conditions might change over the coming weeks and months. The current conditions are:
The Macro MRI is currently in the upleg of its cycle indicating that the long-term trend of the market is positive. 

The Exceptional Macro MRI is present but is weakening and close to the end of its run.
The Micro MRI has moved up rapidly over the last month. Here are the percentile levels over the last few weeks:

    •    April 26: 3rd percentile
    •    May 3: 4th
    •    May 10: 16th
    •    May 17: 41st
    •    May 24: 43rd
The pace of this upleg was rapid, especially in the middle of the month. While the Micro MRI is still in the upleg of its cycle, it is approaching the halfway mark (roughly the 50th percentile). It is possible for it to move meaningfully lower from here but, as of last week, it has not done so.

Taken together, the MRI suggest that we may be nearing a short-term period of greater vulnerability for the DJIA.

In contrast to the MRI, our second set of tools gives us a view of how conditions may change over the coming weeks and months. They measure the naturally occurring shifts in sentiment that are likely to take place over the coming weeks. As mentioned in prior notes, these tools have indicated that at about this time (the end of May) investors are likely to become more pessimistic. Investors can be expected to put a more negative spin on whatever news and events take place. The price declines of the DJIA over the recent days and weeks are probably reflecting both negative news (e.g., persistent inflation and high interest rates, geopolitical tensions) and the more negative disposition of investors.

While we cannot forecast the news, we can forecast the naturally occurring shifts in sentiment. The naturally occurring pessimism is likely to continue into July. At the moment, the MRI may now be detecting the shift to greater market vulnerability.

Because of the expected pessimistic bias of this period, as well as high stock valuations, our portfolios have been only moderately aggressive in 2024. Our lack of aggressiveness has hurt the comparison of our portfolios to the S&P and other portfolios. Yet, our focus is not on these other portfolios. Our portfolios will not be their most aggressive until we move through this period of naturally occurring pessimism and the MRI signal greater market resilience.

Regarding stock valuations, they are high by historical standards and are above the 90th percentile levels since 1997. The price/book, price/sales, and price/earnings ratios of the DJIA are higher than 90% of the readings since 1997. 

Higher Earnings Growth of NASDAQ Stocks

Our NASDAQ-linked ETF has performed much better than that for the DJIA. The largest four stocks in the NASDAQ ETF are Microsoft, Apple, NVIDIA, and Amazon. Together, they represent almost 30% of the entire ETF. These are high growth companies and likely to have higher growth than the top four of the DJIA ETF, which are United Healthcare, Goldman Sachs, Microsoft, and Caterpillar. The higher growth of the NASDAQ companies has made them less sensitive to higher interest rates and has been sufficient to give that ETF much better performance over the last several months. The NASDAQ ETF may be, at least initially, less sensitive to the naturally occurring pessimism and negative economic news than the DJIA ETF.

A Personal Note (update from prior note)

Personally, I would welcome stock price declines because of high stock valuations. There have been ample opportunities over the last three years for the stock market to decline and achieve a more normal valuation level, but it has not done so. As you may recall, our research indicates that we are in a phase of the market in which investors are remarkably unconcerned about valuations. There were similar phases in 1997, 1982, 1970, and 1958. These periods did not see major declines (i.e., losses greater than 20 percent) compared to other market phases and earnings growth did ultimately take place and justify the higher valuation levels. While we can infer from the current MRI that these historical precedents are thus far representative of the current phase, the situation does appear to be changing.