Disappointing earnings season could drive contingent selling, says Ned Davis' Tim Hayes

Key Concepts

• Mature Bull Market: A bull market that has lasted a significantly longer period than historical averages, increasing the risk of correction.
• Market Breadth: The number of stocks or markets participating in an advance, indicating the health and sustainability of a trend.
• Emerging Markets (EM): Developing economies with potential for high growth, often offering attractive valuations.
• Deep CSI Program: China’s Science and Technology Innovation Board, a catalyst for investment in Chinese technology.
• PE Ratio (Price-to-Earnings Ratio): A valuation metric comparing a company’s stock price to its earnings per share.
• Don't Fight the Tape/Fed: Investment principles suggesting aligning with prevailing market trends (the “tape”) and Federal Reserve policy.
• Commodities & Materials Emphasis: Investment focus on raw materials and related industries, benefiting from global demand.

The Maturing Bull Market and Emerging Market Outperformance

The interview with Tim Hayes, Chief Global Investment Strategist at NED Davis Research, centers on the current state of the equity market, specifically highlighting the outperformance of Emerging Markets (EM) and the characteristics of a maturing bull market. Hayes argues that the current bull market, lasting since 1900, is exceptionally long – twice the historical median and the ninth longest on record – making it vulnerable to correction. He notes that while trends are positive, market breadth has been weak, lacking the strong momentum needed for a sustained upward trajectory. “It’s a mature bull market…most bull markets don’t last this long,” Hayes stated, emphasizing the historical context.

Emerging Market Drivers and Performance

A significant portion of the discussion focuses on the factors driving the recent surge in Emerging Market performance. Hayes identifies two key events as turning points: the inauguration of Donald Trump and the announcement of the Deep CSI program in China. The Trump inauguration initially caused US underperformance due to tariff concerns, while the Deep CSI program spurred investment in Chinese technology.

He explains that EM began to accelerate around the end of October when Mediac announced its earnings, triggering problems for large-cap US tech stocks. This created an opportunity for EM tech stocks, which offered more attractive valuations. “We pointed out how the median PE of the top EM stocks has been so much lower than the median PE of the US tech stocks,” Hayes clarified, highlighting the valuation disparity.

Furthermore, the recovery of EM currencies, particularly in Brazil and South Africa, contributed to their strong performance, boosted by the commodities and materials sector. Specific examples include Taiwan and Korea, benefiting from their leverage to the semiconductor industry. The EM tech sector has risen 20% in the last 21 days, while the US tech sector has been the weakest, suggesting a shift in investment towards better value tech outside the US.

The Semiconductor Trade and Global Dynamics

Hayes addresses the question of whether the US semiconductor trade needs to perform for Taiwan and Korea to continue their success. He suggests that investors aren’t necessarily exiting tech altogether, but are transitioning into more attractively valued tech stocks found in Emerging Markets. This implies a global reallocation of capital within the technology sector.

Navigating the Current Market – “Don’t Fight the Tape/Fed”

Hayes’ firm operates under the principles of “Don’t Fight the Tape and Don’t Fight the Fed.” Currently, the “tape” suggests continued upward momentum, while the Federal Reserve’s policy is seen as a positive factor. As a result, NED Davis Research maintains a modest overweight position in equities, but remains cautious. “We’re maintaining a modest overweight to equities. So we haven’t yet…we’re not yet saying it’s time to get out,” Hayes stated.

He anticipates the market will attempt to move higher, contingent on the upcoming earnings reports. A renewed momentum following earnings could signal further gains, while disappointment could lead to a correction.

Data and Statistics Mentioned

• The current bull market is the ninth longest since 1900.
• EM tech sector is up 20% over the last 21 days.
• The median PE ratio of EM tech stocks is lower than that of US tech stocks.
• MSCI Emerging Markets ETF is on track for its biggest monthly inflow since inception in 2012.
• MSCI Emerging Markets ETF is currently outperforming the S&P 500 by the most since March.

Logical Connections

The discussion flows logically from a broad assessment of the overall market cycle (maturing bull market) to a specific analysis of Emerging Market performance. The explanation of EM’s outperformance is linked to specific events (Trump inauguration, Deep CSI program) and valuation dynamics (PE ratios). The discussion then connects EM performance to the global semiconductor trade and concludes with a cautious outlook based on the firm’s investment principles (“Don’t Fight the Tape/Fed”) and the upcoming earnings season.

Conclusion

The interview highlights a potentially significant shift in market dynamics, with Emerging Markets gaining traction as the US market matures. Driven by factors like the Deep CSI program, attractive valuations, and currency recovery, EM is presenting a compelling investment opportunity. However, Hayes emphasizes the need for caution, acknowledging the inherent vulnerabilities of a long-running bull market and the importance of monitoring upcoming earnings reports. The key takeaway is that investors should consider diversifying into EM, particularly within the technology sector, while remaining mindful of the broader market risks.