Two random observations to pass along today. They're not related (at least directly). I'm just throwing them into this post together.

Market breadth narrowing again

Much has been written about the "FAANG" stocks — Facebook, Apple, Amazon, Netflix, and Google (Alphabet) — as this tech quintet has dominated this long bull market. While this is anything but a new story, what is new is the fact that these 5 stocks have been about the only ones continuing to advance over the past 10 weeks (since the beginning of March).

The S&P 500 as a whole has gone nowhere since the 1st of March, closing that day at 2,395.96. Yesterday's closing level was 2,397.88. But as the chart below from John Alexander at MacroCharting shows, the FAANG stocks have continued to rise, while the other 495 stocks in the index have declined by a corresponding amount.

There's no specific take-away from this information, although it's generally considered to be a warning sign when the market's breadth (i.e., the percentage of stocks continuing to advance) narrows. As I mentioned, this FAANG phenomenon is nothing new, as these 5 companies have been dominating for several years now. But it's worth noting that the last time the breadth story became enough of an issue that SMI was discussing it was in late 2015. Perhaps coincidentally, perhaps not, that was about the time the market went through a pair of 12% corrections within a span of 7 months. However, there's no particular reason to think the timing of those corrections was specifically tied to any particular measure of market breadth.

If anything, seeing the continued focus of the market being channeled into such a narrow list of really expensive stocks makes me think how vulnerable the indexes generally (and index fund owners by extension) are to adjustments in the pricing of these handful of stocks. Amazon is a phenomenal company, and with a P/E ratio of 180 it had better be! We love the Netflix product too, but a P/E over 200? Wow.

Valuations look better overseas

Sticking with the valuation topic, I'm seeing more and more written about the disparity in valuations between U.S. and foreign markets. This MarketWatch article is a good example, providing the following chart that shows how dramatically the performance of U.S. and Foreign markets has diverged since 2011.

Eyeballing this chart, it appears that over the past 10 years U.S. stocks have gained 62% while Foreign stocks have lost 16%, with most of that gap opening over the past six years. Clearly, owning foreign stocks lately has been a drag on performance.

But it's worth noting these types of multi-year performance gaps between U.S. and Foreign stocks are common. Here's another chart that shows this clearly.


The upward spikes show the periods when U.S. stocks have had the upper hand, while the downward spikes show the periods when Foreign stocks have been the better performers. While this decade (2011- ) has been dominated by U.S. markets so far, the shoe was on the other foot for much of the prior decade (2001-2010).

Not surprisingly, when one market dominates the other for a period of time, as the U.S. has since 2011, valuations eventually get stretched between the two. This has definite implications for each market's future prospects.

Here are GMO's 7-year projected returns for various asset classes, based largely on today's valuations of those asset classes.


While all of these projections are depressingly low, on the stock side of the chart, you can clearly see how today's elevated valuations have impacted the likely future returns of U.S. stocks (both large and small). GMO projects U.S. stocks will be lower seven years from now than they are today (negative annualized returns). Their prognosis isn't great for International stocks either — slight losses for them as a group — although they expect slightly brighter skies for stocks from the Emerging Markets subset of the international group.

DAA investors have likely noticed that foreign stocks have been 2017's top performing group so far. There's no way to know whether that will continue in the short-term, but the longer-term trends seem to indicate that having the 20%-30% type of foreign allocation included in most of SMI's strategies will be a good idea in the years ahead.