Inside The Stock Market ...trends, cross-currents, and outlook

As noted earlier, “Don’t fight the Fed” is an adage that last year’s performance seems to have debunked, although we think it is too early for equity investors to declare victory.

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It’s too soon to know if the October low for small caps will stand, but it would have been a better, more buyable low if it had been accompanied by a recession. It’s all about “initial conditions.” Russell 2000 lows associated with recessions bottomed with a normalized P/E multiple nearly five points below that of the median multiple for non-recessionary lows—and subsequently gained an average of 185% versus +75%.

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Last month’s break in the S&P 500 above its January-2022 high means that we must officially label the rally since October 2022 as a new bull market. This also means we can now say with certainty that the October-2022 low was the priciest bear market bottom in history—and by a long shot.

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Yale professor Robert Shiller popularized the idea of smoothing out earnings for cyclical fluctuations about 25 years ago. However, about 25 years before the famed “Shiller P/E,” Steve Leuthold was charting S&P 500 5-Yr. Normalized EPS by hand. 

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The jobs numbers are not the first we’d expect to provide evidence of an impending economic turning point, but that is not the view of those in the soft-landing camp. And the most recent “soft” (survey-based) employment numbers have probably contributed to that camp’s swelling membership.

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The stock market leader in the first month of the new year has an above-average chance of persisting during the remaining eleven months. Historical results showed this to be true, not only for index results, but at various other levels of granularity, including sectors, themes, and asset classes.

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As detailed elsewhere in this section, the notion of an economy with unstoppable momentum is undermined by an historic divergence between real growth estimates (GDI vs. GDP), and by the weakness in full-time jobs and total hours worked.

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Remember the nickname for retired San Antonio Spurs star Tim Duncan? “The Big Fundamental.” The stock market itself is a big fundamental—and that’s probably truer now than in past cycles, since market capitalization relative to U.S. GDP is larger today—with the exception being the most extreme phase of the post-COVID mania.

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The S&P 500’s inflation-adjusted gain over the last twelve months is 21%, far above any previous reading seen on the doorstep of a U.S. recession. In other words, the wealth effect—a major contributor to the 2021-2022 inflationary spiral—is back again.

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There are reports that 40% with student loans did not make an initial payment when installments resumed in October. Meanwhile, among seniors aged 65-79, the share with a mortgage rose to 41% in 2022, up from 24% in 1989, while the percentage of those aged 80+ with a mortgage increased from 3% to 31% during the same time! 

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The S&P 500 upswing from its October 2022 low reached +34% at the 2023 high point on December 28th. That’s roughly ten percentage points behind the average gain at the same point of the past 15 major advances since 1957.  Still, it’s a solid gain.

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After the S&P 500 lost 25.4% into its low in October 2022, the fundamental characteristics surrounding the market at that time were hardly the type that pave the way for a multi-year bull market. We’ve therefore maintained that even the most rabid bulls need to temper their expectations. 

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The shortfall of 12.7% in the Equal Weighted S&P 500 compared to the Cap-Weighted version was its second-worst annual showing. Thanks to the lagging action, the valuation profile for the average Large Cap stock has improved.

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There’s a huge difference between having an awareness of the myriad calendar phenomena impacting the stock market, and actually acting on them.

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In the theme that’s reminiscent of all but a couple of the last 15 years, the optimal strategy for equity managers and asset allocators in 2023 was the same: Buy the S&P 500, and then hit the links.

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There’s an old stock market adage that says if the bulls come for Thanksgiving, then the bears will have Christmas. Last month though, Thanksgiving was one of the few days stocks didn’t go up (… but only because the NYSE was closed). No problem. The market found plenty of other November excuses to rally.

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Equities have dodged the impact of this year’s monetary tightening, and Large Cap Growth stocks have once again proved to be the most artful dodgers.

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Our Major Trend Index is not an economic forecasting tool. Still, we thought a U.S. recession might be imminent when the MTI dropped into bear territory on October 6th.

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It’s no surprise that investors have become giddy after the November upside explosion brought the year’s S&P 500 gain to near 20%. The question is whether the giddiness is excessive in light of the price action. The answer is that it is extremely close.

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Lately a few readers have asked how or when we will know that the still-negative leading economic indicators have failed. We don’t have a good answer, other than to observe market-based economic measures for sharp recoveries, like cyclical stocks, corporate credit spreads, and industrial commodity prices.

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