Inside The Stock Market ...trends, cross-currents, and outlook
Profits: Give Credit Where It’s Due
Twenty-five years ago, few investment axioms were held more dearly than the belief that corporate profit margins were “the most mean-reverting series in finance.” Today, if there’s anyone still clinging to that belief, he or she is unwilling to say it publicly.
In Hindsight, It Was Obvious!
The S&P 500’s Very Long Term (VLT) Momentum algorithm generated an immensely profitable low-risk BUY signal in March 2023. Its trajectory since then has vaulted ahead of the average gain following profitable signals back to 1957, and historical results call for still higher prices over the next year, albeit at a likely more muted pace.
Implications Of A Great First Quarter
Realizing a gain in each of the first three months of the year, like Q124, is not as bullish for the next twelve months as are back-to-back gains in January and February. The three-month streak produces a one-year performance advantage of around 2%, while a string of Jan-Feb gains was additive by 900 bps.
Technicals: Four On The Floor!
The market upswing is now confirmed by Cyclicals, Defensives, Breadth, and Bonds. Endorsement by all four occurs about one-third of the time and has led to an S&P 500 average annualized compound return of +15%.
Bubbling Up?
We are not sure whether the stock market’s upswing has reached an altitude that qualifies as “bubbly.” Based on numerous measures, the S&P 500 looks dangerously close.
The Ghost Of Bubbles Past
Our 30x bubble-P/E threshold did a good job of capturing the most speculative phase of the Technology Bubble, as the S&P 500 traded north of that ceiling from early 1999 until the fall of 2000. That bubble and its aftermath should serve as a reminder that the already tenuous connection between the stock market and the economic cycle can become even more unstable during bubble periods.
Stocks “Inoculating” The Economy?
We must acknowledge that our current thinking on the stock market and U.S. economy is based on an element of circularity of which we’re not completely comfortable.
The Inversion: Forgotten, But Not Gone
Mentions of the yield curve by the financial media and market pundits have plummeted the last few months. That’s understandable, but dangerous. We remember the same happening in 2007—with one of the more memorable dismissals coming from Fed Chair Bernanke.
“J” Giveth And “J” Taketh Away
During a summer internship almost 40 years ago, we’d stay a few minutes late on the Chicago Merc’s trading floor for the Thursday afternoon release of the Fed’s money supply numbers. Today, thanks to the joint efforts of “JJ” (Jay Powell and Janet Yellen), the analysis of monetary trends is infinitely more complex.
Which “New Highs” Are They Talking About?
Recent gains have failed to lift the market-cap/GDP ratio back to old highs and, to date, no major index has fully reversed its bear-market loss if the cumulative effect of 2+ years of consumer price increases are considered—small caps look especially bad when viewed through that lens.
Broader Than It Looks?
Breadth and leadership of this bull market have fallen short of the typical patterns of early-cycle bulls, even if contrasted only to other new bulls that did not emerge from recessionary lows, like 1962-66 and 1987-90. Still, participation looks broad enough that the odds are against an imminent cyclical peak.
Bettering An Old Barometer
The team at Caron Wealth Management recently published a modification of the January Barometer strategy, and the results are far-superior: With only two exceptions, when SPX closed higher in both January and February, the index ended the year (ten months later) with an additional average gain of 12%.
Narrower Than It Looks?
It’s been 26 months since the all-time peaks the NYSE Weekly and Daily Advance/Declines Lines. The weakness in the Daily version is especially troublesome given the strong upward bias it’s exhbited since 2001. In addition, figures for 52-Wk. New Highs and New Lows have been anemic relative to the major index gains—especially among NASDAQ stocks.
Superficial Strength?
The stock market remains “externally” strong, with the S&P 500 and DJIA at new all-time highs on February 2nd. However, the YTD performance gap between the S&P 500 and the Russell 2000 is already 8%—the worst five-week start ever for Small Caps on a relative basis. And, on a trailing 12-month basis, the percentage of S&P 500 stocks outperforming the index, itself, is the lowest on record at just 25.6%. That’s made it a challenging time for active managers and dart-throwers alike.
Hold Your Horses
The soft-landing camp is growing, but the new members are not offering anything original to support their case. Most believe the yield curve is broken, though many argued the same in both 2007 and 2019. They say households are in good shape, but that is only true for the consolidated consumer balance sheet and it’s the behavior of marginal consumers that’s most critical at turning points.
Circular Logic?
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.
Sizing-Up Small Caps
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%.
P/E Multiples Still Matter
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.
The Many Flavors Of EPS
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.
January Jobs: Not So Stellar
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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