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

The retail investor is warming up to the stock market. We also see the “smart money” is also taking a shine to stocks. It’s rare to see these two classes in agreement. Usually when the retail public becomes euphoric, insiders become fearful.

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We don’t dismiss the widespread belief that the Federal Reserve has lifted asset prices as well as wealth inequality over the last dozen or so years. Keep in mind, though, the Fed was far from the only central bank to greatly expand its bond purchases in this era.

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Some well-known asset allocators see tremendous value in EM equities. Yes, their P/E ratios are low. However, their “PEG” ratios (P/E-to-growth) are not, if the post-GFC period provides an accurate snapshot of sustainable growth.

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It would take a solid December gain of about 5% to bring the S&P 500 back to its all-time high of 4,796.56—printed on January 3, 2022. Well then, what’s been accomplished in the nearly two-year trip to nowhere? For one, valuations for the cap-weighted S&P 500 have receded from truly bubbly readings to levels we’d merely consider “pretty damn high.” 

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The S&P 500’s 8.9% November gain ranks as the 18th largest over the 800 months since the index’s inception in March 1957. Are such short-term market spikes typically followed by additional upside? The evidence is not quite as compelling as the data-mined analysis we found on X (formerly Twitter) initially had us believing. 

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In 2023, the U.S. economy has continued to grow despite recessionary warning flags, while stocks have shrugged off the most aggressive monetary tightening since Paul Volcker’s reign. Impressive.

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The recent rebound in Small Caps still leaves their entire gain off the lows at a fraction of what a typical bull would have delivered. In the long term, that’s an opportunity; in the short term, it’s a warning.

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Richard Russell, who wrote Dow Theory Letters for 58 years until his death in 2015, would sometimes say, “The stock market always does exactly what it is supposed to do, but never when.”

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We still believe the U.S. economy will suffer a recession in 2024, and it’s also possible the official business-cycle peak will be identified (long after the fact) as having occurred in one of these final months of 2023.

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We think Small Caps’ severe underperformance is an economic distress signal that’s been amplified throughout 2023 by the action of financial stocks—and banks in particular. On the same day the Russell 2000 violated its 2022 bear market low, the S&P Financials sector came within 4% of doing the same.

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At the pre-COVID business-cycle peak of February 2020, the qualifying income for a median-priced home was $47,232. As of September 2023, that level had surged exactly $60,000—to $107,232! How many households have enjoyed a pay boost of even one-third that amount in the last four years? 

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Stock market-liquidity is critical piece of the “weight of the evidence,” and its continued deterioration is a reason the Major Trend Index couldn’t break above its Neutral zone thus far in 2023—even at mid-year, when the Technical backdrop was at its strongest (… which was not very strong at all).

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In January, the “inventor” of the yield-curve indicator—Campbell Harvey of Duke University—suggested that the inversion of the 10Y/3M spread was “flashing a false signal,” and a U.S. recession would be avoided.

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The move higher in the unemployment rate is ominous, but in the last couple of quarters there’s been a surprising development that could—if it continues—cushion the blow to profits from a downturn.

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We’re surprised the recent surge in bond yields hasn’t produced any high-profile casualties (… well, aside from three of the four-largest U.S. bank failures in history—but that was back in March).

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With Small Caps still down 30% from their cycle peak, and now undervalued on many of our measures, we’d expect them to be more “levered” to a continuing economic expansion than the more diversified and internationally-exposed Large Caps. But no.

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With the S&P 500 back to near 10% of its January 2022 all-time high as of early November, it might be worth considering the bear market in time since mid-2021.

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The one-year anniversary of the 2022 bear-market low occurs on October 12th, yet—after all this time—we’re not confident enough to declare it as the bull’s first birthday.

We’re interested to see whether or not CBNC breaks out new baseball caps for the occasion, as they did in the late 1990s for “Dow 10,000.”

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At last October’s lows, we had yet to see any manner of economic, monetary, and valuation “reset” that would clear the path for a resilient cyclical bull. And, in the 51 weeks since that bottom, U.S. economic, monetary, and valuation conditions have only deteriorated further.

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The latest market down-leg triggered one of our short-term breadth oscillators into super-oversold territory. While “oversold” may sound bullish to most contrarians, when SPX becomes as internally weak on a 10-day basis as it did in early October, there’s usually another shoe to drop.

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