Research.LeutholdGroup

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Latest numbers are largely in line with expectations. Higher wages boost the wealth effect, which supports the economy, which also means inflation and rates are likely to stay higher for longer. The latest update of our inflation scorecard shows inflation pressures are starting to build again.

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The 10-year yield made a new cycle high just before the Jackson Hole meeting. That is significant, as it not only broke the lower-high-lower-low pattern since last October, but also rejected the hypothesis, “we have seen the cycle high in interest rates,” which was the consensus at the start of 2023.

The Broker-Dealer Index (XBD) is one of just a handful of indexes to surpass its old bull market high, but its gains are far below average for the first year of a major advance. Meanwhile, the BKW Bank Index (BKX) is revisiting price levels of 25 years ago—it is just one percent above the average daily close in 1998. Yes, as a group, the big banks have been dead money for 25 years (excluding dividends).

After hovering near the highs of the post-COVID expansion, in August, the Present Situation Index turned down, and is now below its 10-month moving average for the first time since December. When this measure is at a high level, but declining (like now), it is the worst backdrop for stock performance.

Based on successful Russell 2000 VLT BUY signals, 1982-forward, the index had gained an average of 23% eight months later—and none had a losing position. Since the VLT BUY on January 31st (eight months ago), the Russell 2000 has dropped 3.9%. Furthermore, Small Caps bottomed 15 months ago, and in a normal cyclical bull market, the Russell 2000 would be up 50-70% by this time.

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An outstanding second half for Q2-23 earnings pushed the S&P 500 bottom-up EPS estimate from $51.30 to $54.92. Amazon and Nvidia were the two largest contributors to the August surge. With the entire index nearly done reporting, our current EPS estimate will end 11% below its high watermark ($61.56).

Despite skyrocketing investor enthusiasm, buy-write strategies are complicated investments with skewed payoff structures that muddle the interpretation of past performance, because returns depend on market conditions.

Read this week's Major Trend.

Read this week's Major Trend. 

Latest numbers are in line with expectations. There are several indicators that start to paint a more muddled picture on inflation going forward. The latest update of our inflation scorecard shows a Neutral reading of 50.

Read the latest MTI update.

All the talk has been about mega-cap growth stocks, but equities with low-quality characteristics have fared even better. High beta, negative earnings, and those with high short interest have trounced the rest of our universe.

The market broadened enough in July for the NYSE Daily A/D Line to “confirm” new SPX highs—a statistical positive: When the A/D Line made a concurrent 12-month high during July, the average return for August-December was +6.5% versus -1.1% when breadth didn’t confirm the index.

As we’ve noted, none of the major indexes has kept pace with the typical path traced out during past cyclical upswings. It has since occurred to us that this nearly ten-month stock rally is being compared to an unrealistically high standard: The current advance doesn’t have the advantages enjoyed by bulls that launched out of recessionary conditions.

If today’s stock market is indeed a new bull, its vital signs advise that it is more in need of a coffin than a cradle. Monetary policies, both in terms of rate hikes and the inverted curve, have never been more hostile at this stage of a major stock market upswing.

The active/passive performance derby experienced a severe case of whiplash the last three months. Through the end of the first quarter, market conditions were advantageous for active managers, now the second quarter has revealed a massive shift in favor of passive styles.

Many investors appreciate the benefit of covered-call strategies, but we wonder how many truly understand the opportunity costs of buy-write funds over time—or under differing conditions. On the surface, these approaches are simple, but they have complicated payoff patterns relative to stock and bond funds.

Q2-23 reporting is about halfway complete for firms in the S&P 500. Bottom-up operating EPS estimates for Q2 are once again sliding lower as we wade farther into earnings season. This attrition is not uncommon but it is certainly a break from Q1 announcements, where EPS estimates rose 5% over the course of reporting. Q1’s action was a bullish talking point for many who touted the end of higher-than-normal erosion in forward EPS estimates over the past year. Since peaking in April 2022 at $61.56, Q2’s EPS estimate has shrunk nearly 17% (Chart 1).

Read this week's Major Trend.

Read this week's Major Trend.  

After years of wandering in the wilderness, Japanese stocks are leading the world’s developed markets higher in what has been a robust opening half of the year. The table shows Japan leading the world’s ten largest developed markets (as measured by the MSCI family of international indexes) with a 24% local currency return through June, easily outpacing the pack. Even as the MSCI USA index gained 17% by successfully “fighting the Fed” this year, Japan surged another 7% beyond that outstanding result.  We were curious to understand the nature of Japan’s spectacular run in 2023, looking to identify the drivers of this strong and relatively quick jump higher.

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Latest numbers are below expectations. Various leading indicators point to softer CPI prints ahead. The prevailing soft-landing narrative underestimates the chances of inflation staying higher than what is acceptable to the Fed.

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Despite this year’s massive underperformance by the Equal Weighted S&P 500, the median stock doesn’t appear substantially more attractive than the cap-weighted index. Three of five valuation measures are now back in the top decile of readings, which we’d consider pricey in any monetary or economic backdrop.

With leading economic measures still trending down, optimists who advocated against fighting the Fed during the free-money era have ditched their own advice. Their focus is now on lagging indicators, like the employment numbers—but that last bastion of strength seems ready to buckle.

The latest pause is widely expected to be short-lived, but many things can happen to extend the pause or even completely end the tightening cycle. While some markets show little distinction between a final pause and an interim one, most behave in a way that’s consistent with the economic backdrop.

This Leuthold Refresh updates our Factor Tilt analysis, an ongoing process to evaluate the attractiveness of commonly accepted investment styles. Factors are investment characteristics that have historically produced excess risk-adjusted returns, but relative results fluctuate over time.

After being ignored for a generation, Japanese stocks are roaring in 2023. The Nikkei puts the S&P 500’s 16.9% YTD gain to shame with its +28.7% return. With developed international equities (ex-Japan) up a paltry 9.5%, diversification from expensive U.S. stocks cannot fully explain Japan’s surge.

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Read the latest Major Trend Index.

The Fed’s June announcement of a pause with further rate hikes to come has extended the uncertainty of whether an inverted curve and persistent policy tightening will ultimately lead to a recession. The business cycle is a critical investment issue because the relative returns of many assets depend on the state of the macro economy. This study examines the Consumer Discretionary (CD) sector’s behavior in recessionary times, with the goal of understanding the typical performance pattern during economic lows in order to help investors position their portfolios for a potential recession.

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With the halfway point of 2023 two weeks away, the S&P 500 has broken out to a 12-month high. The index has accomplished that feat 32 times during the month of June—or exactly one-third of all cases measured back to 1928.

CPI readings for May were pretty much in-line with consensus estimates. Trends continue to play out as if we’re in the last few innings of rapid YOY price increases. Inflation and a deflating asset bubble have led to atrocious real returns across all asset classes.

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Years preceding presidential elections are more likely than others to feature stock-price action that is favorably disconnected from the fundamentals. Since 1926, the average S&P 500 gain in a pre-election year is +14.2%—about double the next-best year of the cycle.