Research.LeutholdGroup

Losses in the Russell 2000 Growth Index and the NYFANG+ Index have topped 40%, and the only true equity rockstar, spawned by a 13-year secular bull market, has watched her fund’s value drop by more than three-quarters. Yet there’s still a televised debate as to whether this decline is even a bear! Could there be a more devious creature on the face of the planet?

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Lent ended last week, allowing Christians to resume the intake of unhealthy foods. But rather than a nice, thick T-Bone steak, we’d suggest sampling one of the few items that’s fattened investors’ accounts in 2022—the Donut!

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Just after yesterday’s close, we loaded our precocious bull into an SUV and drove to the local veterinary clinic for a two-year checkup.

Our bovine buddy drew some sympathetic stares while we were waiting in the lobby. Noting our bull’s droopy eyelids and gray facial hair, an assistant informed us, “You know, you didn’t actually need to bring him here. We now have a mobile euthanasia service.” We just smiled, and waited for the veterinarian, who is said to be a specialist in this new super-species of bull.

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Well before the war drums in Eastern Europe began to beat, this stock market correction had already been marching to a different beat. The market’s confusion might be understandable, because—unlike during most of the post-GFC corrections—it has so far failed to “self-medicate!”

A persistent feature of stock market declines in the past 13 years has been that they have typically triggered a simultaneous falloff in bond yields.

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It’s probably about high time that we check in with our past and present members of the esteemed 4% Club. For those of you not familiar with this vignette: back in the day, achieving a 4% weight in the S&P 500 had been a rare feat, occurring only during periods of extreme enthusiasm for technology, conglomerates or oil. The blessing of membership soon turned into a curse, with most taking just a cup of coffee behind the velvet ropes before being thrown to the curb because of dramatic underperformance to the rest of the Index. Our two most recent inductees seem to be following the proper established Club protocol for not lingering at the party too long. The two other members, however, have been receiving their mail at the Club for quite some time.

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Our ongoing research into the relative performance of active vs. passive fund styles reveals that market conditions play a significant role in the active/passive return cycle. Accordingly, we identified a set of metrics that describe the market conditions we believe influence which of the two management styles is more likely to outperform. This note updates our research efforts through December 31, 2021.

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Yesterday, the Russell 2000 closed down 20.9% from its November 8th high, and market bulls have conceded it was “due” for a pullback after a 146% gain off the March-2020 COVID lows.

The Russell’s decline is moderate by the historical high-beta standards of Small Caps. However, this drop—combined with other developments transpiring over the last few years—has produced a shocking result: The Russell 2000 is now unchanged on an inflation-adjusted basis since its “Quantitative-Tightening Top” of August 31, 2018. But what a three-year ride it’s been!

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We wrote in the latest Green Book that a breadth indicator that should be more well-known than it is—the High/Low Logic Index (or HLLI)—had moved to “maximum negative” right at the cycle high in the NASDAQ Composite on November 19th. Specifically, the 10-week moving average of this indicator showed a perilous internal condition in which too many NASDAQ stocks were reaching 52-week New Highs and New Lows simultaneously. That’s the very definition of a “fractured” market, and has preceded some important NASDAQ declines. There have also been a couple of premature warnings, as in the summers of 1996 and 2019.

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It’s once again that time of year for what our founder deemed the great “thermal pollution.” Market pundits and prognosticators will divine, guess, and predict all that the market will bring in the new year.

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The S&P 500 is flirting with new all-time highs, and the news gets even better for followers of seasonal patterns: The Santa Claus rally has yet to officially begin!

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With the most speculative year in U.S. stock market history drawing to a close, we could probably all use a rest. How about a rest that lasts 12 months?

The year 2022 on the Jewish calendar is a Shmita year—historically considered to be a year of rest, or sabbatical, following six years of work. Unfortunately, markets have frequently taken this suggestion quite literally! There’s been a major financial disruption in seven of the eight Shmita years dating back to 1966:

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Last week we argued that U.S. money growth remains way too high to reasonably expect a peak in consumer price inflation during the next few months. At the peaks of the last five bouts of inflation of 5% or more, real growth in the M2 money supply had turned negative in four cases and had slipped to less than 1% in the other one. Today, real M2 is growing at nearly a 7% rate.

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From the start of the inflation upswing this spring, pundits cited well-known disinflationary factors they believe will soon halt the current inflationary upswing—like free trade, the speed of technological advance, and aging populations globally. 

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In a possible sign we’re not getting enough oxygen at current valuation altitudes, we decided to replace the usual mean-reversion technique with a much friendlier approach that we’ve dubbed “maximum attraction.”

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The recent bout of market turbulence has taken a little shine off of the two most famous meme stocks. Still, the elevated levels at which both AMC and GameStop trade can be described as nothing short of spectacular.

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In a couple of weeks, final second quarter EPS for the S&P 500 will confirm the fastest recovery ever from a recession-related earnings decline. That’s old news, and before it has even hit the tape. But we’ve had a sneak peak from the monthly, 12-month trailing EPS numbers published by MSCI for its USA Large Cap Index. Those figures showed that EPS exceeded their pre-COVID peak in May, and the latest reading (through August) is already 22% above the prior high! Simple trendline analysis suggests that EPS for U.S. Large Caps are likely higher today than they would have been in the absence of the COVID pandemic and hyper-stimulative response. 

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Stimulus and soaring stock prices have contributed to the fastest consumer-confidence rebound of any economic recovery on record. Yet the manner in which this bounce has unfolded is anything but “early cycle.”
 

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The weakness in Value* over the last few months has gotten a lot of attention (Chart 1). While we are still on board with the “Value trade” in general, a subtle but distinct change within the theme has emerged. There is a clear bid for Quality, which had not happened in the massive post-Covid junk rally until recently.

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If you want to see a rocket ship, there’s no need to crane your neck upwards to see the latest exploits of our billionaire space cowboys. Rather, look to our earnings glidepath chart and marvel at the contrails of the 2021 full year operating earnings for the S&P 500.  

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Those who heeded the old advice to “Sell In May” have missed out on an additional 5% gain (and counting) so far in 2021. However, the best way to have played this seasonal anomaly over the years was not to have “sold-out,” but rather to have “reduced the beta” of one’s equity holdings versus cutting equity exposure outright. That strategy has paid-off handsomely the last three months, even as this “Nothin’ Matters And What If It Did” stock-market powers higher.

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