Inside The Stock Market ...trends, cross-currents, and outlook
Late Summer Heat Wave
A Fed that’s been incapable of controlling the intensity of the flame will soon be supplying it with more oxygen in an attempt to stimulate real activity. The odds are that any new fuel on the fire will find its way into consumer prices, long before it stimulates “unit growth” in slumping sectors.
Old Worries, New Highs
After a springtime scare, the stock market has shrugged off more than its fair share of troubles. We offer some quick observations on a range of topics, including our stance on the bull market and historical comparisons, IPO and speculative activity, equity leadership, and the economy/interest rates/inflation.
Abandoning 2%
The Fed has been neither correct nor anticipatory for an extended period of time. Ironically, if a September rate cut were followed by a decline into recession later this year, the Fed may be hailed as both correct and anticipatory—and some semblance of Fed independence could be maintained.
Unintended Consequences?
There are unmistakable parallels between September’s likely Fed rate cut and the initial lowering of rates preceding the GFC. In each case, despite leading inflation gauges still trending up, a housing slump and deteriorating labor market served to justify the move. In 2007, after the Fed cut, measures of real growth failed to respond and inflation, in fact, shot higher.
Checking In On The Bellwethers
Not only is the stock market no more expensive than in February, but it’s also looking internally more healthy. At the February 19th high, seven of the eight bellwethers were waving warning flags versus just four today.
“Wealth-Flation” Can Go Both Ways
To the extent that inflation has been propped up by escalating asset prices, it could also prove to be self-correcting. While rising stocks prices have only been inflationary once in a while, falling stock prices have almost always been disinflationary.
Value: Another Call For A Turn
Commercial hedgers’ bullish activity the last two months has triggered a series of buy signals on the Russell 2000 and DJIA. Conversely, hedging by the same savvy cohort of futures traders tripped a double-sell on the posterchild for Large Growth: the NASDAQ 100.
A Cross-Check On Valuations
Be it the S&P 500 or MSCI USA Index, U.S. Large Caps are on par with the valuation extremes reached in 1999/2000, and again in late 2021—but they aren’t entirely at the point of qualifying the market as the most expensive of all time. (Give it a few more months, perhaps.)
Fighting The Political Odds
In the last 100 years, there’s been only a single Republican presidential term that did not see the economy fall into recession. Since 1925, twelve recessions began under Republican administrations, compared to just four under Democrats.
Bucking The Seasonal Trend
With this year’s gains in each month of the typically weak May-August period, the S&P 500 has taunted those who chose to “Sell In May.” This streak bodes well stocks. Albeit a small sample size for comparison, after successive advances May-August, SPX returned +5.3% over the next four months vs. +1.9% all other years.
Debauchery & Debasement
Whether or not the label "bubble" fits this market, U.S. economic risks continue to rise, while Mega Cap valuations home-in on levels seen only in 1999 and early 2000.
Bellwethers Look Better, But…
The stock market looks (superficially?) better in late summer than it did at its “old” high on February 19th. It’s far from cheap, but is no more expensive than in February, and technically speaking, the S&P 500’s July’s highs were broader than those of February. That said, there’s divergent action among secondary measures that are troubling.
Yet Another Milestone
As a testament to the severity of the 2000-2002 Tech Wreck, performance of recent years’ laggards, like the Equal-Weighted S&P 500, S&P MidCap 400, and S&P SmallCap 600 are still well ahead of large-cap Growth on a 25-year basis.
Inoculation Looks Up-To-Date
Nine of ten components in the LEI are signaling there’s trouble dead ahead. Yet, the 12-month momentum of the sole outlier, the S&P 500, still looks sufficient to forestall an imminent slide into recession. Additionally, the index’s short-term strength also supports the argument that SPX is “too strong.”
The Bull Market In Context
Given the prevailing conditions at the beginning of this bull market, the S&P 500 has been an overachiever, though the same can’t be said of the broader market. This translates to an opportunity for active equity managers that nearly matches conditions in Y2K—and at a time when the active manager pool is now dwindling.
The Confidence Gap Persists
The market lacks the traditional bubble feel because investor giddiness is simply not shared by consumers—which is markedly different that of the late 1990s. There is a huge disparity between confidence about stock price gains vs. expectations for consumers’ near-term economic well being—a gap that did not exist during the Tech Bubble.
More On The LEI Misfire
The LEI’s recession warning in June 2022 was woefully premature and has persisted for so long that it’s now met with eye-rolls. Nonetheless, economic momentum—specifically the lack there of—is why it may be time to take that ominous signal seriously.
Stag-Flating Away
The U.S. economy is now mired in what we view as a temporary phase of stagflation. To our way of thinking, the “flation” is, in fact, exacerbating the “stag”—a situation that should soon self-correct in an unpleasant manner.
Super-Stretched Cyclicals
The Cyclical/Defensive Relative Valuation Ratio jumped to yet another record in July, with Cyclicals commanding a valuation premium of 23%. Put differently, investors have a very strong implicit bet that the economic expansion will continue.
Sentiment-al Reflections
Though it’s ramping up daily, the level of retail participation in the stock market is not quite on par with that observed during the last gasp of the Technology Bubble. Maybe a phase of full-blown euphoria still lies ahead.