We have two ears, two eyes and one mouth, which, according to the old aphorism, means that we have to listen and look about twice as much as we talk. Investors who heed this advice by resisting the impulse to tell the market what it should do and instead listen to it will likely find an optimistic message, albeit one that is hard to believe. A first signal is the general resilience of the broader market, finding support last week where needed to preserve an uptrend while absorbing a sharp rise in bond yields over the past month. .SPX 6M mountain S&P 500, 6 months Yet the message to the market is more surprising to many, a higher sprint in “early cycle” sectors of a type that typically reflects a recovering and shrinking economy. acceleration. What the Charts Say Ned Davis Research maintains a composite early-cycle gauge and shows here that since October’s market low, it has followed the average historical path out of the half-dozen non-recession bear markets. Did the “soft landing” happen six months ago, at least in market terms? Renaissance Macro Research founder Jeff deGraaf said the band is back in a broad uptrend and says, “The most important thing is the characteristics of the rally. Cyclicals are leading this rally to the dismay of a very large number of bears. I may not understand how this could happen. We are kind of reassured by that. The leadership profile speaks, perhaps, of an elongated Fed and economic tightening cycle and suggests where, in a particularly bifurcated market, investors should migrate. Steel and hotel stocks are tearing up, for example, and utilities and consumer staples stocks are tumbling. All of this lends some credence to the fact that the October low was important, but fails to convince that the indices are poised for quick and uneventful gains beyond their multi-month long trading range. . Yes, the Treasury yield curve remains deeply inverted in typical pre-recession mode, the Federal Reserve’s ultimate destination for interest rates has again been pushed back in time and distance, and valuations are not have never gotten really cheap (even though they are in the “fair” zone excluding a few top stocks). Still, it would be hard to script a more classic plot to embolden bulls than the one that’s been playing out since the fall: a classic October low just before the unusually bullish midterm election trigger, on the very day of the last ultra-high inflation reading. High and falling inflation has historically been one of the most constructive environments for equities. A rally in the new year that triggered several signals of rare and favorable magnitude and momentum, followed by an orderly seasonal pullback in February that was of routine magnitude but managed to cool sentiment and skim some from the scum of the market. All the while, the corporate credit market held firm and the volatility index was undisturbed, as bondholders and options traders saw no signs of stress or need for panic. What investor sentiment says Retail investors only briefly experienced a more positive mood in January with a whiff of optimism, with the American Association of Individual Investors’ survey last week showing twice as many bears as of bulls. Outflows from equity funds have been significant, as money is funneled into high-yielding money markets and blue-chip bond funds. And here we see the reversal in this week of the hunt earlier this year for equity exposure among members of the National Association of Active Investment Managers. This shift in attitude is certainly understandable given the Fed’s vigilance, skidding earnings forecasts and pockets of deep weakness in housing and manufacturing. But it’s also reassuring proof that complacency has not outweighed caution. The fixation on Treasury yields as the determinant of what stocks “should” do makes some sense, but is also likely overdone. To be sure, the 10-year ramp from 3.4% on Feb. 2 — the S&P 500 high for the post-October rally — to over 4% last week was shockingly quick and fraught with many potential dangers. They partly reflect persistent inflation that could force the Fed to raise rates beyond the economy’s ability to handle them. With the 10-year now just below 4% and the fed funds rate above 4.5%, the S&P 500 is now higher than it was nearly ten months ago, when the 10-year was at 3% and fed funds at less than 1%. The interplay between rates and stocks and stock valuations is neither as precise nor as fixed as conventional wisdom would have it. Despite all the encouraging actions that we can observe, it is also not difficult to push back the positive inferences. On the one hand, the stock market may certainly be prone to misjudge the next macroeconomic turning point and may overshoot reality in the short term. And the unorthodox nature of this compressed, high-amplitude economic cycle should leave minds open to results that deviate from historical patterns. What the business cycle says Leuthold Group notes that a key labor market indicator in the Conference Board’s consumer confidence survey has just made an unprecedented turnaround. Last July, the gap between those who said jobs were plentiful and those who said jobs were hard to come by fell more than nine points from its peak. Since 1970, this has only happened during a recession or within six months of its start. But since then the gauge has risen by more than nine points, “something that has always confirmed that further economic expansion is underway,” says Doug Ramsey of Leuthold. To repeat the question, was this the “soft landing” of last year (with its slight temporary rise in the unemployment rate)? For Ramsey, this suggests that the current strength of the labor market could well undermine calls for a new bull market in progress by forcing the Fed to forcefully ease it. Another common vector for reacting to the acceleration message of the early market cycle is that we have seen very strong rallies that seemed decisive but eventually hit new lows in extended bear markets. This has often happened when the Fed had or was soon to complete its tightening and the economy seemed, for a short time, to come out of it in decent shape. BCA Research shows here the sobering harmony between the current market trajectory and that of the post-tech bubble bear market of the early 2000s. It always pays to be aware of potential pitfalls, that’s for sure. We can note, however, that the S&P 500 at the time never spent more than a month above its 200-day moving average as it did this year. And credit conditions remained healthier this time around, with the yield spread for triple B-rated companies over Treasuries never falling below two percentage points from early 2000 through 2003; it is now around 1.5 percentage points. The next wave of the early 2000s collapse also coincided with the 9/11 attacks and the massive accounting and corporate fraud scandals of Enron, WorldCom and others that wiped out huge portions of profits. reported from previous years. Of course, things could break down treacherously again. But the market message at the moment contains no real hint of this, even if you listen carefully.
The resilient stock market finds support at the right time, preserving the uptrend