Andrea | Wellington Shields & Co. LLC

Follow the trend … But that’s following the herd

Posted on 06/23/202306/23/2023 by Andrea

DJIA: 33,946

Follow the trend … but that’s following the herd. The trend is pretty clear. The problem is it’s so clear most are on to it. They say the crowd is wrong at extremes but right in between. This may be one of those extremes, if only temporarily. When it comes to gauging settlement, we typically prefer to look at investor action rather than investor talk. Put-Call Ratios relate to the former, and they’re back to levels of last March. When it comes to indicators that use investor surveys, Investors Intelligence has been around forever, and measures the opinion of market letter writers – a drop dead smart group. Here the spread between bulls and bears has moved from 0% to 30%, a change which typically results in a couple weeks of stall or pullback. Subsequently, however, the outcome is surprisingly positive, with the market almost always higher a year later.

Meanwhile, while pretty clearly up, the S&P has achieved a milestone of sorts. It has moved from a one-year low to a one-year high. This has happened some 25 times since 1948, according to SentimenTrader.com, with only one loss in the six and 12-month period. Of course, up doesn’t mean straight up, but there were only two drawdowns of 10%. You might argue this time is different given what most consider a narrow market. Indeed, fewer than 5% of the S&P stocks are at one-year highs. Historically this did not significantly change the outcome. So we can add this to other aspects of the background that have similarly suggested favorable outcomes. The first quarter, for example, held the December lows, leading to a higher prices April – December some 90% of the time. And we have seen back-to-back up quarters which, according to Tom Lee of Fundstrat, never happens in bear markets.

Despite what many consider the market’s limited participation, the A/D index for the S&P has reached an all-time high. Note this is for the S&P components, not all NYSE stocks, which is what we typically reference. It’s not unusual to see a discrepancy in these numbers, it’s again about progress not perfection. The NYSE numbers show no important divergence, at least with the DJ, against which we typically measure. The S&P A/D Index itself has a credible record, leading to an annualized return in the S&P of almost 19% since 1928, according to SentimenTrader.com. Interestingly, too, of the 23 occurrences there were only three drawdowns of 10% at any point in the next six months. Contrary to what might seem logical, the average stock tends to drag along the stock averages, both up and down.

Watching the after-hours trades Tuesday night, we couldn’t help but be struck by the juxtaposition of Tesla (265) going by up some 17 points as Cramer stood on the floor of a Ford assembly plant. To be fair, while no Tesla, both Ford (14) and GM (37) have more than respectable charts, and Tesla has come in a bit since then. These almost sacred stocks like Tesla, the “Magnificent Seven” or whatever, have been pretty much impervious to market weakness, at least so far. We hesitate to say corrections here might be healthy, since we never understood why losing money is healthy. But we know what they mean, and a respite of sorts would do some good. And a little weakness in the sacred would put a little fear in things, fear creates selling and selling creates a low. While we consider this a minor selloff, it could take another week or so to be resolved.

The Energy sector is what you might call lurking. They’re probably not quite ready for prime time, but they’re getting there. A stock like Vista Energy (24) did break out the other day, but failed to follow through and is, in any case, not exactly an Energy bellwether. Stocks like Baker Hughes (30) and Halliburton (31) are promising, but still not there. Meanwhile, NatGas seems particularly interesting, but here the seasonal pattern is unfavorable until almost the end of July. During this time NatGas is up only some 15% of the time. Still, seasonals are one thing but not the only thing. We would pay attention to a breakout in something like UNG (7). After a little respite, we fully expect Tech to continue as leadership, though we certainly wouldn’t forget those economically sensitive names we went through last time. We would also note the better action in drug wholesalers like McKesson (417), AmerisourceBergen (188), and Cardinal Health (93).

Frank D. Gretz

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Trend isn’t just your Friend … It’s your nearest, dearest, bestest buddy

Posted on 06/16/202306/16/2023 by Andrea

Trend isn’t just your friend … it’s your nearest, dearest, bestest buddy. Look at what trend has done for Tesla (256). When it recently got on one, it stayed on one 13 days through Wednesday, without so much as one down day. Consider, too, Tesla isn’t exactly known for a lack of volatility. Sure the market’s new dynamics has played a role, but not even Nvidia (427) can match Tesla here. There is, however, another and more mundane stock that is perhaps our favorite example of a consistent uptrend. Those of us who trade, and a measure favored by IBD, know the weighted 21-day moving average. The weighting here simply means day 21 counts for 21 times as much as day one. It is as they say, a very fast-moving average, one which very closely hugs the price action. Since the start of the year, GE has gone from 65 to 105 without falling below its 21-day weighted moving average.

Meanwhile, the backdrop seems to be filling in the bull market blanks. Forever it seems it has been “don’t fight the Fed.” Now if not over, the fight seems close to over, and the Fed won to look at recent CPI and PPI numbers. Of course, only the Fed would remain data dependent while the data they depend on is old news. You would think they’ve never heard of the lagged effects of monetary policy but hey, nobody’s perfect. So that just leaves the looming recession standing in the way here. And while well-advertised, it doesn’t mean it won’t happen. We just think there will be no significant downturn, and we say that after consulting with the charts of Grainger (744), Cintas (492), Ingersoll Rand (65), Lincoln Electric (196), Eaton (197), and Parker Hannifin (374) – the latter was used by Greenspan as an economic indicator. These economically sensitive stocks are at or are near all-time highs. We doubt this would be the case if we were facing a severe downturn.

The bear market was itself unconventional, perhaps helping to explain why many are uncomfortable with this new uptrend/bull market. When it comes to the bear market, even its low seems misunderstood. Most call October the low, true enough if you’re talking about the market averages. When it comes to the market in terms of the average stock, the low was last June. Last June was a washout low, October was what they call a secondary low, a low with less selling pressure. In turn, that has left the recovery a bit disjointed, and complicated by ongoing rotation. And then, of course, there was the setback of the banking crisis. The NAZ/Tech breakout in mid-May and the S&P breakout a few weeks later were the game changers. You might argue this is when the real uptrend/bull market began. Even now, however, we still have not completely come out of what has been three or four months of base building. Stocks above the 200-day, for example, are still only just about 50%, well below the 70% level of February.

The VIX (14), or Volatility Index is always a bit controversial, often misunderstood, and taken by many to be pretty much useless. The latter, in this case, often have a point. When it comes to market weakness, volatility as measured by the VIX rises out of fear, fear creates selling, and selling eventually creates a market low. However, there is no magic number to the rise needed for such a low, rather it’s a peak and subsequent decline in the VIX that signals the panic/selling is out of the way. A low VIX, in turn, seems often to stay low without consequence. Indeed, the VIX currently is at a two-year low as the S&P makes higher highs. Contrary to popular thinking, multiyear lows in the VIX tend to occur in bull markets, not in bear markets. Except for August 2000, every two- year low in the VIX occurred in a bull market, suggesting that at the very least the VIX is not a worry.

They didn’t see inflation coming, what makes anyone think they’ll see it going. The Fed does seem determined however, probably out of fear of being wrong twice – it’s called human nature. Fortunately, the market sees things differently. Even the Fed induced market bashing Wednesday saw 1700 stocks advance, not bad for any day. And Thursday’s better than 3-to-1 up day wasn’t exactly the “weak rally” about which we forever worry. The numbers, of course, speak to a broadening market. Note the breakout in the Russell despite its 17% weighting in Regional Banks. One group that would further help here is Energy, which had a good day Thursday – especially Nat Gas. But most stocks are at least lifting, and why not. After all, they stopped going down a year ago and since have just been base building. We don’t like to sound more bullish on the way up, but in this case things have become more bullish.

Frank D. Gretz

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US Strategy Weekly: An Old Wall Street Adage

Posted on 06/14/202306/20/2023 by Andrea

A Hostile Pause

The Federal Reserve is likely to pause at this week’s FOMC monetary meeting for a number of reasons, but none greater than the fact that this is precisely what the market has discounted and is expecting on June 14. To date, the Fed has been successful in molding sentiment for a rate hike well in advance of each meeting and therefore it has not shocked investors with its actions. This is done quite adeptly through presentations and speeches made by various Board Governors in the weeks preceding each FOMC meeting. However, while sentiment is currently looking for a pause, we do not think Chairman Powell is convinced that rate hikes are over. We believe he is being honest when he says that future policy will be driven by future data.

Right now, it is difficult to predict how weak or how strong future data and the economy will be in the second half of the year. As we pointed out last week, there were a number of weaknesses in May’s jobs report that were hidden by a strong headline number. Plus, no one can predict what will happen in October when the moratorium on student loans ends and 40 million borrowers will begin repayment for the first time in over three years. This will be an unprecedented event. What is certain is that it will dampen consumer spending.

Yet as the FOMC meets this week, a major discussion is likely to center on the impact of the debt ceiling resolution on the second half of this year. How the debt markets will respond to what is expected to be the issuance of more than $1 trillion in Treasury bills will be another unknown. This massive debt issuance is a double-edged sword since the increase in supply is expected to result in rates moving higher. And with so much of America’s debt on the short end of the curve, interest payments will also rise, increasing America’s overall debt load. This circular problem of higher rates and more debt issuance may not become a problem in the near term but barring a change in the trend of US debt and US interest rates, it will become a significant problem in the intermediate-to-long-term.

Nevertheless, investors have been celebrating the expectation that the Fed will pause in June and may or may not raise rates again in July. There is a growing consensus that a July rate hike is one and done, or that rate hikes are already done. But keep in mind that this has been what has been fueling the June rally. Recent equity gains are due to a shift in sentiment and not a result of good earnings. Yes, the first quarter’s earnings reports did generally beat expectations, but only because those expectations were already beaten down dramatically. What really matters is whether earnings are growing on a year-over-year basis. According to Refinitiv’s “This Week in Earnings” report, the first quarter earnings results are expected to show a rise of 0.03% on a year-over-year basis, and if the energy sector is excluded, earnings are expected to fall 1.7% YOY. According to S&P Dow Jones consensus data, which uses GAAP accounting, first quarter earnings are expected to rise 6% year-over-year, but from a much lower 2022 base. S&P Dow Jones data shows S&P 500 earnings per share fell 5.4% YOY in calendar 2022; whereas, Refinitiv had earnings rising 4.8% YOY in calendar 2022.

Equity prices have not been rising due to expectations of a stronger economy. According to data from the Mortgage Bankers Association, housing has become unaffordable for most Americans. In April the industry group’s Purchase Applications Payment Index rose to a record high of 172.3. Similarly, a recent report from the National Association of Realtors and Realtor.com states that over 75% of homes on the market are too expensive for middle-class buyers. In sum, a combination of inflation and rising interest rates is having a very negative impact on most households.

There has been some good news recently. The Fed’s balance sheet is contracting again following the liquidity boost in March done to offset the banking crisis. Although reserves are still $50 billion above the low level seen in early March, there is a sense that the banking crisis has eased. Meanwhile, a key liquidity benchmark – the 6-month rate of change in total reserves at the Fed – continues to be negative, indicating that the Fed is generally draining reserves from the system. This could become meaningful in coming months. While an increase in the Fed’s reserves tends to coincide with bull markets, the draining of reserves has been less predictive for the equity market; however, it tends to coincide with flat trends. See page 3.

Money supply (M2) continues to contract at a record pace as bank deposits and other liquid deposits leave the banking system in search of higher-yielding substitutes. This is not surprising, but it does hinder banks that need to borrow on the short end of the interest rate curve and loan at the higher end. It points to the fact that credit will be tighter in the months ahead. See page 4. And since the Fed has raised the fed funds rate nine times in the last twelve months, higher interest rates also impact borrowers. It is notable that the real fed funds rate is now positive for the first time since October 2019. See page 5.

If you wonder why there is a big debate among economists about whether a recession is at hand, or not, the charts on page 6 may help. It might be different this time, but history suggests a recession is on the horizon when we look at historical parallels. The current inversion in the yield curve is the greatest seen in over 42 years, and inversions have historically preceded economic recessions. Economic recessions produce bear markets in equities. The inversion of the yield curve may come early, but an inversion of this depth and length has predicted a recession in every case since 1954. We are of the view that history is a good guideline for defining risks in the equity market despite the fact that market sentiment is now tilting toward a mild recession or no recession. The one indicator that does not (yet) point to a recession is the year-over-year change in employment. That remains positive.

The acceptance of the current advance in stocks has been swift and dramatic and this is worrisome to us. Last week’s AAII sentiment survey resulted in a 15.4% surge in bullishness, now at 44.5%, and a 12.5% fall in bearishness, now at 24.3%. Investor bearishness is currently at its lowest level since November 11, 2021. Bullishness is now above average for the first time since February 2023 and at its highest level since November 11, 2021. Note that November 11, 2021 was less than two months prior to the major top in equities seen in January 2022. The Bull/Bear 8-week Spread remains in positive territory, but barely. See page 11.

Several technical indicators have improved this week including the 10-day averages of new highs, now at 172, and new lows, now at 60. This combination has turned positive with new highs above the 100 benchmark. But our 25-day up down volume oscillator remains neutral at 1.26 and is actually down from last week’s high. More importantly, the NYSE volume has been below the 10-day average for the last nine consecutive trading sessions and has not been impressive. The last high-volume day took place on May 31, 2023 when the DJIA lost 134 points. In sum, we would not chase this rally, particularly the large cap technology stocks that have been in the lead. If it is true that the real catalyst for the advance is the expectation that the Fed will pause in June, the wisest thing may be to follow the Wall Street adage “sell on the news.”

Gail Dudack

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Turn your back… and it’s a new bull market!?

Posted on 06/09/202306/09/2023 by Andrea

DJIA: 33,833

Turn your back… and it’s a new bull market!? So they say, they being those who believe a 20% rally in the S&P makes it so. Fine with us, though it doesn’t quite feel like a new bull market. To feel it, you probably have to be in what someone aptly called the Magnificent Seven, and probably little else. Even if you were in uptrends like McDonald’s (286) or Microsoft (325), they never seem to go together. It’s like Superman, why is it you never see Superman and Clark Kent together? And who amongst us is without sin, that is, a few clunkers. So the S&P has been tough to match, much like the 80s when few owned enough Microsoft to keep up. Apple (181) these days is a 7% position in the S&P, so to speak, while most funds can’t hold a 7% position in anything. Whatever you choose to call this market, Friday’s rally says they want to go higher.

Last Friday’s was a surprisingly good rally, and in ways that were more subtle than most realize. The Dow, for example, rose 700 points, both impressive and not very subtle. Consider, though, the Dow has lagged the NAZ and S&P, making its rally a bit more impressive. Similarly, Friday’s 5-to-1 A/D numbers are not unheard of, but they typically come along after a washout sort of selloff. There was more concern than fear about the debt ceiling, and certainly no real weakness. The QCHA is a number from the old Quotron system, which measures how much stocks are up, not just whether they’re up like the A/Ds. Friday was the best day since January, meaning stocks were not just 5-to-1 up, they were up a lot. A number of years ago we used that number in a piece and got a call from Barron’s asking where they could find it. We both had a good laugh when we said – Barron’s.

Not only were the Friday moves in some individual stocks dramatic, they also seemed technically important. A 17-point move in Caterpillar (234), for example, is an outsized move for that stock. More importantly, it also moved the stock above its 50-day moving average for the first time since mid-March. Similarly, without wanting to be demeaning of our four-legged friends, Dupont (70) has been among them. Here, too, its five- point rally on Friday lifted the stock above its 50-day. Then there are the Regional Banks, a group we had begun to think of as investment shorts, especially in light of the Treasury’s required financing. The Regional Bank Index (KRE-44) on Friday also moved above its 50-day. Meanwhile, there were a myriad of Econ-sensitive stocks, already with decent patterns, that performed well – names like Cintas (483), Eaton (188), Fastenal (54), and Parker Hannifin (356). And who knew AI was so dependent on welding – to look at Lincoln Electric (191), you might think so.

What has been a narrow market has not gone unnoticed. And things noticed usually don’t matter, or at least they’re not the market’s undoing. Now things seem to have gone a step further, where some are arguing narrow markets don’t matter. While we have heard, but not read the arguments here, we’re sure they have their data. Then, too, there’s your data, there’s my data, and there’s the undisputed data. Unfortunately, there’s no undisputed data here, the real issue may lie in time frames. Back in 2018 the Dow moved to successive new highs in three days, while the A/Ds were negative each of those days. The market subsequently abruptly fell 20% into the end of December. In 1987 the A/D Index peaked in March, and subsequently showed a pattern of negative divergences against the Averages. While the latter continued to move higher, it didn’t matter until October – then came the Crash. Divergences matter, sometimes not until they matter.

While we haven’t exactly embraced the Cathie Wood/ARK concept, there are a couple of the ETFs that cover some stocks we like. The ARK Autonomous Technology ETF (ARKQ-53) has a 15% position in Tesla (235), along with Nvidia (385) as one of its top 10 holdings. When it comes to stocks like NVDA, our rule of thumb is the first time you think it’s over, you’re wrong, and so too the second time. Typically, there’s no third time. Momentum like this doesn’t go away easily or quickly. Not to dismiss the market’s seeming broadening, Tech is leadership, but as Wednesday made clear, there will be setbacks. Meanwhile, stocks above the 200-day have improved to 51%, but here it’s progress not perfection. And don’t forget those A/Ds, it’s not just the Averages that will keep this going, you have to have the average stock as well.

Frank D. Gretz

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US Strategy Weekly: It’s Not What It Seems

Posted on 06/07/202306/16/2023 by Andrea

Regional Banks

Last week’s passage of a bi-partisan debt ceiling bill extended the worrisome debt ceiling debate to January 2025. This bill resolved a major crisis that could have triggered a default on US obligations and crushed the US dollar and economy. However, the aftermath of this bill could result in different unintended circumstances. And while some investors may be celebrating these consequences, we believe the short-term positives may not outweigh the longer-term problems.

The balance in the Treasury General Account dropped from $140 billion in mid-May to under $23.4 billion last week and the lifting of the debt ceiling means the Treasury can and must refill its coffers in the coming months. Analysts at Deutsche Bank have estimated that a whopping $1.3 trillion in Treasury bills will be issued over the remainder of 2023, bringing total issuance for the full year to about $1.6 trillion. This massive issuance of Treasury bills will almost certainly drain liquidity from the financial system and could also steepen the yield curve.

The problem with this is that a further rise in short-term interest rates and a further steepening in the yield curve will make the environment even more difficult for the banking system and for the regional banks in particular. Banks borrow on the short end of the yield curve and lend on the long end and a steep yield curve is not a profitable situation. Regional banks are already suffering from a serious exodus of deposits as account holders seek higher-yielding investments found in the Treasury market and/or money market funds. And as deposits continue to leave the financial sector, credit conditions will continue to tighten, and this will slow economic activity.

Adding to the pressure on the banking sector is the fact that regulators are currently planning to increase capital requirements for all banks with $100 billion in assets or more (down from $250 billion in assets) and this could mandate increases in capital cushions for some banks by as much as 20%. Again, this would add another burden on regional banks.

Last, but far from least is the potential for a crisis in commercial real estate and the ramifications on the commercial real estate debt market. According to the Wall Street Journal, in the next three years an estimated $1.5 trillion in commercial mortgage loans will come due. Data provider Trepp indicates that interest-only loans as a percentage of newly issued commercial mortgage-backed securities have represented 65% or more over the last ten years but this increased to 88% in 2021. And while borrowers typically pay off these mortgages by selling real estate or getting a new loan, falling real estate prices, and rising interest rates make neither of these options attractive in the current environment.

Given all these pressures on the real estate and financial markets, we find it curious that regional bank stocks have rallied in recent trading sessions. However, it may be that investors have viewed this from a short-term perspective and have concluded that the Federal Reserve is unlikely to raise interest rates next week. Given the fact that the Treasury market will already be dealing with a significant increase in supply in the month of June and is faced with an unknown amount of demand, this may prove to be true. In fact, it is questionable whether the Fed can continue with its quantitative tightening policy in the face of record debt issuance. Therefore, we are less convinced that the Fed will raise rates in June. But while the Fed may choose to pause next week, this is not great news, and it does not make us bullish.

Labor Markets

The BLS establishment survey indicated an increase of 339,000 jobs in the month of May, which was stronger than expected. However, the accompanying household survey suggested that employment fell by 310,000 jobs and that unemployment grew by 440,000. This discrepancy explains the increase in the unemployment rate from 3.4% to 3.7% for the month, but it also raises questions about the real strength of the job market. Job trends are important since one of the best leading indicators of a pending recession is a year-over-year decline in jobs. From this perspective, neither BLS survey suggests the economy is on the verge of a recession. See page 5. And the household survey showed other cracks in the data. Permanent job losers as a percentage of all unemployed was 26% in May, up from 21% in October. Of job losers and those completing temporary work, 36% were permanently laid off in May. The number of workers no longer counted in the labor force, but who indicated they want a job, increased from 5% to 6%; while discouraged workers increased 93,000 in the last 2 months to 396,000 in May. See page 6. Overall, the headline 339,000 job increase with upward adjustments to previous months was just not what it seemed. There were signs of weakness beneath the surface.

The Stock Market

Tesla Inc. (TSLA – $221.31), Alphabet Inc. C (GOOG – $127.91), Amazon.com (AMZN – $126.61), Apple Inc. (AAPL – $179.21), Meta Platforms, Inc. (META -$271.12), Microsoft Corp. (MSFT – $333.68), Netflix Inc. (NFLX – 399.29) and Nvidia Corp. (NVDA – $386.54) , represented about 22% of the S&P 500’s market capitalization at the start of the year, and now account for more than 30%. These stocks have been investor favorites this year which helps to explain why the equally weighted version of the S&P 500 (.WEGSPC – $5842.49) is up just 1.1% this year, the DJIA is up 1.3%, and the Russell 2000 index is up 5%, while the SPX is up 11.6% and the Nasdaq Composite has gained nearly 27% YTD. The recent rally clearly generated breakouts in the SPX and the Nasdaq Composite but is not visible in either the DJIA or the Russell 2000. See page 11. And despite the drama of a 701-point gain in the DJIA on June 2, 2023, there was no meaningful change in our 25-day volume oscillator or the NYSE cumulative advance/decline line in recent days. Moreover, the 701-point move materialized with NYSE volume that was below the 10-day average and volume continues to trend below its 10-day average. See pages 12-13. These are not impressive breadth statistics. We remember the Nifty Fifty and Dot-com eras, so we know narrow markets can be sustained longer than many expect. But we are not chasing this rally and believe the broad market will remain in a wide trading best seen in the Russell 2000 between 1650 and 2000.

S&P Earnings As the first quarter earnings season ends, the S&P Dow Jones consensus estimates for 2023 and 2024 were $218.69 and $244.70, up $0.77, and $1.03 for the week, respectively. Refinitiv IBES earnings estimates for 2023 and 2024 were $220.89 and $246.70, up $1.54, and $1.63, respectively. But note that last week’s big increases effectively erased the declines seen in estimates over the prior three weeks. We did not see any major earnings release to account for this big change and therefore believe it is due primarily to positive forward guidance. However, it is also important to note that S&P data shows that 18.4% of companies reporting first quarter earnings had a decrease of 4% or more in their shares outstanding. This decline in shares outstanding boosts earnings per share but does not represent a significant change in overall earnings growth. In sum, earnings are not all that it seems. See page 9.

Gail Dudack

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Party like it’s 1999! That is to say, party like you own Tech, and little else

Posted on 06/02/202306/06/2023 by Andrea

DJIA: 33,061

Party like it’s 1999! That is to say, party like you own Tech, and little else. Back then you could put dot-com behind your name and it made it worth another 20%. The same is true now if you’re anything AI-ish. The latter is the new, New Economy. Meanwhile, the Old Economy stocks are pretty much everything else. Hence, it’s an S&P Index hovering around its highs with fewer than 40% of stocks in uptrends, that is, above their 200-day. This is anything but a healthy backdrop, technically speaking. While this will last until it doesn’t – you can’t underestimate momentum. The Semis had their best day ever last Thursday, gaining some 11%. When they have gained 5% or more in a day, they’re higher a month later more than 70% of the time, according to SentimenTrader.com. Back in 2000, it took a peak in the dot-coms to get the rest of the market going again, by then the rest had become sold out. On the plus side, with better than 3-to-1 A/Ds, Thursday was a surprisingly good day.

Speaking of Tech, it wasn’t a pretty picture after hours for those reporting on Wednesday. We don’t like to see downside gaps, but we find their significance less when they don’t change an overall uptrend. You might want to look to Snowflake (167) as a guide here.

Frank Gretz

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US Strategy Weekly: All Icing, No Cake

Posted on 05/31/202306/06/2023 by Andrea

If you are focusing on the recent gains in the S&P 500 and the Nasdaq Composite index, you might think a major equity rally is underway. However, with the exception of seven technology stocks, the S&P 500 is unchanged this year as seen by the SPX equal-weighted index which is down 0.35% year-to-date. Viewed another way, the Nasdaq Composite is up 24% year-to-date, while the Dow Jones Industrial Average is down 0.3%. Our favorite index for monitoring the market is the small-cap Russell 2000 index which is up 0.3%, or essentially flat. In short, the 2023 stock market is all icing, no cake.

Most of the recent excitement in the stock market comes down to one stock — Nvidia Corp. (NVDA – $401.11) – up 30% in the last three trading sessions as a result of the billions of dollars expected to be invested in artificial intelligence in coming years. We have no doubt that there will be a lot of investment dollars directed at AI in the years ahead, but a mania seems to be the best description of the action in NVDA this week.

Volmageddon

And there are other interesting market trends that should be noted. A recent Wall Street Journal article titled U.S. Stock Market Stays Calm With Help From Quant Buying, suggests that the equity market remains calm in the face of the debt-ceiling debate due to demand from quant funds. The article states: “At the end of March, quant-focused hedge funds held about $1.13 trillion in assets, according to research firm HFR, hovering just below last year’s record high. That represents about 29% of all hedge-fund assets.”

“It’s rules-based trading,” said Charlie McElligott, a managing director at Nomura Securities International. “There’s no emotion involved.” Data from McElligott shows quants tend to move together quickly when volatility strikes. Take, for example, the stock market selloff of May 2019, when the S&P 500 slid some 7% as investors panicked about U.S.-China trade tensions. McElligott estimates that CTAs unloaded $35 billion worth of equities over the course of a month.”

However, rather than being a calming influence on the equity market, we believe this concentration of quantitative investments could prove to be risky down the road. It is reminiscent of another memorable event in equity history – Volmageddon — which is a blend of the words volatility and Armageddon. Volmageddon refers to the unusual activity that occurred on February 5, 2018. On this day, after about a year of rising stock prices and low stock market price volatility, the CBOE Volatility Index (VIX – 17.46) soared from an opening value of 18.44 to 37.32 at close. Unfortunately, the low volatility that characterized the 2017 stock market had generated huge demand in leveraged short volatility trades, especially in the Velocity Shares Daily Inverse VIX Short-Term note, whose ticker was XIV. The XIV (no longer traded) shrank from $1.9 billion in assets to $63 million in one day due to the jump in the VIX. The SPX only fell 5% on February 5, 2018, but February 5, 2018 proved to be just the beginning of a volatile year that ended in a large December sell-off, a 6.2% decline in the SPX and a 12.2% loss in the Russell 2000 index.

In short, this big increase in quant-based investment can have a calming impact on equity prices today, but if sentiment changes, it can also trigger a lot of volatility, illiquidity, and serious damage to stock prices in the future. In sum, we would not chase this rally and remain focused on recession resistant stocks with predictable earnings streams.

Economics review

After hitting cyclical lows in June or July of 2022 and rebounding to 12-month highs in February 2023, both the University of Michigan and the Conference Board sentiment surveys dropped in the month of May. The declines were across the board including the overall index, present conditions, and future expectations. May employment will be reported on Friday, and it will be interesting to see if these declines in sentiment are a leading indicator of job market weakness. See page 3.

June’s FOMC meeting is only two weeks away. Another month of inflation data will be available in early June, but April’s inflation data could support another rate hike. Both headline and core CPI were relatively unchanged at 4.9% YOY and 5.5%, respectively. Service sector inflation fell from 7.3% to 6.8%, services less rent fell from 6.1% to 5.2%, services less medical care fell from 8% to 7.6%, while other services rose from 4.4% to 4.7%. Nevertheless, all service sector inflation data remains high and well above the Fed’s 2% target. See page 4.

However, small declines in inflation are helping households. April’s personal income rose 5.4% and CPI rose 4.9% which means real personal income is improving. Moreover, disposable income rose nearly 8% as tax payments fell and this produced a 3.4% YOY gain in real disposable income. April became the fourth consecutive monthly gain seen in real personal disposable income. See page 5. Personal consumption expenditures (PCE) rose 6.7% in April. Although expenditures are positive on a year-over-year basis, there are clear signs of deceleration in all categories including durable goods, nondurable goods, and services. See page 6.

Several financial commentators have stated that the current savings rate is “average”, but this is far from accurate. The current savings rate of 4.1% compares to the historical average of 8.8% or the 22-year average of 6.6%. In short, savings are well below average. And while the savings rate did soar to 33.8% in April 2020 as a result of pandemic stimulus checks, that buffer has been depleted. Therefore, it is not surprising that personal consumption expenditures are also decelerating. See page 7.

Retail sales rose a mere 0.15% YOY in April and real retail sales fell 3.2% YOY. Much of this was due to a decline in auto sales which fell 5.8% in the month and 3.4% YOY. However, a lack of motor vehicle inventory has hampered auto sales due to supply chain disruptions; but auto sales face a new hurdle from rising interest rates which will increase the cost of leases and auto loans. See page 8.

Technical Indicators The charts of the S&P 500, DJIA, and Nasdaq Composite are technically positive, but the SPX and DJIA failed to better critical resistance at SPX 4,200 and DJIA 34,500. The Nasdaq bettered the 12,500 resistance, but this was due primarily to Nvidia Corp. (NVDA – $401.11). The Russell 2000 remains our favorite guide for the broader marketplace and it remains well within a defined range with support at 1,650 and resistance at 2000. See page 12. The 10-day average of daily new highs is 94 and new lows are 109, making this combination negative since new highs are below 100 and new lows are above 100. See page 14. With the debt ceiling vote still incomplete, the Russian/Ukraine conflict escalating, Chinese GDP expected to slow from the first quarter’s 4.5%, Friday’s job report, and the FOMC meeting on June 14, there are many ways sentiment could change. Note that there was renewed weakness in crude oil and gasoline prices this week which implies fear of an economic slowdown may be increasing. We remain cautious.

Gail Dudack

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A Yogi Berra Market… Not Over Until It’s Over

Posted on 05/26/202305/26/2023 by Andrea

DJIA: 32,764

A Yogi Berra market… not over until it’s over. Without question this is the most divergent market we’ve seen in some time. That everyone seems to get it doesn’t make it less so. And seeing it also doesn’t make its negative implication less so. Narrow markets are a reflection of the liquidity and its decline. There isn’t enough to push up as many stocks as there once was. This shows up in the A/D Index, the Equal Weight S&P, and perhaps most clearly in stocks above the 200-day, a decent proxy for stocks in uptrends. Currently around 40%, it’s down from 74% in February but it’s relative. The S&P now is higher than it was in February, meaning the performance gap between big cap stocks and the average stock has significantly widened. This kind of divergence doesn’t end well. Still, there’s no magic timing or levels here, it can go on until it doesn’t.

History has its examples of markets like this outlasting the naysayers, 1972 and 1999–2000 being prime examples. Both had their themes, 1972 the Nifty 50, and 2000 of course the Dot-com’s. What is often forgotten about both, and especially the Dot-com period, was how poorly everything else performed. During this market phase it wasn’t just that only the Dot-coms were going up, the rest of the market was not only not going up, it was going down. This past Monday we thought we were back there again – Pepsi (184), down five points and Tech up, the Dow down more than 150 points. and the NAZ up 50 points. Back in 2000 everyone saw the divergence to the point they named it “old economy” versus “new economy,” which is beginning to look familiar. Still, the divergence went on, the NAZ continued higher though the Dow did not.

In these diverging markets, at least one of the major Averages moves higher – the Dow in 1972, the NAZ in 2000. The leaders, the few, drive the Averages, in this case the NAZ. The insidious part of this is that it offers hope for the rest, the poor, the downtrodden, the huddled masses – the Equal Weight S&P. The history isn’t promising here, likely because the liquidity just isn’t there to pull up the rest. It’s not just that the leaders lead, in this case Tech, it’s pretty much them and little else. AI no doubt will change the world just as Cisco (49) did back in 1999–2000, when it sold for 80 and change, roughly double where it has sold since then. On the plus side, just like the Nifty 50 and the Dot-com’s in their day, there’s money to be made in this market, provided of course you’re pretty much focused on Tech.

After that diatribe on Tech, we should point out a couple of other areas acting better. The Saudi‘s have said don’t short oil, which would be interesting if you thought you could believe anything the Saudi’s say. We do believe price action, however, and USO (64) seems about to cross above its 50-day, which should drag equities higher as well. The other area to come alive recently is Biotech, though not the Amgen‘s (217) and other household names. If you look at the iShares ETF (IBB-127), it’s market cap-weighted whereas the Equal Weight SPDR (XBI-84) shows a much different and better picture. Unlike the overall market, here small seems better, perhaps anticipating more consolidation. You might also look to the Ark ETF (ARKG-31) which has a number of positive charts.

The Kabuki dance that is the debt ceiling negotiations has put a damper on the market, and rightly so. The odds of an unfavorable outcome are low, but so too are the odds of an unfavorable outcome in Russian roulette. In both cases, the consequences of a losing outcome are severe. The good news is that good news should be met with a make-up rally, and then we can get back to normal worries like the Fed’s next move, employment numbers, and the mess in banking. Although we’ve been doing this for a while now, we really don’t recall a stock more loved than Nvidia (380), and apparently rightly so. Not to rain on a parade that should continue, we’re always reminded that stocks are pieces of paper, not companies. Overloved stocks become over owned stocks, and eventually who’s left to buy? But there’s that word again, eventually. The A/Ds, you might have noticed, were almost 2-to-1 down and the Equal Weight S&P unchanged amidst Thursday’s euphoria.

Frank D. Gretz

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Buy the S&P or Sell the S&P… Yes!

Posted on 05/19/202305/19/2023 by Andrea

DJIA: 33,535

Buy the S&P or sell the S&P… Yes! And you thought we couldn’t take hedging to a new level. There is, of course, the S&P Index and it is pretty much the benchmark for the world. The other S&P to which we are referring is the so-called Equal Weight S&P, where all stocks are created equal by market cap. In this case equal isn’t such a good thing since it’s the larger cap stocks that are in favor. These dominate the Averages by virtue of their market weight construction. If you’re thinking Tech for the most part you ‘re right, but don’t forget a few names like McDonald’s (294). The distinction between these two measures of the S&P these days is a bit dramatic. The Index has traded in a range since mid-April, just below the early February high. The Equal Weight Index by contrast is below its April peak which, in turn, is below the January peak. It’s a narrow market favoring the big.

Good markets always have their leadership, and that leadership by definition outperforms and like now sometimes significantly so. It’s not something to lose sleep over, some stocks will always be better than others and the better tend to dominate. So when 5 or 10 stocks account for most of the gain in the S&P, it happens. When it’s a problem is when the rest of the Index isn’t following – when the rest of the Index is moving down. Measures like the Advance-Decline Index and stocks above the 200-day average show this as well. Stocks above their 200-day are hovering around 40% while the averages dance around their highs, a rather dramatic discrepancy. We wish we could say there’s some magic number here, but there is not. We can say the many eventually drag down the few, but the key word here might well be eventually.

They like to call this market a trading range, but which market? The NASDAQ certainly isn’t a trading range, even the Composite let alone the NDX. The Russell 2000 has been in a trading range since its mid-March low, but that range is well down from its earlier February high. The S&P has been range bound of late, but well up from the March low, which in turn was up from the December low. If you look at the series higher lows from last October, it’s an uptrend. The problem is the average stock is different. NASDAQ A/Ds made a new low not long ago. If the NAZ is literally 100 stocks, let’s further refine it to 10 via the Micro Sectors FANG Plus Index, FNGU (133). It’s clear what’s working, and you have to be careful with the rest. When the Averages are doing well, it’s easy to hope the others will come along, but you know what they say about hope as an investment strategy.

So why can’t the few drag up the many? In theory we suppose they could, it just never seems to work that way. The explanation here we suspect is sideline buying power – there isn’t enough to continue to push up all stocks, just enough to push up strong stocks and eventually not even enough for them. Sideline buying power or liquidity is only restored in an eventual market correction. Meanwhile, enjoy it while you can. These diverging markets can last for a while, including through 1972 and 1999. There was money to be made as long as you were in the Nifty 50 or the Dot-com’s. The leaders will be the last to give it up as will the big-cap beverages they include. There’s an old Wall Street story about a wonderful party, everyone was having a good time and no one wanted to leave, yet they knew it would end – but the clock had no hands.

The Advance-Decline Index is another proxy for the average stock versus the stock averages. It peaked in early February, had a lower peak in mid-April, and a pattern of lower peaks since then. In other words, it’s very similar to the unweighted S&P, and other measures showing the bifurcation. Recently, however, the A/D numbers have been mixed. We have long pointed out it’s not bad down days but bad up days that cause problems. Recently we saw a day with the Dow basically unchanged and 700 net declining issues – not a good day. Then there was a modestly up day with 1300 net advancing issues. Given how selective the market has been we are almost surprised the numbers haven’t been worse. That said you don’t want to see them become worse. Those up days with poor A/Ds are a warning.

Frank D. Gretz

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US Strategy Weekly: Take Your Pick

Posted on 05/17/202305/23/2023 by Andrea

Economic Mish Mash

One could build a case today for either a strong or weak economy based on recent data releases or from financial headlines. And it could be difficult to say who is right or wrong. In terms of economic strength, financial headlines noted that the US consumer is strong and resilient as seen by April’s total retail sales which rose 0.4%, the second month-to-month increase in the last six months. Industrial production increased 0.2% YOY in April led by a 16% YOY increase in auto and truck production. In terms of housing, the NAHB/Wells Fargo Housing Market Index (HMI) rose to 55 in May, a 10-month high. This NAHB survey of homebuilders is designed to take the pulse of the single-family housing market and it appears that housing may be on the mend. In general, economic activity appears healthy.

However, if one unpacks the April retail sales data it is easy to see that total retail & food services rose 1.6% on a year-over-year basis, a deceleration from the 2.4% YOY gain seen in March. Moreover, this 1.6% YOY increase was well below the level of inflation, which rose 4.9% YOY in April. In other words, real retail sales are negative and are decelerating which does not suggest the consumer is improving. In addition, a deceleration in sales implies corporate margins could be squeezed as consumption declines. What was notable in April’s report is that the standout segment of retail sales was, and continues to be, food services and drinking places, which rose 8.3% YOY before adjustments and 9.4% YOY after seasonal adjustments. See page 3. But in our view, this is not a broadly encouraging picture for an economy that is consumer driven.

Plus, offsetting the nice rebound in homebuilder sentiment was the University of Michigan consumer sentiment index for May. The headline consumer sentiment index tumbled to 57.7 from 63.5 in April. The decline was led by expectations, which fell a sizeable 7.1 points to 53.4. Current conditions also fell 3.7 points and as a result, each component is in recessionary territory. See page 5. In our view, the University of Michigan sentiment indices could be a warning for the homebuilders, since this survey is for May and the homebuilder survey was for April.

In terms of being either strong or weak, inflation data for April was also a tale of two cities. Headline CPI was 4.9% YOY in April, down only slightly from 5% in March. Core CPI was 5.5%, nearly unchanged from the 5.6% reported in March. More importantly, core service CPI was 6.8% versus 7.1% in March and remains stubbornly high.

The producer price index data was much the same. PPI for finished goods was 2.6%, down from 3% in March and final demand PPI was 2.4%, down from 2.8% in March. However, final demand PPI for the service sector was 3%, up from the 2.8% reported in March. Core PPI was also down from the 6.4% YOY pace seen in March, but it nonetheless remains high at 5.4% YOY. See page 4.

The importance of the stubbornly high inflation seen in the service sector is that it gives the FOMC a reason to worry about the embedded inflation in the economy, and to possibly raise rates again in June. This has not been the consensus view, but it has been something that several Federal Reserve governors have hinted at in recent discussions.

Earnings and Valuation

As earning season nears completion, and with over 91% of the S&P 500 companies having reported results, the S&P Dow Jones consensus estimates for 2023 and 2024 are $218.86 and $244.26, which rose $1.15 and fell $0.59, respectively, this week. Refinitiv IBES earnings estimates for 2023 and 2024 are $220.09 and $245.83, falling $0.78 and $0.60, respectively. See page 7.

We match our historic estimates to the S&P Dow Jones estimates since they have the longest historical database and because S&P is careful to see that estimates are uniform and reflect GAAP standards. [GD1] Nevertheless, our 2023 forecast of $180 for the S&P 500 is currently well below both the S&P Dow Jones consensus estimate of $218.86 and the IBES Refinitiv consensus estimate of $220.09. But this does not change the basic valuation standing of the market.

On page 6 we show two versions of our valuation model, one with the S&P Dow Jones estimate of $218.86 for this year and one with our $180 forecast. Surprisingly, there is little difference between these various estimates in terms of whether the equity market is currently overvalued, fairly valued, or undervalued. With both estimates, equities were overvalued prior to the surge in inflation in 2021 and became even more overvalued as interest rates rose in the last twelve months. The only difference is how much the fair value range increases, or not, by the end of the year. In both cases, our other model inputs for 2023 include an inflation target of 3.6% at year end and a fed funds target of 5.25%. We can envision scenarios in which inflation is better or worse in the second half of the year, but we believe our estimates are relatively sensible.

Still, the bottom line is that the equity market appears quite overvalued at current prices when using both the S&P estimates and our forecast. The main difference is that with S&P estimates the midpoint for the 2023 year-end fair value range rises from the year-end level of SPX 2700 to SPX 3235. Using DRG estimates, the midpoint of the fair value range falls from the year-end level of SPX 2700 to SPX 2660. We may be too pessimistic in our earnings estimate; but it is worth pointing out that even with the S&P estimates of an 11% increase in earnings this year and a 12% increase next year, coupled with inflation falling to 2.4% by the end of 2024, our model shows the midpoint of the fair value range to be SPX 3860 at the end of 2024.

In sum, this exercise shows that many things would have to go much better than expected for the stock market to move significantly higher from current levels. This is one of the reasons we remain cautious and would focus on companies and stocks with the most predictable earnings and reliable dividend payouts.

Technical Update

The charts of the S& P 500, Dow Jones Industrial Average, and Nasdaq Composite are technically positive, but each has failed to better critical resistance just above current prices. These levels are: SPX 4,200; DJIA 34,500; and Nasdaq 12,500. The Russell 2000 remains our favorite guide for the broader marketplace since it remains well within a defined range with support at 1,650 and resistance at 2000. See page 9. The 25-day up/down volume oscillator fell to a negative 1.99 reading this week but it is still in neutral territory. The oscillator recorded one-day overbought readings of 3.0 or higher on April 18, April 24, and April 28, but was unable to maintain an overbought reading on a rally. These failed overbought readings revealed a weakness in underlying buying pressure, i.e., demand. See page 10.

Gail Dudack

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