What a Difference a Day Makes … It Doesn’t

DJIA:  37,771

What a difference a day makes … it doesn’t.  We’re thinking here of Monday, a more than good day.  After a tough start to the year, we feared what we’ve called a bad up day – higher in the Averages but flat or modestly positive A/Ds.  Monday was not that day.  The A/Ds were a more than respectable 3-to-1 up.  Still, and you might want to write this down, one day is just one day.  And one day is never analytically meaningful.  Some of the best one-day rallies have happened in bear markets, not that that’s relevant here.  The A/Ds need not be positive every day, but needed is a pattern of positive numbers.  Strong stocks like the Techs bore the brunt of the recent weakness.  The template here might be XLK (192) – down to the 50-day, and now bouncing.  It likely will take time to get back or through the highs for the stocks, but more important those lows around the 50-day now need to hold. 

A selloff in the year’s first week is always a bit surprising.  It has been said for tax considerations investors waited until the new year to take profits.  Logical enough, but the logic that escapes us is why profit-taking at all, particularly in stocks that have acted so well.  The only logical explanation we can see is to move on to other areas, which seems to have been the case if we look to almost anything in Healthcare.  Rather than try to explain why the market does what it does, best just to recognize it and take it for what it is.  Techs were sold hard enough to take them down to the 50-day.  Still, Healthcare was bought hard enough to leave them now in impressive uptrends.  The Averages suffered simply as a function of the differing market caps.  If not exactly a zero-sum game, it could’ve been worse – selling in one area without commensurate buying in the other.

While the jockeying around we’re seeing could go on for a while, it’s important to remember the market has the momentum of the last two months at its back.  S&P stocks above the 50-day and the reversal in the Russell both say higher prices over the next six months.  To that you can add a positive change in junk bonds.  Here the 50-day moving average of its A/D Index rose above the 200-day, a so-called “golden cross.”  This seems important for a couple reasons.  Junk or high-yield bonds can be thought of as the most sensitive of corporate credit.  So in terms of the economy’s financial health, all seems well.  In terms of the stock market, these crossings have seen the S&P rise at a near 15% annualized rate, according to SentimenTrader.com.

While you have been sleeping, so to speak, China has been quietly drifting lower.  Clearly there are some real problems in the form of real estate and debt there.  They claim to be growing at 5% yet intend to stimulate.  If they’re really growing at 5%, they shouldn’t need to stimulate.  Meanwhile, the charts there are across the board poor.  With all the focus on the Fed, rates, and the Middle East, we are not sure how, but China could be a problem that sneaks up on markets.  It’s often where you’re not looking that causes the problems.  Meanwhile, despite the prospect of an expanded war in the Middle East, defense stocks seem unfazed.  Of course, the ETFs here have been hurt by Boeing (223).  What have acted well are the cyber security stocks like Palo Alto (323) and CrowdStrike (285).

Wednesday seemed like old times – at least for Nvidia (548), Meta (370) and Microsoft (385).  As for Apple (186), it may be time to think Magnificent 6.  On behalf of Tech and other strong stocks, let’s hear it for the 50-day.  Meanwhile, it’s a brave New World for most of Healthcare.  So far so good it would seem overall, but that’s a bit superficial.  A breadth momentum measure we follow closely has turned negative for the first time in two months.  After the strength in the fourth quarter some setback had seemed likely – February is typical, but you never know.  Meanwhile, it’s time to waste time on the January effect.  January is thought to be predictive of the year, the first five days predictive of the month.  This year the S&P was basically unchanged the first five days, not a great sign – outcomes proved poor over the next couple months historically.  Looking at the entire month of January, when up the next 11 months were positive 78% of the time, when negative only 59%.  By the way, the month of April is more predictive.

Frank D. Gretz

Click to Download

US Strategy Weekly: The Underpinnings of Targets

How much potential or risk there is in stock prices is best explained by current and forecasted fundamentals, in our opinion. Momentum and sentiment can drive stock prices over the short-to-intermediate term, but over the longer term, earnings growth, or lack thereof, always underlies the trend of the equity market. For this reason, we sought to understand the underpinnings of the many S&P 500 forecasts of 5100 or 5700 for this year.

There are two simple components to any S&P forecast: the appropriate PE multiple and the earnings estimate. However, it is never that simple because both can be moving targets. As we noted in our 2024 outlook, our valuation model is a PE forecasting model derived from our expectations for inflation and interest rates. Our assumptions for 2024 are that inflation will ease to 2.75%, short-term interest rates will fall to 4.25%, and Treasury bond yields stay relatively stable at 3.6%. These are optimistic forecasts in our view; however, they fall well within the range of consensus forecasts. With these estimates, our valuation model indicates that the average PE for this year should be 18.5 times and the maximum PE multiple could be 21 times. A 21 PE multiple would be a possibility if inflation falls to 2% or less, since this would imply earnings growth is more “real.” In short, the model provides a broad range of possibilities.

When we take a multiple of 18.5 times and apply it to our 2024 earnings estimate of $234.00, a 10% increase from S&P Dow Jones 2023 estimate of $213.55, the result is an SPX target of 4330 for this year. If we use a maximum PE multiple of 21, we get an SPX target of 4914.

If we assume our earnings forecast is too pessimistic and use the IBES consensus estimate of $243.98 for this year, we get an SPX target of 4514 with an 18.5 multiple. To get to an SPX target of 5123, we need to use a maximum PE of 21 times and the IBES 2024 earnings estimate. This is a good explanation of why several strategists are using a 5000+ target for this year.

However, for those looking for even higher SPX targets, the forecaster must use not only a maximum PE of 21 times, but also the IBES 2025 earnings forecast of $274.59. This combination equates to a target of SPX 5766. In short, this exercise explains how one gets to an SPX target of 5100 or 5700, but it also reveals how much risk there is to these targets.

First, both targets assume stocks will reach and maintain a maximum PE which is likely only if inflation falls to 2% or less later this year. Second, an SPX 5100 forecast assumes that the IBES consensus earnings estimate for this year is correct. The risk here is that consensus earnings forecasts tend to peak early in the year, start to decline in March and then during each reporting season thereafter. This declining trend is rarely absent unless the economy is coming out of a recession. Analysts tend to be too pessimistic after a recession; and as a result, consensus earnings estimates are usually too low and increase during each quarterly earnings season.

Nonetheless, an SPX target of 5700 discounts not only a perfect year of low inflation but all the optimistic earnings growth expected over the next 24 months. There are many risks to these assumptions, the most obvious being that the economy may slow, revenues will decelerate, and earnings growth could disappoint. The first few days of 2024 have already been an adjustment to the overly optimistic view that there will be multiple interest rate cuts beginning in early 2024. And after analyzing the basis of the bullish targets for 2024 it becomes clear that every earnings season, every inflation report, and every FOMC meeting will be very important to substantiate the bullish forecasts for this year.

Employment Data

The 216,000 increase in payrolls in December was stronger than expected, but the unemployment rate was unchanged at 3.7%. Note that the unemployment rate for those with less than a high school degree has been rising and was 6% in December. Clearly, the lower-income worker was experiencing a more difficult job market at the end of the year. The household survey showed roughly a 1.5 million increase in people no longer counted in the labor force in December; meanwhile, there was a 460,000 increase in the number of people not included in the workforce but who indicated they want a job. Job growth was 1.75% in December, which is above the long-term average of 1.7%. However, job growth in the household survey was 1.18% and this was below the 1.5% long-term average for the first time since March 2021. In short, there were some signs of stress in the jobs data. See page 3.

Economic Data

The ISM manufacturing index improved slightly from 46.7 to 47.4 in December; however, the services index fell from 52.7 to 50.6. Since 50 is the breakeven level, the December services survey was indicating only modest economic activity. Perhaps more importantly, the services survey saw the employment index fall from 50.7 to 43.3 in December, the lowest reading since July 2020 and a sign that job growth has slowed or is declining in the service sector. The employment index in the manufacturing survey has been below 50 (neutral) since September. See page 4.

When we look at a variety of components in the ISM manufacturing index, it is obvious that most have been below 50 for most of 2023, a sign of weak economic activity. In the services survey, the overall trend was above 50 but slowly decelerating. The drop in the employment index may be a bad omen for 2024. See page 5.

The small business optimism index improved slightly in December, rising 1.3 points to 91.9. However, this reading was still the 24th consecutive month below the long-term average of 98 and a sign of recession. In December, businesses indicated they were generally unhappy with the level of their inventories and indicated a reluctance to increase capital expenditure. Hiring plans also continued to decline. On a hopeful note, plans to raise prices appear to have peaked for most entrepreneurs. See page 6.

Technical Update The breakouts in all four of the popular indices were perpendicular and dramatic at the end of 2023, but only the Dow Jones Industrial Average managed to record an all-time high. The S&P 500 is most interesting since it has been fractionally away from recording a new high but is yet to better its January 3, 2022 high of 4796.56. The Russell 2000, after beating the key 2000 resistance, has now dropped below this level, which neutralizes the breakout seen at the end of the year. See page 9. The 25-day up/down volume oscillator is at 1.76 and neutral this week after being in overbought territory of 3.0 or higher for 22 of 25 consecutive trading days ending January 5. This indicator needed to remain in overbought territory for a minimum of five consecutive trading sessions to confirm the recent uptrend as “significant.” This is positive, however, weakness in the early part of a new year is often a warning sign of fading demand for equities. In sum, 2024 is apt to be a volatile and unpredictable year.

Gail Dudack

Click to Download

Wring Out the Old … Ring in the New?  

DJIA:  37,440

Wring out the old … ring in the new?   Quite a change to start this or any new year.  Profit-taking in last year’s winners and dip buying in last year’s losers.  It also saw some interesting numbers on that first day of trading – the Dow modestly higher, a very weak NAZ and 1700 advancing issues.  All things being equal, not a bad configuration. Those A/D numbers were pretty much the same for the NASDAQ, surprising given the weakness there.  Clearly Tech was the most prominent part of the weakness, but it was almost anything that has done well recently.  Meanwhile, just when you thought a stock like Hershey (191) might never lift it, other food and pharma stocks did quite well.  The question, of course, for how long.  With the overall background favorable, ideally this dichotomy will meet in the middle.

Despite this week’s setback, history and its probabilities still seem on the market’s side. The upside momentum we’ve seen carries with it some impressive outcomes.  If we look at the broader S&P 1500, 90% of the components there are above their 50-day average, a number with a 90% probability of higher prices six months later, according to SentimenTrader.com.  The Equal Weight version of the S&P (RSP-155) has cycled from a 52-week low to a 52-week high near record time, also suggesting higher prices over the next six months.  Of course, probabilities are not certainties, but they should put the odds in your favor.  If God told us to buy 1000 S&P call options, we would first say thanks, and then ask where to put our stop.  For the S&P, the Index is teetering on its exponential 21-day weighted averages, one utilized by IBD.  Granted it’s a trader’s measure, but the S&P has been above it since November 2, making any break somewhat noteworthy.

The worry we have about Tech is that everyone treats the stocks like they are the companies.  They’re not – they are pieces of paper and pieces of paper can become over owned, or just go out of favor.  One of our favorite charts is a long-term chart of McDonald’s (292) from the 70s and early 80s.  McDonald’s in 1973 peaked approximately at 75, went down to 22 in 1974, rebounded to 66 in early 1976 and then went sideways for the next five years.  Interestingly, the earnings continued growing throughout the decade at a compounded rate of 25% a year and the company never missed a quarter.  Despite all that, by its 1980 low McDonald’s was selling at 10 times trailing 12-months earnings, compared with selling at 75 times trailing 12-months earnings in 1973.  Even good stocks can become over owned and/or fall out of favor.   

With the leadership dust more than a little unsettled, a stock like McDonald’s might make sense.  It didn’t have a great year last year, thanks to a 20% drawdown in August – September, but has a more than decent uptrend going for it now.  Also going for it, it could easily be among our Other Mag Seven stocks in that it has a great long-term pattern.   As things sort themselves out, you might also look to Oil which also didn’t have a great year in 2023, and it has failed to respond to threats in the Gulf.  Still, if not quite ready for prime time, the stocks are shaping up, and are among the laggards that are a recent market focus.  Among the better charts are Diamondback (156) and Phillips 66 (135).

Tech isn’t going away, but it could go dormant.  Not dormant like MCD in the 70s, but dormant relative to last year.  Clearly it’s too soon to say, weakness there is what the old westerns used to call a flesh wound.  The stocks of course have had runs that deserve a break, and now there seem options.  If Hershey is not on your diet, there are many healthcare stocks with good short and long-term patterns – even most of Biotech has a turn.  With all the recent cross currents, the best guide to overall market health isn’t the NAZ, S&P, or even the RSP, it’s the average stock.  Because the large caps dominate the Averages, the Averages for now can be almost misleading.  Dare we say, look to the A/Ds as a better guide to market health.  When most days most stocks, go up, whatever they may be, markets don’t get into trouble.

Frank D. Gretz

Click to Download

US Strategy Weekly: History, Liquidity, and Valuation

A Bit of History

The media is filled with headlines stating that the S&P 500, the Dow Jones Industrial Average, and the Nasdaq Composite Index have booked nine consecutive weekly gains — the longest weekly winning streak for the S&P 500 since January 2004, and the longest stretch for the Dow Jones Industrial Average and the Nasdaq Composite Index since early 2019. Many in the media have then suggested that this strong run means more gains are ahead. Indeed, double-digit gains in the equity indices don’t suggest a bear market … unless there are three years in a row of double-digit gains. But as you can see from page 7, the full year 2004 had a fairly mediocre performance after its early advance. In 2019 an early advance in the first quarter stalled, then rallied, and in November, COVID-19 became a global pandemic, making comparisons difficult.

However, the parallel between 2004 and 2024 is not only due to the nine weekly gains, but that both are presidential election years. And they are years ending in “4.” Depending upon which market index one uses, the presidential election year has the third or fourth best performance of the four-year cycle. In short, election years tend to be mediocre. The pre-election year is the year with the biggest stock gains in the four-year cycle. This is probably due to fiscal stimulus done early in the year to help the economy and to help the incumbent president win votes due to a strong economy. This pattern seems to fit the current cycle, even though it is a most unusual economic cycle.

However, one of the most interesting things about an election year is that it has some ability to predict the outcome of the presidential election. When the incumbent is about to win, equities tend to be weakest in May in July. The May decline sets up a classic summer rally which is followed by a weak July. Typically, July is the fourth best performing month of the year, so this works against seasonality. In years when the incumbent loses, the weakest months of the year tend to appear in January, February, September, and October. January has a history of being the sixth best performing month, on the heels of good gains in November and December. So, this too, goes against seasonality and weakness early in the year is a bad omen for an incumbent president. In both cases, or most election years, the strongest months tend to be November and December. See page 8.

This is also a year ending in 4, and the decennial pattern suggests it will be a year with an average gain of 7.1%, leaving it tied for fifth place in the 10-year cycle. Still, “4” years have produced gains in nine of the last 14 cycles, so there is a bullish bias to years ending in 4. See page 6. All in all, history points to an up year, but more in line with a single-digit gain than a double-digit gain.

Liquidity

The dramatic gains seen at the end of 2023 were driven by the widely held belief that interest rates are coming down in 2024. Federal Reserve Chairman Jerome Powell attempted to dampen these expectations in subsequent days, however, his comments after the last FOMC meeting did indicate that rate cuts were likely in 2024. This suggestion triggered a swift decline in long-term interest rates and a rush out of cash and into equities. The momentum of the equity market is strong, and this is seen in our technical indicators. However, behind good momentum tends to be good liquidity. For this, we looked at Federal Reserve data on commercial banks. What we found was that banks hold nearly $19 trillion in customers’ liquid short-term assets. This number is the sum of $4.99 trillion in demand deposits, $1.7 trillion in retail money market funds, $1.0 trillion in small-denomination time deposits, and nearly $11 trillion in other liquid deposits. See page 4. In recent years, money flowed into short-term assets as interest rates rose and the threat of recession was looming. Powell’s “pivot” on interest rates created a “pivot” in investor sentiment and their opinion of cash. In a Cinderella world of falling interest rates, declining inflation, and no recession, $19 trillion is a substantial amount of potential demand for equities. Moreover, we know that the cash held at commercial banks is a majority, but not all inclusive, of household cash coffers.

Nevertheless, we have experienced liquidity-driven markets in the past and have learned that it is important to put any “liquidity cache” in perspective to the size of the overall market. If we compare current cash assets to total US market capitalization, we find that it represents 38% of total US market capitalization. This is a substantial, but not historic ratio, of cash. See page 4. Most secular bull cycles began when cash equals 50% or more of market capitalization. In short, cash levels support a strong momentum-driven market for a while, but do not suggest this is the start of a major secular bull market.

Valuation

If the equity market is on the verge of a bubble market, we will know fairly quickly since bubbles are driven by sentiment, liquidity, and leverage, not by earnings or fundamentals. At present, the fundamentals are not supportive of the bulls. There are many ways to measure valuation, but most show the market to be richly valued today. On page 9, we show the Rule of 23, which implies that when the sum of the trailing PE and inflation exceeds 23.8, the stock market is extended and overvalued. The current trailing PE is 22.3 times and the S&P PE based on 2024 earnings estimates is 19.6 times. With inflation at 3.2% and potentially easing, when coupled with the trailing PE of 22.3, the sum of 25.5 is well above the dangerous 23.8 level. Perhaps more importantly, if we add the estimated 2024 forward PE ratio of 19.6 times to inflation of 3.2%, the sum of 22.8 is only two points below the 23.8 danger level. In short, the stock market’s valuation has already discounted a substantial decline in inflation and all of this year’s potential earnings growth. This implies that every CPI report and every earnings reporting season has the potential to be a market-moving event.

Bullish Technicals

What keeps us from getting too negative about valuation too soon is the significant change in our technical indicators. The breakouts in all four charts of the popular indices are both perpendicular and dramatic, but to date, only the DJIA has managed to make a new all-time high. The SPX is most interesting at this juncture since it has been fractionally away from a new record high for several sessions but is yet to better its January 3, 2022 peak of 4796.56. The Russell 2000, after beating key resistance at the 2000 level, is now testing this level as support. If the Russell begins to trade below 2000 once again, it could neutralize what is now a very bullish technical pattern. See page 11. The 25-day up/down volume oscillator is at 3.45 this week and has been in overbought territory of 3.0 or higher for 19 of the last 22 consecutive trading days. To confirm the recent advance this indicator needed to remain in overbought territory for a minimum of five consecutive trading sessions, which means the oscillator has definitely confirmed the recent uptrend as “significant.” The current 19-day overbought reading is far better than the 11-day reading seen between January 25, 2022 and February 8, 2022. The only missing ingredient to the current strength of this indicator is an overbought reading in excess of 5.0. Extreme overbought readings of 5.0 or more are often seen at the start of a new bull market cycle. However, this is not a requirement for a significant advance. What will be important is that any pullback in the equity market ends once this indicator approaches an oversold reading. In a bull market oversold readings tend to be brief or nonexistent.  

Gail Dudack

Click to Download

Liquidity-driven Market

2023 ended with a flourish after Federal Reserve Chairman Jerome Powell indicated that interest rate cuts were likely in 2024. This surprising “Fed pivot” by Powell following the last FOMC meeting of the year, unleased a buying surge that generated one-month gains of 4.8% in the Dow Jones Industrial Average, 4.4% in the S&P 500, 5.5% in the Nasdaq Composite and a stunning 12% in the smaller cap Russell 2000 index. The December 2023 rally carried the Dow Jones Industrial Average to a new record high and the S&P 500 came within 1% of its all-time high.

Chairman Powell’s indication that rates would soon come down, unleashed a liquidity-driven advance fueled by the $7.5 trillion in cash seen in demand deposits, retail money market funds, and small-denomination time deposits. Yet, despite strong December performances, the Nasdaq Composite closed the year 6.5% from a record high and the Russell 2000 ended 17% below its November 8, 2021 high of 2442.74.

For the full year, the Dow Jones Industrial Average gained 13.7%, the S&P 500 gained 24.2%, the Nasdaq Composite inked a gain of 43%, and the Russell 2000 index rose 15%. Overall, it was an amazing yearend performance for a year that until then had been only modestly successful and a time most analysts expected to include a recession and a poor stock market.

Remembering 2023

The first half of 2023 was expected by many, including us, to be the final chapter of the post-pandemic hangover. There were many signs of an imminent recession, including a long and severely inverted Treasury yield curve, a slump in the real estate markets, recessionary levels in consumer and business sentiment surveys, historic weakness in the leading economic indicators, and negative year-over-year retail sales. Consumers were experiencing declining purchasing power due to rising prices, and corporations suffered profit margin squeezes from escalating costs for labor, transportation, and raw materials. Yet despite all these warnings, the economy continued to grow a bit each quarter, and in the third quarter of 2023, GDP reached 4.9% on a seasonally adjusted annualized basis.

In the early and unsettled environment of 2023, some investors began to focus on the long-term growth prospects of artificial intelligence. This led to the popularity of a small group of stocks called the Magnificent Seven, which included Apple Inc. (AAPL – $192.53), Microsoft Corp. (MSFT – $376.04), Amazon.com (AMZN – $151.94), Nvidia Corp. (NVDA – $495.22), Alphabet Inc. (GOOG – $140.93), Tesla Inc. (TSLA – $248.48), and Meta Platforms Inc. (META – $353.96). These companies quickly became the investment darlings of 2023 driven in part by an analysis from PwC indicating that artificial intelligence was expected to improve productivity by 40% by 2035 and the global AI market was expected to grow 37% annually from 2023 to 2030. Not surprisingly, at a time when a recession appeared to be around the corner, these stocks became the most exciting investments to own. From our perspective, we felt it was also important to note that PwC’s surveys also showed that 73% of US companies have already adopted artificial intelligence in some areas of their business. This poses questions about the near-term potential of AI.

A Wall Street Journal article (“It’s the Magnificent Seven’s Market. The Other Stocks Are Just Living in It.” December 17, 2023) noted that these seven stocks soared 75% in 2023, while the remaining 493 stocks in the S&P 500 rose only 12% and the S&P 500 index gained 23%. But more importantly, these stocks represented 30% of S&P’s market value, which approaches the highest-ever share for seven stocks. Perhaps most surprisingly, the group represents more than the combined weighting of all stocks in Japan, France, China, and the UK, in the MSCI All Country World Index.

This outsized performance of a small group of stocks is reminiscent of the bubbly Nifty Fifty and the Dot-Com eras. In these earlier equity manias, a small group of stocks led dramatic advances that persisted for a year or two. But eventually, an extremely overvalued market later ended in tears. In our opinion, even though the current advance may not be over, there is risk in the overall market, and more importantly in these seven stocks. The Magnificent Seven stocks have discounted a substantial amount of future growth which means they would be vulnerable should anything challenge the expectations of AI-driven earnings growth. At the same time, these numbers suggest there is much better value found in the broader marketplace.

Our 2024 Forecasts

Our assumptions for 2024 include GDP growth of 0.8% YOY for the full year, which implies slowing economic activity and the possibility of a negative quarter of growth, but the year should escape a full recession of two consecutive falling quarters of GDP. In this environment we are assuming some weakness in topline revenues, but efficiencies developed during the economic shut down and a rocky economy in 2023 will help companies generate modest earnings growth of 10%. Given the Fed’s recent pivot we are expecting a possible 75 basis point decrease in the fed funds rate. To do this, we are assuming a modest decline in inflation to 2.75% which will allow the Fed to maintain a real yield of 220 basis points in the fed funds rate throughout the year. In line with this, our forecast expects Treasury bill yields to fall to 4.25% in line with an easier Fed policy, and for Treasury bond yields to be lower and stable at 3.6%.

There are many risks to these forecasts since external factors like the Houthi’s attacks in the Red Sea have the potential to interrupt trade and send oil prices higher. Other risks include the possibility that efficiencies from artificial intelligence may prove to be less than expected. The wars in Ukraine and Israel could increase past current borders and trigger fear of a widening escalation. Politics should be a major topic in 2024 since there will be nine parliamentary elections in Europe in 2024, as well as elections in the UK, Mexico, Taiwan, and the US.

Although the economy may manage to muddle through a year of sluggish growth in the economy and earnings, equity valuation remains a hurdle. Our forecasts for 2024 coupled with our valuation model, yield a mid-point predicted PE of 15.8 and a top-of-the-range PE of 18.4. This, combined with our 2024 S&P 500 earnings forecast of $230 creates a midpoint S&P 500 target of 3634 and a high of 4295 for 2024. Using a higher IBES 2024 earnings estimate of $245.21, these targets rise to 3875 and 4511, however, yearend prices have already exceeded these levels. And for those who think our model’s predicted PE multiples are too low, note that at the end of 2023, the S&P trailing PE was 22.3 and the 12-month forward PE was 19.6. These are at or above the top of the normal range for PE multiples. In sum, this implies that next year’s earnings growth has already been factored into current prices and this will leave the equity market vulnerable during every earnings season in 2024.

Sector changes

A shift in relative performance at the beginning of an advance is often a sign of new sector leadership and we are using December’s relative performance as a predictor of 2024 price action. As a result, we expect good performance from the consumer discretionary, financial, and materials sectors. Weak relative performance in December suggests underperformance in energy, staples, and utilities. December’s good performance in financials is a bullish factor since new bull market cycles require participation from this sector. However, the out-performance in the materials group may be a warning that inflation is not yet under control. Altogether, 2024 may be a year that requires nimbleness and attention to good fundamentals.

Closing prices are as of December 29, 2023

Click to Download

It’s the Most Wonderful Time of the Year… Thank You J. Powell

DJIA:  37,248

It’s the most wonderful time of the year… thank you J. Powell.  In reality, it’s the market’s momentum off of the October low that should be thanked.  We have alluded to the 6-to-1 up day a couple of weeks ago and the 10- to-1 up day of 11/14, and now Wednesday’s 7-to-1 up day.  It’s important to remember these occurred within a cluster of positive days, recently five, rather than standalone events.  Stocks above their 200-day have more than doubled from the October low, and more than half of the S&P reached a 21-day high last week.  This also happened a year ago when the market began an 8% rally.  Perhaps most important in any discussion of momentum is the idea of its durability – it doesn’t turn on a dime, rather it takes time to unwind. The other part of the analytical equation is investor psychology, or sentiment, always difficult to interpret this time of year.  The VIX has dropped to 12 from the low 20s, not a worry in December.

It may be a wonderful time of year, but December isn’t always easy.  Recently, IBM (163) has outperformed Microsoft (366) and Intel (45) has beaten Nvidia (484).   As measured by the Roundhill Magnificent Seven ETF (MAGS-33), those leaders have been stalled for a month now.  We suspect this might simply be called December.  Meanwhile, Monday saw six of our Other Magnificent Seven reach 12-month highs, and Parker Hannifin (455) had done so a few days earlier.   Either we are better than we thought or there’s more to this market than just Tech.  Then, too, it could be an early indicator of a shift away from over priced/over loved Tech, but it seems a bit premature to go there.  Certainly the charts are intact, and for now pause seems more the correct take.  When it comes to our Other Mag Seven, the added appeal seems their long-term uptrends – see the monthly charts.

Of our Other Mag Seven, many have an economic leaning. We’re thinking here of names like Cintas (563) and Fastenal (64) among others.  Grainger (829) has a segment called “endless assortment,” Cintas deals in uniforms and other workplace supplies, while Fastenal does nuts and bolts – not very techy techy, as Penny might say. That these companies act as well as they do helps assuage our worries about the economy.  Nonetheless, and you can quote us here, you never know.  While the tightening may be done the lag effects of that tightening may not be completely clear.  On the positive side, the world did change in October.  Yields peaked, the Banks and every other rate-sensitive area began strong rallies.  Rates remain high enough to impact the economy, but the market has taken a decidedly optimistic view here.

Natural gas has been under pressure to the point that the worst may well be over.  However, there is a seasonal pattern which started November 4 and will persist until February 15.  During this period Nat Gas has been lower 25 of 32 years.  If not lower, odds are for continued underperformance. Since Nat Gas is typically in Contango, a Spanish dance we presume, there is a downward bias to the UNG ETF (5), according to SentimenTrader.com. Also of note is an apparent washout in Consumer Staples.  Back in October half of the stocks in the XLP (71) reached a 52-week low, capitulation sort of numbers.  Stocks there above the 50-day were only 5% and since have moved above 80%.  This sort of extreme momentum shift has led to higher prices in almost every case. The real impact starts around now, typically some two months after the washout.

Good news out of Powell?  Who would’ve guessed.  We had expected his usual “lean against” performance, which the market then ignores.  The Fed it seems now sees what the market has been seeing for a while. Meanwhile, of course, it’s the market that makes the news, and it’s a market that has acted well since the October low.  Someone once said the secret to forecasting is to keep forecasting.  Forecasting is hard – we prefer to stick with observing.  It’s a strong market.  When that changes we will follow the advice of Keynes and change our mind. The change, of course, will typically show up in the average stock rather than the stock averages.  Through all this, there have been bad days, but no bad up days – days up in the Averages with negative A/Ds.

Frank D. Gretz

Click to Download

Momentum Isn’t Something That’s Borrowed

DJIA:  36,117

They say November borrowed from December.  Momentum isn’t something that’s borrowed, it’s something that unwinds of its own accord.  Last Friday’s 6-to-1 up day and the 10-to-1 up day of 11/14 speak to momentum which will take time to unwind.  December’s early problems might best be blamed on December – it’s a good month but one rife with crosscurrents.  Will they continue to sell the winners, the Mag 7 and the rest of the Tech, and buy the losers, the Financials and the rest?  Or will they revert to the winners – Apple (194) did break out on Tuesday.  Regardless of the outcome there, the sold out seem just that – sold out and unlikely to go lower.

All Bitcoin wants for Christmas is its ETF.  It may not be for Christmas, but it’s said to be in early January.  What is seen as inevitable rate cuts also has been a driver for Bitcoin, and the usual suspect short covering.  We are not quite sure of the logic here, but we are sure of those lines on a piece of paper called a chart.   It’s an impressive break out and uptrend.  Bitcoin, of course, isn’t for everyone.  And it may well be another case of buy the rumor, sell the news.  Still, it seems another case of momentum not likely to go away in a hurry.  The existing ETF, BITO (21) seems a reasonable way to participate.

Frank D. Gretz

Click to Download

US Strategy Weekly: Great Expectations

The yield on the 10-year Treasury note plummeted over 50 basis points during November and expectations for a fed funds rate cut shifted from late in 2024 to the first quarter of the new year. This sentiment shift supported a rally in US equities and in gold since gold tends to move inversely to interest rates. In other words, the market has been pricing in a Goldilocks scenario that consists of lower inflation, a soft landing or non-recession, Fed easing early in 2023, and a rebound in corporate earnings in 2024. However, as Mohamed El-Erian noted on CNBC this week, believing this scenario is possible in the current complicated environment is the equivalent of believing a pilot could land a jumbo jet without any passenger feeling any landing at all. The risks are therefore high, that the consensus will be proven wrong.

China/Debt/Gold

Perhaps if the US were functioning on its own, a soft landing might be possible. But there are risks on the horizon. The largest of these could be China. We have often written about the problems facing the Chinese economy in terms of its property crisis, but this week Moody’s lowered its rating on China’s A1 debt rating from stable to negative. This was the first rating shift on Chinese debt by Moody’s since 2017 and the company commented that the costs to bail out local governments and state firms while controlling its property crisis would weigh heavily on China’s massive economy. China’s total outstanding off-balance sheet debt is estimated to be somewhere between $7 trillion and $11 trillion, according to the International Monetary Fund. This figure would include corporate bonds issued by thousands of local government financing vehicles which borrowed money to build roads, bridges, and other infrastructure. According to a senior economist at UBS, most local government financing vehicles currently depend on capital injections from local governments, government subsidies, and external funding because they do not generate enough cash from their operations to cover the interest payments. The longer-term risk is that this massive debt problem becomes systemic to the Chinese banking system and becomes a global banking problem.

Meanwhile, China’s CSI 300 Index (000300.SS – 3,394.26 CNY) is trading at its lowest level in nearly five years. This backdrop of falling real estate prices, risk of debt defaults, falling stock market prices, and a weakening currency, explains why Chinese consumers are actively buying gold (GC=F $2038.30). According to the latest Chinese retail sales data, gold and silver jewelry have been among the best-performing consumer goods in China this year, with a 12% rise in value year-on-year in January-October and outpaced only by garments. A Chinese consumer survey released in late October found that 70% of consumers between the ages of 18 and 40 intend to purchase pure gold jewelry. Together, China and India, the world’s two biggest gold buyers, account for more than half of total global demand. And according to commodity analysts, China is the world’s top buyer of physical gold has been an increasingly important driver behind this year’s rally in global spot gold prices. Gold has clearly become the safe haven trade for Chinese investors. Perhaps the rally in bitcoin (BTC – $43,886.05) is also a result of Chinese investors looking to protect themselves from a weakening currency and falling stock and property prices.

Pivotal Points in Technical Indicators

As we noted last week, the technical charts of the popular equity indices remain bullish with the first level of resistance encountered at the July highs and the second, and most important resistance, found at the all-time highs. Only the DJIA has exceeded its July high on the recent advance, touted by many to be the start of a new multi-year bull market. The July highs of 4600 in the SPX and 14,500 In the Nasdaq Composite have not been bettered and stock prices retreated as they tested those levels. The Russell 2000 index, which is our personal favorite for defining the broad marketplace, broke above its 100-day and 200-day moving averages last week, but the index remains neutral in its long-standing trading range between 1650 and 2000. In sum, the recent uptrend is unconfirmed. See page 8.

The 25-day up/down volume oscillator is at a positive 3.49 reading this week and has been in overbought territory of 3.0 or higher for four consecutive trading days. This is a positive development, but to confirm the recent advance this indicator should remain in overbought territory for a minimum of five consecutive trading sessions. In short, this indicator is close, but has not yet corroborated the recent uptrend as a significant trend. To date, both downtrends and uptrends have failed to sustain oversold or overbought readings for a minimum of five consecutive trading sessions. See page 9. However, this is in line with our long-held view that the stock market is in a broad trading range, which is a substitute for a bear market. We expect this range, best seen in the Russell 2000 index, to remain in force until inflation has been clearly brought under control.

The American Association of Individual Investors (AAII) survey showed a 3.5% increase in bullishness (48.8%), and a 4.0% decrease in bearishness (19.6%) last week. Bullish sentiment remains above average for the fourth consecutive week and bearishness is also below average for the fourth consecutive week. But more importantly, bearishness is at its lowest level since the January 3, 2018 reading of 15.6%. This extreme bearish reading in 2018 was followed by a 10% decline in the S&P 500 by February 8, a 13.6% advance by September 20, and a 19.8% decline by December 24. For the full year, the S&P 500 fell 6.2% in 2018. This too supports a view of a volatile trading range marketplace.

An Economic Mix

The headline ISM manufacturing index was unchanged in November, but six of the 10 components fell. The backlog of orders component declined to 39.3, its lowest reading since May 2020. The non-manufacturing index rose from 51.8 to 52.7, but the rise was mostly due to a buildup in inventories to 55.4. Order backlog also fell from 50.9 to 49.1. Readings below 50 indicate a contraction. See page 3.

The 5.2% GDP pace in the third quarter was the fastest rate recorded in nearly two years. Inventory build was a big contributor, consumption rebounded from a weak second quarter, and trade was a drag. However, this was the fourth consecutive quarter of negative real retail sales, which is typically associated with a recession. The key risk factor for the 2024 economy will be the strength of the consumer. See page 4.

Personal income rose 4.5% YOY in October, down from 4.8%. Disposable income rose nearly 7% YOY, down from 7.4%. Real disposable income increased 3.85% YOY, unchanged from September. Personal savings were $768.6 billion, up $19.6 billion, and the savings rate rose from 3.7% to 3.8%. But this remains well below the average long-term savings rate of 5.7%. See page 5.

Personal consumption expenditures rose 5.3% YOY in October and personal disposable income rose nearly 7% YOY. This marked the tenth consecutive month in which income exceeded consumption and it follows 21 consecutive months of consumption exceeding disposable income. Note that wage growth is decelerating for most employee sectors of the economy, except government, where wage growth was 8% YOY in October. See page 6.

Gail Dudack

Click to Download

Sufficient Unto the Day… Is the Evil Thereof

DJIA:  35,950

Sufficient unto the day… is the evil thereof.  Less biblically, it’s good enough for government work.  Of course, we’re talking about the rally off the 10/27 low – it’s good, but yet to be great.  While we don’t find instant coffee fast enough, we are told these things sometimes take time.  Meanwhile, there’s enough to at least muddle us through year-end.  The enough in this case is momentum, and it goes back to 11/14 if we were to single out just one day.  That day saw advancing issues 10 times greater than those declining, and it was a 90% up day.  Also, more than a quarter of all stocks rose by 4% or more, according to SentimenTrader.com, a real rarity.  Stocks follow through to this kind of momentum pretty much across all time frames, the only problem being the small sample size.

While Nvidia (468) garners all the attention, of all things Intel (45) recently has outperformed. Together with almost daily new highs in IBM (159) and Dell (76), it’s enough to make you think PCs are here to stay. These may not be as much fun as the Mag 7, but that’s only true if you define fun as volatility rather than making money.  In any event, the real point here is that it is encouraging to see stocks like these acting well, in addition to the Nvidia’s of the world.  Meanwhile, the Cyber stocks make so much sense it’s a wonder they haven’t done better, but they did have a great week.  Perhaps most interesting was the price action in Zscaler (198).  The stock gapped down eight points or 4% at the open Tuesday yet managed to close modestly higher on the day.  Of course, opening gaps don’t really matter if they’re filled during the day.  And gaps typically don’t matter unless they change the price trend, which in the case of ZS was unlikely.

Obviously, there has been more to the upside than just one good day.  For what seems a good rally, however, it holds some concerns. The percent of stocks about their 200-day, for example, remains below 50%. While up from its low around 30%, the S&P is up some 12% from its low.  There’s no magic number here, and while the A/Ds have been positive throughout the recovery, we are surprised more stocks haven’t been pushed into uptrends, that is, above their 200-day. Meanwhile, on the NASDAQ 12-month lows numbered more than 300 issues, also a surprise given the 10% recovery there. None of this is rally killing, and for now we are happy to buy into the progress not perfection argument. However, these numbers need to improve.

Had you invested 10% of your portfolio in Homestake Mining back in 1929, it would’ve hedged the rest. What is surprising is that was a period of deflation, not the inflationary backdrop against which Gold typically is associated. Perhaps the recent better price action in Gold is suggesting at least a period of disinflation. Meanwhile, whatever the driver Gold is acting better, though Gold and “false dawn” have become almost synonymous.  Gold is in one of its historical four year down cycles which should last through next year. However, after the always difficult October, Gold tends to rally through the following February.  Also, the Dollar is now a tailwind.

While the market looks higher through year-end, we doubt it will prove as easy as it looks.  December may be one of the most positive months of the year, but typically there’s a downdraft someplace along the line. If not actual weakness, there’s the jockeying which comes with year-end – buy the winners or is it sell the winners, it’s never quite clear. If anything usually proves true, it’s don’t sell the losers, which by now are usually sold out. We may have seen a little of these cross currents Wednesday and Thursday when Tech sold off despite for the most part good news.  If worry you must, the market did sell off when Nvidia reported last July. Through what could be a lot of noise in the coming month, it’s even more important to watch the average stock, the A/Ds to gauge the market’s health.

Frank D. Gretz

Click to Download

US Strategy Weekly: Oh Media!

Media Hyperbole

It is widely known that there is political bias in the mass media, but we continually see signs of bias in the financial press as well. The bias tends to be bullish or optimistic, which may seem constructive and comforting, but it can also be dangerous if it is misleading to the public and/or investors. We have pointed out several situations in the past and there was more this week. In particular, we just read a headline from an international news source that shouted in bold letters “US consumer confidence rebounds, house prices maintain upward trend.” We had just finished writing the back pages of this report, so we knew what these economic releases contained, and this headline did not match what we learned from the data.

This headline sounded like the economy was on the verge of an economic rebound. However, within the article it did state that “the Conference Board said its consumer confidence index increased to 102.0 this month from a downwardly revised 99.1 in October. Economists polled by Reuters had forecast the index dipping to 101.0. The improvement in confidence was concentrated mostly among households aged 55 and up. Consumers in the 35-54 age group were less optimistic about their prospects.”

The fact that the 35-54 age group was less optimistic than those over 55 is noteworthy since this age group is of prime working age and has children in school, a combination that makes them core consumers and important drivers of the economy.

What was not made transparent in this article was that October’s index had initially been reported to be 102.6. This means the consensus estimate for November was 101.0 implying a decline in sentiment. And the only reason November’s index of 102.0 was better than forecasted was the large negative revision in October’s index, to 99.1. In our opinion, there is a bit of a sleight of hand to say that November’s confidence was a positive surprise and/or represented a rebound. Plus, the University of Michigan consumer sentiment index for November showed consumers were clearly worried, especially about higher inflation. The main index fell 2.5 to 61.3, present conditions were 2.3 lower to 68.3, and expectations fell 2.5 to 56.8. All in all, none of this supports a headline that says consumer confidence is rebounding, in our opinion. See page 6.

In terms of suggesting there is an upward trend in house prices, it is more of the same. The article was referencing housing data from the Federal Housing Finance Agency (FHFA) which does not measure home prices but calculates an index (1991=100) which is defined as a weighted repeat-sales index, meaning that it measures average price changes in repeat sales or refinancings on the same properties. It is a broad-based index but does not represent actual home prices. We doubt that the journalist understood this. Moreover, the FHFA index is released a month later than most other home price data, i.e., the article was referencing September data when data for October and surveys for November had already been released. See page 5.

As for the trend in new home sales and prices, according to data from the Census Bureau, sales were lower in October versus September, but up 17.7% YOY. New house inventories were at their highest level since January and the total months of supply of housing was 7.8, back to August’s level. But in terms of home prices, Census data showed that the average new single-family home price fell 10.4% YOY to $487,000 while the median price fell nearly 18% YOY to $409,300. This data does not support the international news article, but it does support the negative NAHB survey results reported for October and November. See page 4. In sum, do not believe everything you read.

Media Neglect

Not getting much attention by the media are the risks appearing in the Chinese economy. Most investors know about China’s property crisis and its impact across China is immense and ongoing. However, foreign investors have been souring on China for most of this year, and recent data shows strong evidence that the global trend of diversifying supply chains and other de-risking strategies are having a negative impact on the world’s second-largest economy. In the July-September period, China recorded its first-ever quarterly deficit in foreign direct investment, a sign of capital outflow pressure. See page 7. According to Rhodium Group (www.rhg.com), the value of announced US and European greenfield investment into China dropped to less than $20 billion last year, from a peak of $120 billion in 2018, while investment into India shot up by some $65 billion or 400% between 2021 and 2022.

Given this backdrop, it is not surprising that Chinese President Xi Jinping recently met with President Biden at the Asia-Pacific-Economic-Cooperation (APEC) Summit in San Francisco. Investment in China has dropped to historic lows, and President Xi attended the Summit in San Francisco to promote China’s economy. However, the data suggests that foreign firms are not only refusing to reinvest their earnings in China but are selling existing investments and repatriating funds. This trend could put further pressure on the yuan and dampen China’s economic growth in the long run. It also reduces China’s need to invest dollar inflows, which helps explain China’s decreasing demand for US Treasury bonds.

In terms of China’s economic activity, a survey released by The Conference Board showed that more than two-thirds of responding CEOs indicated that China’s demand has not returned to pre-COVID levels. Forty percent of respondents are expecting a decrease in capital investments in China and a similar proportion are expecting to cut jobs. In sum, corporations will become more dependent upon US consumers for top-line growth in the future.

Market Update

Not much has changed this week. The charts of the popular equity indices remain bullish with the first level of resistance seen at the July highs and the most important resistance found at the all-time highs. The near-term levels to monitor are 4600 in the SPX (July high) and the 1820-1827 area of the Russell 2000 index where the 100-day and 200-day moving averages merge. These short-term challenges are yet to be tested. However, while moves above these levels would be favorable for a year-end rally, the all-time highs are the real source of resistance. In our view, the longer-term trading ranges remain intact. See page 10.

Beware What You Wish For The consensus believes rate hikes are over and rate cuts, accompanied by a soft landing are in store for 2024. Yet, today’s rapid Fed tightening cycle would be most comparable to the early 1950s or the early 1980s. In both cases, Fed tightening led to multiple recessions. And while the stock market is currently rallying based upon the view that rates have peaked and will soon decline, the decline in interest rates following a tightening cycle has usually appeared in tandem with a recession. In short, the current stock market rally appears to be celebrating the onset of a recession, whether it is aware of it or not.

Gail Dudack

Click to Download

© Copyright 2024. JTW/DBC Enterprises