US Strategy Weekly: When Emotions Run High

The S&P 500 is down 5.26% year-to-date and is currently 9.3% below its all-time high. More importantly, this 9.3% decline took place in just the last 14 trading sessions. But the real carnage has taken place in the Nasdaq Composite index, which is now 13.6% below its record high level and the Russell 2000 index, which has fallen 17.1% from its record peak. In short, the S&P 500 may be slightly short of the 10% correction level, but many stocks, particularly in the small capitalization and technology sectors, have experienced a full bear market in the last two months. This is the bad news. The good news is that perpendicular moves in the equity indices tend to be counter to the major trend. Dramatic moves reflect emotion, either fear or greed, and are rarely the beginning of a new trend. This should be some consolation for investors.

The other bit of good news is that the stock market appears to be discounting a recession, which may or may not occur. At the moment there is no real evidence that a recession is ahead, although there are a few warnings which we will discuss this week. The catalyst for this week’s bloodbath is entirely President Trump, who first shied away from negating the prospect of a recession and then shocked global investors by threatening to place 50% tariffs on Canadian goods. All in all, this meant that there is no way to predict what President Trump’s next move might be and this rising uncertainty drove investors to the exits.

Without the need or ability to run for another four-year term, President Trump, appears to be playing hardball both domestically and internationally to fix a myriad of problems such as runaway fiscal deficits, bureaucracies with no oversight, unfair trade practices, and wars in Europe and the Middle East. None of these problems are easy to fix and they are all serious. But after only 50 days in office, Trump seems to be making progress on many of these issues, but not without creating an uproar in Washington DC and Europe!

Technically Speaking

The key market index to monitor in our view is the Russell 2000 index, which has dropped back to the 2000 level. This level was resistance throughout 2022-2023 and part of 2024 and should now act as support on the downside. Failure to hold at the 2000 level would be a warning that a recession may be a real concern. See page 12.

The 25-day up/down volume oscillator is at minus 0.87 this week, neutral, and surprisingly up for the week. This is shocking in many ways, but our oscillator only uses NYSE volume versus composite volume in order to try to eliminate the noise from program and algorithmic trading that now dominates daily composite volume. Automated trading techniques rely on volatility but do not reflect the conviction of investors. Our indicator looks to measure the conviction behind price moves. Twice this year this oscillator rose close to an overbought reading of 3.0 or greater but failed to confirm the rally earlier this year. Now we expect the market to bottom out before recording a long or deep oversold condition, in keeping with a long-term bull market cycle. See page 13.

Last week’s AAII survey showed bullishness fell 0.1% to 19.3% and bearishness fell 3.5% to 57.1%. Bullishness is below average for the eighth time in 10 weeks, was last lower on March 16, 2023, and was among the lowest 66 readings in the survey’s history. Bearishness is above average for the 14th time in 16 weeks. These numbers now exceed the bull/bear split of 20/50 which is rare and favorable. The 8-week bull/bear is minus 14.1% and the most positive since March/April of 2023. Again, bear markets rarely begin with this level of skepticism. See page 15. The 10-day average of daily new highs fell to 94 this week and new lows are averaging 128. This combination of daily new highs below 100 and new lows above 100 is a change that turns this indicator from neutral to negative and is the only real negative in our collection of indicators. See page 14.

Liquidity is what drives bull markets, and even though the Federal Reserve’s quantitative tightening continues, liquid deposits at commercial banks continue to rise. Both demand deposits and retail money market funds reached record highs recently and total liquid assets in the financial system equal $19.3 trillion, close to the record $19.88 trillion seen in April 2022 during the post-pandemic fiscal stimulus. Cash is currently 34% of total estimated market capitalization of $57.2 trillion – not a record, but a healthy level. In short, fear is generating selling at the moment, but there is plenty of cash on the sidelines once the fear dissipates. See page 9. 

An Economic Mix

The increase of 151,000 new jobs in February and the small rise in the unemployment rate from 4.0% to 4.1% was reassuring, particularly with the increase in recession fear. Our favorite employment benchmark measures the year-over-year change in total employment in both the establishment and household surveys. Both indices indicated growth in jobs in February that was slightly below their long-term averages, but still solid and improving. In our view, this was one of the best features of the February report. See page 3. But there were quirks in the February report including the sharp increase in U-6 unemployment rate, which jumped a full percentage point to 8.5%. There was also a 393,000 increase in multiple job holders, indicating that multiple job holders represent 5.6% of total employment, the highest since 5.7% in October 2004. However, this was not a record percentage when compared to total employment. Still, these two statistics may be signs of rising stress in the job market. Nevertheless, the Misery Index (the sum of inflation and unemployment) sits at 7.1% and is comfortably in the neutral zone of 5.8% to 12.6%. See page 5.

Earnings were a bright spot in the February report and average hourly earnings rose $0.09 to $30.89, reflecting a 4.1% YOY increase. Real hourly earnings rose 1.1% YOY in February, down from the recent 1.7% YOY peak seen in September 2024, but still showing real growth in earnings and purchasing power. See page 6.

Consumer credit has been on our radar for months and total credit expanded $18.1 billion in January. But the real story was that December’s previously reported $48 billion growth in credit was dramatically revised to a $100 billion contraction. Discontinuities in source data explain much of this adjustment; however, inflation-adjusted nonrevolving credit per capita has been decelerating since 2021 and revolving credit has been slowing more recently. The revision in December’s data resulted in the 6-month ROC and the YOY growth in credit turning negative, which is often a sign of a strapped consumer and a pending recession. This is a worrisome sign. See page 7.

The ISM Nonmanufacturing index increased for the 8th straight month in February and indicated that the service sector was expanding for the 54th time out of the last 57 months. Seven of the 9 components increased in February. Not surprisingly, the inventories index rose the most, from 47.5 to 50.6, as businesses ordered ahead of new tariffs. Most importantly, new orders rose from 51.3 to 52.2 and the employment index increased from 52.3 to 53.0, reflecting solid growth in the service sector in the first quarter. Last but not least, the decline in equity prices has improved market valuation. Although the trailing PE for the S&P 500 is still 23.3 times, it is down two points from a few weeks ago. More importantly, the 12-month forward PE is currently at 18.2 times on earnings forecasts that have been coming down in recent weeks. This is approaching the long-term average of 17.8 times earnings for the first time since late 2023. See page 10.

Gail Dudack

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