“Stock Pickers Market”, Isn’t That Always The Case?
With its modest gains last week, the S&P 500 pushed its weekly winning streak to six – the longest winning streak since November 2019. All three of the major indices (Dow, S&P 500 and Nasdaq) are hitting new 2023 highs as we head into the last two weeks of the year.
The S&P 500 is up 20% on the year and just 4% shy of reclaiming its all-time high reached two years ago at the start of 2022.
Say what you will about how these 20% year-to-date gains have come to be – on the back of a very concentrated list of companies, but at the end of the day we are where we are. Frankly speaking, this year epitomizes the definition of a stock pickers market even more so when you consider that more than 40% of the companies in the S&P 500 are down on the year (oy vey). You either owned the Magnificent 7 in size this year and performed well or you didn’t, and you lagged (I’d argue the equal-weighted S&P 500 up +7% ytd is a better proxy for the overall market). It’s as simple as that – all those complaining about, like me at times, need to acknowledge reality and get to work identifying the next opportunity. Lucky for us we had the uranium trade on in size this year which is up over 50% ytd as proxied by the Uranium Miners ETF (URNM) with some individual miners outperforming the ETF.
As for the general stock market and the S&P 500 it is bumping back up against resistance around the 4,600 level – the same level that acted as a ceiling at the end of July. Similar to the end of July the sentiment and positioning pendulum has swung decisively to the side of the bulls (a negative from a contrarian standpoint). Retail inflows into equities have been net positive for eight consecutive weeks as the ‘soft landing’ narrative is fully embraced. A VIX slipping into the low 12’s screams complacency as was last seen in January 2020 just before the pandemic upended everything. And then we have the notoriously late-to-the-party CTA’s ramping up their equity exposure at the swiftest rate in nearly a decade. They have bought around $225 billon worth of stock in the last four weeks (this pushes their equity exposure to the highest level in eight years) - “everyone in the pool”!
However, it is worth pointing out that the upward move in the S&P 500 over the past three weeks has been relatively modest (roughly 65 points or 1.4%) which has quelled the extreme overbought conditions we were seeing just two weeks ago. That said, around 19% of the index still has an RSI reading over 70, which is a historically high level. If history is our guide, then some weakness or a period of consolidation is to be expected as momentum resets and trends normalize.
As for the bond market, yields took a bit of a breather from the torrid pace at which they’ve been falling after Friday’s jobs report. The labor market continues to remain resilient and although I see a jobs market that is losing momentum with each passing month the headline figures were strong enough to push back on a rate cutting cycle starting early next year. Fed fund futures went from pricing in 120 basis points of cuts next year to 110 basis points – odds of a rate cut in March fell to 40% from 50% prior to the jobs report and May odds are at 60%. Too little attention (in my opinion) is being paid to the deflationary readings coming out of China. This matters because we’re talking about the second largest economy in the world and CPI there fell the most in three years in November – down -0.5% on a YoY basis. PPI deflated -3.0% and has been mired in negative terrain now for 14 months in a row. Whether you like it or not China is still the center of the world when it comes to manufacturing goods that the rest of the world buys. Ongoing deflation is a positive signal that inflation will continue to wane in the U.S., but it is also an ominous signal for an economy combatting the bursting of a debt bubble.
It is a big week ahead in that we get inflation readings in the U.S. on Tuesday, a Fed meeting announcement with updated SEP’s on Wednesday, and the BOE, SNB, and ECB central bank policy decisions on Thursday. Markets have started to price in rate cuts across 2024 for all the central banks– to bad LA Dodgers newly signed two-way stare, Shohei Ohtani, didn’t get his $700 million record setting contract up front so he could plop it into bonds before yields decline next year.
The key piece to listen for in the Fed meeting on Wednesday will be the forward guidance in the press statement. To me the path is becoming clearer with the passage of time and incoming data, but the timing of subsequent views remains muddled. Look, in hindsight you have to tip your cap to the Fed and what they were able to accomplish this year. Coming into the year I don’t know of many people that thought the Fed could get the Fed funds rate north of 5% without breaking something, but they did. Here’s to hoping they remain flexible with their view as the cycle evolves and are not wed to their dot plots. I say this because their dot plot for the end of 2023 that was published two years ago forecasted a fed funds rate of 1.625% (today we’re at 5.50 – 5.75%). Similarly, in late-2018 Powell was guiding to at least two more hikes in 2019 and instead he cut rates three times before Covid hit in 2020 and wrecked everything. Even going back to Janet Yellen’s days at the head of the Fed, in December 2015 she was trying to convince markets that the Fed wanted to put through three hikes in 2016, but they ended up only hiking once at the end of 2016.
The moral of the story is that good policy like good capital stewardship has to be flexible. Sure, we all have forecasts and expectations on what we think will happen or worse, what we want to happen, but we have to retain flexibility and humility to change our minds when necessary. I suspect these necessary characteristics will come into play in 2024. The decline in yields from 5% on the 10-year Treasury to 4% has thus far been received by all markets as a breath of fresh air giving a lift to all asset classes. However, I think that a further all in yields from 4% to 3% won’t be treated the same as it will be seen as a signal that we are transitioning from a ‘soft landing’ to a ‘hard landing’. This will be bearish for all asset classes outside of gold, treasuries, and cash.
Whether it’s the inverted yield curve (inverted for 17 consecutive months), the LEI contracting for 19 consecutive months, the ISM manufacturing survey in contraction for 13 consecutive months or the monetary aggregates tipping into negative territory, there are signs warranting caution even in the face of ripping stock market prices. All these economic indicators have a history of preceding recessions and should not be cast aside as completely irrelevant. Moreover, recent economic data like the Beige Book which cited 8 of the 12 Fed districts were in contraction over the past six weeks and the Citigroup Economic Surprise Index being at seven-month lows are confirming to me that the bond market is telling the right story. The stock market likes it for now, and rightfully so, but if/when this economic momentum continues its downward trajectory it’s going to start negatively impacting equities both through lower multiples and falling EPS estimates.
I’ll leave it there for this week other than to say I think most markets continue to trend into year-end and likely into options expiration on January 17th. That is a calendar date I have circled as a possible window for a trend change. One market on my mind as we head into year-end is gold which is retreating a bit after yet another push above $2,000/oz. I think gold is an asset that should be owned in all portfolios over the next decade and not in just a token size position. Should this pullback extend down to $1,960/oz I’ll be taking action to increase its weighting in client portfolios going into next year. Central banks are poised this year to surpass their record bullion purchases in 2022 when collectively they added 1,100 metric tons to their reserves (absorbing 30% of global production). This to me is a secular shift to diversify into gold and out of U.S. dollars in part with the transition to a multi-polar world from a U.S. centric uni-polar order and as an insurance policy to mounting U.S. fiscal deficits that seem destined to be inflated away. The fact that gold never really sold off aggressively during the most aggressive rate hiking cycle in four decades is another head scratcher that something has changed. Historically higher Treasury yields, and a strong dollar were kryptonite for gold, but not this time.
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