by We have two ears, two eyes and one mouth, which, according to the old aphorism, means that we should listen and see about twice as much as we speak. Investors who follow this advice by resisting the impulse to tell the market what it should do, and instead listen to it, are likely to find a positive—if difficult to trust—message. An initial signal is the general resilience of the broad market, which last week found support just where it needed to preserve an uptrend while absorbing a sharp move higher in bond yields over the past month. .SPX 6M mountain S & P 500, 6 months Still, the message in the market is something more surprising to many, a sprint higher in “early cycle” sectors of a type that typically reflects a recovering and accelerating economy. What the Charts Say Ned Davis Research keeps an early-cycle composite gauge, showing here that since the October market low it has tracked the average historical path coming out of half a dozen non-recessionary bear markets. Found the “soft landing” six months ago, at least in market terms? Renaissance Macro Research founder Jeff deGraaf has said that the band is back in a broad uptrend, asserting: “The most important thing is the characteristics of the rally. Cyclical parties are leading this rally to the dismay of many bears. They can only I may not understand how it can be the case. We’re a little reassured by that.” The leadership profile perhaps speaks to an extended economic and Fed tightening cycle and suggests where within a particular two-part market investors should migrate. Steel and hotel stocks are tearing, for example, and consumer and consumer goods stocks are stumbling. All of this lends some credence to the fact that the October low was important, although it does not deliver conviction that the indices are poised for quick and unhindered gains outside their long multi-month trading range. Yes, the Treasury yield curve remains deeply inverted in typical pre-recession mode, the Federal Reserve’s final destination for interest rates has again been pushed out in time and distance, and valuations never really got cheap (although they are in the “fair” zone except for the largest get the shares). Still, it would be hard to write a more textbook plot to encourage the bulls than what has played out since the fall: A classic October bottom right before the unusually bullish midterm election trigger, on the very day of the latter. ultra high inflation reading. High and falling inflation are historically among the most constructive backgrounds for shares. A rally into the new year that set in motion several rare and supportive breadth and momentum signals, followed by a seasonal pullback in February that was routine in scope but succeeded in cooling sentiment and skimming off some market froth. All the while, the corporate credit market held firm and the volatility index was undisturbed, as bondholders and option traders saw no signs of stress or the need to panic. What Investor Sentiment Says Retail investors experienced only a brief burst of optimism in January, with the American Association of Individual Investors survey last week returning to show twice as many bears as bulls. Outflows from equity funds have been heavy, while the money commutes to generously yielding money markets and high-quality bond funds. And here we see the reversal into this week of the early-year hunt for stock exposure among members of the National Association of Active Investment Managers. This change in attitudes is certainly understandable given the still-vigilant Fed, slippage in earnings forecasts and pockets of deep weakness in housing and manufacturing. But it is also reassuring as evidence that complacency has not overtaken caution. The fixation on government interest rates as a determinant of what stocks “should” do makes some sense, but is also probably exaggerated. True, the 10-year’s ramp from 3.4% on Feb. 2 — the S&P 500 high for the post-October rally — to over 4% last week was quick and jarring and brought with it plenty of potential dangers. They partly reflect sticky inflation that may require the Fed to push interest rates beyond the economy’s capacity to handle them. With the 10-year now below 4% and Fed Funds above 4.5%, the S&P 500 is now higher than it was nearly ten months ago, when the 10-year was 3% and Fed Funds below 1 %. The interaction between prices and stocks and stock valuations is neither as precise nor as fixed as conventional wisdom would have it. Despite all the encouraging action we can observe, it is also not difficult to push towards the positive conclusions. First, the stock market can certainly be prone to misunderstanding the next macro reversal and can overshoot reality in the short term. And the unorthodox nature of this compressed, high-amplitude economic cycle should leave minds open to outcomes that deviate from the historical templates. What the Economic Cycle Says The Leuthold Group notes that a key labor market gauge in the Conference Board’s Consumer Confidence survey has just made an unprecedented turnaround. Last July, the spread between those who said jobs were plentiful and those who called jobs hard to come by fell by more than nine points from the top. Since 1970, this has only happened during a recession or within six months of a start. But since then, the gauge has ticked up by more than nine points, “which had always confirmed that another economic expansion was underway,” says Leuthold’s Doug Ramsey. To repeat the question, was the “soft landing” last year (with its slight, fleeting increase in unemployment)? For Ramsey, this suggests that the current tight labor market strength may well undermine calls for a new bull market in progress by requiring the Fed to forcibly unwind it. Another frequent reversal of the market’s message of early-cycle acceleration is that we’ve seen very strong rallies that appeared to be decisive but eventually collapsed into new lows in prolonged bear markets. This has often happened when the Fed was or would soon be done tightening and the economy briefly seemed to be coming through in decent shape. BCA Research shows here the sober harmony of the current market trajectory and the early 2000s post-tech bubble bear market. It always pays to be aware of the potential pitfalls. We can note, however, that back then the S&P 500 never spent as much as a month above its 200-day moving average as it has this year. And credit conditions have remained healthier this time around, the triple-B-rated corporate yield over government bonds never falling below two percentage points from early 2000 to 2003; it is now around 1.5 percentage points. The next wave of the meltdown in the early 2000s also coincided with the 9/11 attacks and the massive accounting and fraud scandals of Enron, WorldCom and others that wiped out large portions of previous years’ reported earnings. Sure, things can break again in treacherous ways. But the market’s message at the moment contains no real hints of that, even if one listens carefully.
The robust stock market finds support at just the right time, and maintains an uptrend
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