The backdrop for the equity markets is continuing to be a quite good one. In last week's report, I tried to touch on a point that I am going to expound on a little bit more before I get started this time. I had mentioned a factoid that in the last 80 years when the equity markets have turned from a negative (bear market) market to a positive one, it has started with less than 10% of the companies of the major index going up. This one is no different. If one is to look simply at the "Magnificent 7" it is clear where the major heat that has pulled the S&P 500 has come from. Digging down to the underlying holdings of the S&P 500, the top 10 holdings of the S&P account for the majority of the performance of the index YTD. This means the remaining 490 holdings were net detractors to performance! See the chart of the top 10 voting constituents of the S&P 500 below. Note that these 10 represent 30.47% of the index and their respective contributions to the total performance FROM 1/1/23-5/24/23 are in the final column.
The second point from last week that is very important is the argument that the breadth of companies that are pulling the market up is too few companies and this is not healthy. As evidenced by the last 80 years in the markets, this is a common occurrence. What is desirable to have happened after this burst is for the laggards, or those sectors and companies that did not add to this initial bump higher to join the charge. This IS a broadening of breadth, and this IS what appears to be happening. According to statisticians, when the markets have risen 20% from their lows an official new bull market is in the making. This happened last week on June 8th. Many institutional commentators were quite frustrated with this as it took 165 trading days to get to this point from the October 2022 lows. This is the second longest time it has taken to confirm this measure in the past 75 years. What I’ve heard from nobody but Thomas Lee of FundStrat report is that the earnings on the S&P 500 since 2019 are up substantially, but consistent with the markets- even taking into account the bear market of 2021-2022:
So, the logical question then becomes, "What happens next, now that we have hit this magic point?"
As can be seen in the table below, forward returns after a bull market is confirmed, have historically been strong. The S&P 500 has posted average and median gains of 18-19% in the 12 months following this 20% threshold. The next question would then be, "How long does a bull market last when this has happened?" This answer is not so cut and dry. The duration of a bull market can vary significantly, but historically they have been longer-term. Since 1929, the average S&P bull market has lasted for 39.4 months and produced an average gain of 130.1%.
I am not beginning to say this is underway, but rather that if this is the start of a new uptrend, things can get pretty tasty! Along with the table of performance going back to 1949, I also wanted to include a picture of the progression of this current advance since the market lows. This is a compliment of Piranha Profits and has a nice explanation of important events that have transpired since Mid-2022.
And if I haven't given you enough facts about how good the market currently is, how about the fact that after this last Friday's upmarket, the market is showing its best performance on Fridays of any year since 1953 (source: Bespoke Media). So, let's cover one of the elephants that still are in the room, the one of breadth. Along with the June 8th 20% line, the Mid-Caps, and the Small-Caps have now joined the general market advance and are breaking out of two-month highs. Dipping into the sectors, the Transports and the Industrials have joined in. I bring these up as Thomas Lee of FundStrat has almost weekly mentioned how this should occur following the action out of the widely followed ISM economic indicator. The third point supporting the market's advance is the NYSE Advance/Decline line that has also broken out. Many were complaining that the A/D line was not showing an expansion of the number of advancers to support the belief that the advance had legs. Along with the small and medium companies gaining some momentum, this A/D line has just exceeded the downtrend that existed since back in February.
The major issue this week that the media is focused on is the Fed meeting this month. Aside from the labor numbers, which were weaker than expected last week, the measures of Consumer Prices (CPI) and Producer Prices (PPI) are showing the effects of voracious Fed interest rate hikes and are dropping at a rate faster than they rose due to the immense liquidity dumped on the market during the COVID crisis. What I find most important is that the major issue concerning the markets began with inflation, then the incessant rising in interest rates, and now the feared recession.
After inflation normalizes, I expect the Fed to consider an increase in their inflation target from 2% to 3%. During the heat of the inflation battle itself, it would be politically impossible to give up on its 2% target right now. But there is good theoretical motivation to move the target up from 2% to 3%. A decade ago, the normal and neutral Fed Funds rate was over 4%. This rate gave the Fed ample room to stimulate the economy into a downturn by cutting rates. This new rate of accepted inflation would give the Fed latitude to cut rates should we begin to experience a slowdown that many feel is imminent. There has been widespread speculation that the Fed will pause this week. The basic thought is that a pause is due to make sure that all the hikes are baked into the economic cake.
The last point I want to make is that Jack's beanstalk doesn't grow to the sky. There should be some level of backing and filling. I don't mean this to say that the markets should drop precipitously, but rather that we could be doing for some short-term turbulence. According to the renowned technician, Larry Williams, 23 out of the last 24 years the markets have digested on the 15th trading day of June. This means that with all the hoopla that is expected from the CPI and Fed this week, a little digestion could be due. Larry went on to say that by mid-July the advance could be back on track and this period could be a pause that refreshes. Stay tuned!
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