Markets seem to have begun the process of bottoming out and are carving out the first meaningful move off the lows since late last week on above-average breadth data. Despite FOMC lowering its Growth forecast (from 2.1% to 1.7%) and raising inflation expectations (from 2.5% to 2.7%). Last Wednesday stocks turned in their best “Fed Day” performance since 2022. What I mean by this is that the markets tend to be quite volatile the day of the Fed announcement and the morning after. This is because the markets can't know for certain what the Fed Chairman will or won't say and what subtle nuances there are in their comments. Remember the old Greenspan briefcase indicator? Back when Alan Greenspan was the Fed Chief there was always some strange interpretation of his intent based on his briefcase!
Moreover, the combination of sentiment data turning fearful, followed by an above-average surge off last week’s lows, looks bullish for Equities in the immediate future. When markets and leading companies are down 10-15% this can often lead to a washed-out situation and some level of recovery. But please remember, there is a normal sequence to things. A bottom, followed by a bounce, followed by a retest, then a possible resumption higher. According to Mark Newton, the market technician at Fundstrat, it looks right to be more positive with movement on the S&P 500 above 5703 on a closing basis. Based on Monday’s action in the markets, these are the boxes that have been checked off:
- Biggest gap on an open for a Monday since October 2022.
- S&P, QQQ, and Dow all broke their downtrends in place since February 19th.
- All the Mag 7 held where they needed to. Gives greater confidence.
- Given US dollar and interest rates, a move further to the downside.
- All the positioning that had gone abroad should quickly see technology racing back and out of international.
Newton feels that the markets are currently 75% sure to have put in an interim bottom and that a recovery above this price level could lead to a meaningful rally back to new all-time highs. He went on to say that since the last week has been somewhat of a bounce so far that the downside should be limited to roughly 3%, while the upside back to new all-time highs should get underway to carry SPX up more than 9% initially. His five factors that looked most important this past week as to why Equities might be bottoming:
1. Severe bearishness looked to have become more capitulatory. This is measured by the AAII Net Bulls reading. Currently, as seen below, this ratio is at the same level that it was when the markets bottomed out in late 2022.
The gross number of net bears is also at an extreme. We are currently at a 4-week average of 58.1% net bears. In looking at the chart below, this only hit this level in 1990, the Financial Crisis of 2009, and October of 2022. In every case: 1 week, 2 weeks, 3 weeks, 1 month, 2 months, 3 months, 6 months, and 1 year later, the markets were higher 100% of the time, and substantially at that. See the picture of the S&P, the bearish sentiment levels and the table of performance below:
2. The Equity put/call ratio having neared 1.0. This means that a great many more defensive puts were being bought verses offensive calls. At the same time the VIX (gauge of fear) showed an extreme high yet the futures of VIX pointed to a lack of continuation of this move.
3. Bank of America’s recent Global Portfolio Managers report illustrated some of the most negative investments from US Equities in allocation of all time. The rush out of the US into foreign markets was one of the quickest ever.
4. Breadth gauges such as McClellan’s Summation index and SPX “Percentage stocks above 10 and 50-day moving average(m.a.)” failed to break down under January lows and have held up remarkably well despite the damage in SPX and QQQ. This would imply that the velocity of the decline has run out of steam and therefore overdone on the downside.
This is the 5th fastest decline in the past 75 years! Here is the graphic that shows these five. Needless to say, if it felt very fast and very sharp, it truly was.
In looking deeper at these five prior sharp declines, it was clearly a shock to the markets, but it wasn’t a downturn in the economy. This is super important. If the economic backdrop is still a positive one, then the declines should be corrections, not endings to bull markets. The reasons for this 10% correction was a combination of four very tangible impediments to markets and the economy. They are illustrated below:
5. Advance/Decline surge off the lows on back-to-back days is a welcome development following the recent quick 10-15% decline in SPX and QQQ off recent all-time highs from February.
The March Bank of America Global Fund Manager Survey (FMS) shows ample reason for there to be a recovery in market optimism (from a contrarian perspective). This March survey shows the biggest drop in money being invested by fund managers in the US Equity market ever in history. Again, it’s quite an extreme.
Interestingly enough, the most recent FMS study above showed the 2 biggest drops in global growth expectations ever, the biggest drop in US Equity Allocation ever, and the largest jump in cash allocations since March 2020. Bottom line, this rapid transition out of US stocks looks ill-timed in my view, and investors who are paying attention to how rapidly sentiment has been deteriorating should be sensing a good opportunity is approaching and/or has likely arrived. I say this because it is truly quite rare to see such negativity in such a broad-based fashion all at once when earnings, and the Economy largely remain in good shape.
Chair Powell himself acknowledged as much. I believe this is why he failed to consider cutting rates on Wednesday yet remains largely consistent in his future forecasts with two cuts planned for 2025. He knows that rate cuts are needed, but since the economy is still healthy, and inflation measures are still not down to levels he would prefer, he intends to ease rates to assure that the growth rate of the economy stays positive without the need for further Quantitative Easing. His focus on employment was also discussed. In looking at the chart below, I felt it important to put in perspective the effect that DOGE has had on employment. I wanted to point out the difference in public sector jobs verses the general job market. As can be seen, we have a nice increase in private sector jobs verses the expected decline in the Government-Driven Jobs.
What we experienced last Monday and the Friday before are what are termed "breadth thrusts." The combination of last Friday and this past Monday registering back-to-back 90% “Up” days, meaning that 90%+ of the total tradable SPX issues rose on the day, is a very positive development. Going back over 30 years to 1990, when two back-to-back thrusts like this occur, the forward action of the markets tend to be quite positive on a 3-month, 6-month, and 12-month basis when this happens in greater than 80% of the occurrences.
The question is whether the current bounce "is" a major low or a temporary stop before markets head lower.
To many, this will be determined by the severity of Trump's tariffs. He is expected to soften many of them from here. The possibility of earnings weakness, which could become more noticeable in part due to the tariffs, and how this all impacts inflation and GDP are front and center. To put the overall size of the tariffs in perspective, this is a chart of the total trading tariffs for 2024.
This could also affect the Fed's decision on rates which, in turn, affect global liquidity, and subsequently an overall driver of global financial markets. According to Thomas Lee of Fundstrat, the tariffs, if they were to be implemented, are not to be started until April 2nd. He believes that this provides ample time for negotiation and resolution so that major tariffs that could affect future GDP are not put in place.
Getting shorter term in nature, and looking at the last 5 years specifically, seasonal trends have become a tailwind for a market bounce too. Based chart overlays, the average trajectory of the S&P 500 over the last 5 years (2020-2024) the index has tended to top on February 16th (it topped February 19th this year), and then bottomed on March 12th to then start a rally again on March 23rd (this week).
The market took Powell's testimony as bullish when he said any tariff-related price increases would be transitory, then said Quantitative Tightening would be reduced, and that he expects two more rate cuts this year. While the Fed projects a weaker economy, real GDP of 1.7% is hardly recessionary or weak, given that it’s averaged just over 2.6% for the past 40 years. With the Fed adopting an easier money approach and more rate cuts on the way, global liquidity should get another boost. But markets in the meantime currently remain in downtrends and may stay volatile, so, as always, we will use the price/volume action of major indices and leading stocks to guide the way. At present, such action is bearish, but sentiment was recently at extremes so could result in improved price/volume action this week or next.
In our view, it’s a “here we are again” period in which the negative pitch book meets head on with the fundamentals. Time might well tell sooner than later this year with the outcome to surface from the current negative period of turbulence as cooler heads prevail freeing the market from its current sour disposition. In our view, stateside economic conditions and corporate earnings as reflected in Q4 earnings season which ended last week point to resilience strong enough to weather the current levels of uncertainty driven by concerns tied to tariff policy, and the reduction of the size of government.
- Ken South, Tower 68 Financial Advisors, Newport Beach
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