Well-Positioned for an Everything Rally

Well-Positioned for an Everything Rally

May 22, 2024

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The S&P 500 closed out another strong week last week, with gains of +1.4% in the week alone, taking the total gains for May to close to 6%. As I stated last week, the markets are appearing to be more of a "Buy in May" rather than a "Sell in May and go away!" Looking into this week the economic and earnings reports are pretty light. This week has been more of an AI week with Microsoft's Windows and Surface AI event, followed up by their Build AI event and this afternoon's report of earnings from the market juggernaut Nvidia. 

There are other reasons for stocks to rise this week, even though volume might come in a bit light given Memorial Day holiday tends to have traders leaving for the Hamptons early. This is particularly true when markets have been positive. The traders may simply say, "Hey, let's book some profits, leave and enjoy the holiday without stress, and come back to reengage the following week." But there are reasons that I feel this could be a good week for equity markets. The latest data from ICI shows cash balances continue to rise for corporations and for individuals. A lot of this could be attributable to huge pre-existing cash balances banking 5% returns for zero risk, but much of it could also be from selling securities of various types. So here is what we are seeing:

Institutions have added $11 Billion to cash balances and building this up for 4 consecutive weeks.

Retail investors have added $6 Billion to cash balances and building cash balances in the face of markets at new all-time highs for the last 3 weeks consecutively.

This past weekend my friend Ari Wald penned an important observation of the recent action of smaller companies (small-caps). According to Ari, as a market signal, he reminded investors that it's more important for small-caps to participate in price terms than to lead their big-cap index brethren. The small-cap index, although trailing the larger S&P 500, has broken to a new high over a two-year period. Breaking this two-year resistance is a manifestation of bullish change in character vs. the lack luster corrective period it experienced in 2023. This "joining of the party" tends to position the broader index for a stronger continuation move to the upside. One of the fears that has been espoused by many analysts was the lack of participation of the small-cap index. This seems to no longer be the case. 

Bottom line, should the markets even attempt a dip, the weight of evidence seems to lean towards moves higher. Actually, it is really quite puzzling that institutions and retail investors are raising cash and appearing quite bearish / cautious when indexes are at all-time highs. 

  • Historically this tends to be a very bullish set up when the mood is negative, and the markets are rising. When the mood changes it could create a buying stampede.
  • Many stocks, like the leading semi's, are coming out of 10-week consolidations. This could be them building their strength for the next move higher. 
  • Interest rates dropped on the CPI and PPI numbers last week even when the CPI number didn't appear to be that soft on the surface.
  • The Fed didn't come out and say they were going to cut rates, but they did seem to remove the fear of continued tightening from their discussion.
  • There is still $6 Trillion sitting in cash on the sidelines. If this money wants to find a home instead of the 5% it is currently earning, this could provide the fuel for quite an explosive continuation rally. 

This all brings me to the two major concerns in the markets: CPI and economic growth. In looking under the hood of the CPI, it is almost as though the bond market has already sensed a slowdown coming in the CPI. Last week's CPI report came in at up .292% for the month, less than the .3% expectation, but clearly still not yet close to the Fed's 2% target.

Under the hood there were three line items that made up almost the entire move in the CPI. By combining shelter, motor vehicle insurance and health care services 95% of the number is accounted for. Shelter has been coming off, the car insurance was reflective of much higher auto prices, parts, and repair costs (auto prices have started to decline so insurance is sure to follow). Below is the progression of most aspects of Motor Vehicles. Note that I have highlighted the car insurance. If it follows the action of used cars and trucks, we should see a clear reversal:

Housing has been a perfect storm of events over the past few years and created a massive distortion in the typical seasonal pattern. Pandemic fueled household formation surged, work from home inspired buyer preferences at very low interest rates, supply chain constraints for homebuilders and massive cash hordes provided by the Fed all added to this distortion. But within the non-seasonally adjusted data, rent has been cooling rapidly and now sits squarely within the pre-pandemic range. 

I believe that the bond market has figured that highs have been seen in these CPI numbers and is also focusing on the broader economy. One of the scariest is the sudden rise in Bank Loan Default Rates that has turned up since March. This does not speak well of the consumer and their pocketbooks. Could it be that the lower- and middle-income consumers have begun to run dry of their excess capital afforded them by US Government programs and their lack of discipline to stop spending cash and relying on the bank loans in various forms? The default volume of $2.5 Billion was the highest since June of last year. 

On top of the default increases, according to a new study from GOBankingRates, the cost of the American Dream has become prohibitively expensive. They found the cost to live the "American Dream" now takes $100K in income for the typical family, and in 29 higher priced states, $150K/ year. An interesting look at the cost of living in the US, focusing mostly on home affordability as that is the single largest, by far, debt class for the US consumer. 

On the positive side, according to a May 8th comment from Investment House:

According to Investopedia- the election cycle theory is predicated on the view that shifts in presidential priorities are a primary influence on the stock market. The theory suggests that markets perform best in the second half of a presidential term when the sitting president tries to boost the economy to get re-elected. Data from the past several decades seem to support the idea of a stock surge during the second half of a presidential term, although the limited sample size makes it difficult to draw definitive conclusions. Just for most recent history, I include how the change in net worth progressed in the Trump administration vs. the current. Adjusted for inflation, there are even more reasons why another Trump presidency might prove to be best for American households:

The last point I wanted to bring up is that it appears that even though the US tends to lead in the action of the Fed and their easing policy, it is appearing more likely that the Euro region might take their foot off the brake first. This is highly unusual, especially when looking at recent history. Since the early 1980's, the US Fed has led all but one (in 1998) of the easing cycles among major developed market central banks. Equities have rallied no matter which central bank has gone first if the Fed eventually cuts. The Fed has engaged in three rate cut cycles that were limited in magnitude. These occurred in 1971, 1995, and 1998, when the Fed cut no more than 75 basis points. As Joe Kalish of NDR Research noted in his February Hotline, equities did quite well during these periods, partly because these rate-cut cycles weren't associated with recession!

- Ken South, Newport Beach Financial Advisor

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