Short and shallow seems to be the growing expectation surrounding any 2023 recession, if it ever even arrives at all. The US economy is stronger than most people expected and inflation is clearly stabilizing. This is the “immaculate disinflation” that many optimists talked about a year ago, with an economy simply showing signs of normalizing after a pandemic. Under this theory, the Federal Reserve may just get to have its cake and eat it, too.
At the beginning of the year, stocks were priced for a meaningful economic slowdown and an earnings drop that never in fact happened. This reality pushed stocks higher through the first quarter and April. Then, the AI craze hit markets and the super-cap tech names carried the S&P 500 higher almost by themselves - giving the (false) impression that the entire stock market was rallying hard and all worries about recession and corporate profit declines were gone. That caused more chasing from those who had sat out the rally up to that point and fueled even higher stock prices.
Now the S&P 500 is trading at a 16-month high based on three assumptions. These are the new pillars of the rally:
No economic slowdown (i.e., no landing or a soft landing)
A consistent drop in inflation (over the next few months)
Fed not hiking interest rates more than expected (one more hike, maybe two at a push)
As long as the economic and inflation data does not damage those pillars, then stocks can hold onto, and maybe even slightly extend, this rally.
The S&P 500 is now only 6% below its all-time high from the first trading day of 2022. That’s quite extraordinary when you think about it. To extend the rally substantially from here and threaten those all-time highs, however, it will take the introduction of something new. Specifically:
Interest rates actually falling, and/or
Economic growth further re-accelerating, and/or
An increase in S&P 500 company earnings (specifically the Earnings per Share ratio).
The reality is that the risks still facing this market are essentially the same ones as we had to start the year. Just because they haven’t materialized yet does not mean that they are no longer present. It’s essential that these risks are monitored and watched for (as I will do for you weekly in this report) because, with pretty much zero cushion should they emerge, it’s a long way down to fundamental value if they do.
To that end, we saw last week that the Consumer Price Index (CPI) measure of retail inflation fell more than expected to an annualized rate of 3.0% (in fact, 2.97%, unrounded), down from 4.0% a month earlier. It has plunged from a 9.1% year-on-year rate last summer. The closely-watched Core CPI that strips out volatile food and energy costs cooled from 5.3% annualized in May to 4.8% in June.
It’s important, however, to take a step back and note that the headline rate’s big drop has a lot to do with the year-ago month rolling off. Remember, headline CPI rocketed 1.2% in June 2022 alone. Replacing that month in the calculation with June 2023's 0.2% increase shaved a full percentage point off the annual change all by itself.
As has been the case for ever, the financial and mainstream media focused on that drop in headline CPI to a multi-year low, but that’s not the number that the Fed is focused on. It’s that half point drop in annualized Core CPI to under 5% that was the diamond in this data as far as the Fed was concerned.
CPI proved to be a crowd pleaser; stocks moved bigly higher, market interest rates shifted lower, oil and gold prices went back up and the US Dollar accelerated its decline. The next day, CPI’s twin brother, the Producer Price Index (PPI) measure of wholesale inflation experienced by manufacturers rose just 0.1% from a month earlier and just 2.6% from a year before, the smallest advance since 2020, adding to the pile-on of positive inflation news.
The initial takeaway from the markets was that these numbers indicate that the worst of the inflation crisis looks to be firmly behind us and, while they may not move the needle in that the Fed will almost certainly still raise interest rates by a quarter of a point on July 26th (that probability remains at 93%, see FEDWATCH INTEREST RATE PREDICTION TOOL below), a second swift follow-up increase may be somewhat less likely now given this evidence of solid progress.
Consumer sentiment came in last week at its highest level since September 2021, with its biggest one month improvement since 2006.
The Q2 earnings deluge began on Thursday, investors getting another heathy dollop of good news with numbers from Pepsi, Delta Airlines, JP Morgan Chase, Wells Fargo and Citigroup all looking mighty fine.
Right now, the sun is shining and the birds are singing. It’s not a given that rain clouds will definitely move in, but it is very important to understand that if they do, the storm could be very sudden and very severe and the fact is that most investors are without an umbrella and dressed in t-shirts, shorts and flip-flops.
OTHER NEWS ..
Thursday was a busy day in crypto .. A federal judge came out with the bizarre ruling on Thursday that Ripple Labs’ crypto coin XRP was classified as a security (and therefore potentially subject to regulation from the Securities and Exchange Commission - SEC) if it was bought by an institution, such as a bank or a hedge fund. But, said US District Judge Analisa Torres, it is NOT a security if it is bought by a human being from the general public on an exchange (and therefore not subject to any SEC oversight).
Libertarian fiat-hating bros around the country rejoiced in their parents’ basements in San Francisco or in smelly wooden shacks piled high with ammunition and canned goods halfway up some mountain in Montana and crypto prices surged as the initial interpretation of this ruling was that it may make it more difficult for actual sensible adults to regulate what goes on in the cess-pool of fraud and criminality that is much of currently unregulated crypto-world and the boys may now be left alone and unsupervised to continue committing fraud and corruption and stealing their clients’ funds.
In an ironic twist, on the same day as this frankly nonsense ruling from Judge Torres, former Celsius Network CEO Alex Mashinsky joined the lengthy list of high-profile crypto industry figures to be arrested, accused by US prosecutors of pumping up the price of his firm’s cryptocurrency to entice (human being) customers to the platform — all so he could line his own pockets to the tune of $42 million. He faces both criminal charges and massive regulatory suits from the SEC, the Commodity Futures Trading Commission (CFTC) and the Federal Trade Commission (FTC).
Mashinsky was criminally charged in a 46-page indictment with wire fraud and other crimes, after waging a years-long scheme to mislead customers, according to prosecuting attorneys, before Celsius - having gained popularity by paying high interest rates on digital-asset deposits - imploded last year with more than $1 billion in debt resulting in massive losses for its duped (mostly human being) customers. The company’s former Chief Revenue officer, Roni Cohen-Pavon was also charged with four criminal counts, including fraud - but he is currently hiding out back home in Israel.
UNDER THE HOOD ..
On the shorter term charts, the S&P 500 (which closed on Friday at 4505), blew through upside resistance levels of 4470 and 4485 with the next big one at 4560 while there is no big downside support until 4430.
In the more medium term, the next major upside resistance is at 4529 while initial downside support is down at 4375 and then not much until 4309.
So are bears fully back in hibernation?
While the last week’s index performance was pretty impressive, the improvement in Demand and retreat of Supply was far less so, another divergence between the index illusion and the technical reality.
Currently, we are observing the extraordinary condition of new all-time highs in Demand in the Large Cap segment with Small Caps rattling around near multi-year lows. Without a significant broadening in Demand, probabilities remain stacked against a self-sustaining advance.
From a technical standpoint, you can compare this rally to a game of musical chairs in which there are far more players (investors owning stocks) than chairs (willing buyers once stocks begin to decline) so if the “music stops” via some negative catalyst, sellers could overwhelm buyers and prices will then drop sharply due to this low liquidity condition. Technical analysis is indicating that, in the not too distant future, the music will indeed stop and volatility will rise considerably.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
Q2 earnings season picks up this week. Around 60 S&P 500 firms are scheduled to report including Tesla, Netflix, Bank of America, Morgan Stanley, Goldman Sachs, American Express, IBM, Johnson and Johnson, United Airlines, American Airlines, Lockheed Martin, Newmont Mining, Taiwan Semiconductor and Prologis.
On the economic data front, it’s a real estate-y kind of week. On Tuesday, after we get Retail Sales - forecast to show a 0.4% monthly increase in consumer spending, it’s time for the Housing Market Index. The next day, we learn about Housing Starts and Existing Home Sales.
Thursday sees the release of the latest Leading Economic Index, which is currently on a streak of 14-straight monthly declines.
LAST WEEK BY THE NUMBERS ..
Last week’s market color courtesy of finviz.com
Last week’s best performing US sector: Communication Services (two biggest holdings: Alphabet/Google, Meta/Facebook) - up 3.5% for the week.
Last week’s worst performing US sector: Energy (two biggest holdings: Exxon-Mobil, Chevron) - unchanged for the week.
The proprietary Lowry's measure for US Market Buying Power is currently at 161 and rose by 4 points last week and that of US Market Selling Pressure is now at 125 and fell by 5 points over the course of the week.
SPY, the S&P 500 Large Cap ETF, is made up of the stocks of the 500 largest US companies. It remains above its 50-day and 90-day moving averages and above its long term trend line, with a technically overbought RSI (see EXPLAINER: FINANCIAL TERM OF THE WEEK below) of 70**. SPY ended the week 6.0% below its all-time high (01/03/2022).
IWM, the Russell 2000 Small Cap ETF, is made up of the bottom two-thirds in terms of company size of the group of the 3,000 largest US stocks. It remains above its 50-day and 90-day moving averages and above its long term trend line, with a RSI of 62**. IWM ended the week 21.0% below its all-time high (11/05/2021).
** RSI (Relative Strength Index) above 70: technically overbought, RSI below 30: technically oversold
The VIX, the commonly-accepted measure of expected upcoming stock market risk and volatility (often referred to as the “fear index”) implied by S&P 500 index option trading, ended the week 1.5 points lower at 13.3. It remains below its 50-day and 90-day moving averages and below its long term trend line.
AVERAGE 30-YEAR FIXED RATE MORTGAGE ..
6.96%
(one week ago: 6.81%, one month ago: 6.69%, one year ago: 5.51%)
Data courtesy of: FRED Economic Data, St. Louis Fed as of Thursday of last week.
FEAR & GREED INDEX ..
“Be fearful when others are greedy and be greedy when others are fearful.” Warren Buffet.
The Fear & Greed Index from CNN Business can be used as an attempt to gauge whether or not stocks are fairly priced and to determine the mood of the market. It is a compilation of seven different indicators that measure some aspect of stock market behavior. They are market momentum, stock price strength, stock price breadth, put and call options, junk bond demand, market volatility and safe haven demand.
Extreme Fear readings can lead to potential opportunities as investors may have driven prices “too low” from a possibly excessive risk-off negative sentiment.
Extreme Greed readings can be associated with a sense of “FOMO” and investors chasing rallies in an excessively risk-on environment, possibly leaving the market vulnerable to a sharp downward correction at some point.
Data courtesy of CNN Business.
US INVESTOR SENTIMENT (outlook for the upcoming 6 months) ..
↑Bullish: 41% (46% a week ago)
↔ Neutral: 23% (29% a week ago)
↓Bearish: 36% (25% a week ago)
Net Bull-Bear spread: ↑Bullish by 5 (Bullish by 21 a week ago)
For context: Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Net Bull-Bear spread: Bullish by 8
Weekly sentiment survey participants are usually polled on Tuesdays and/or Wednesdays.
Data courtesy of: American Association of Individual Investors (AAII).
FEDWATCH INTEREST RATE PREDICTION TOOL ..
What are the latest market expectations for what the Fed will announce re: interest rate changes (Fed Funds rate, currently 5.125%) on July 26th after its next meeting?
↔ No change .. 7% probability
(one week ago: 7%, one month ago: 33%)
↑ 0.25% increase .. 93% probability
(one week ago: 93%, one month ago: 67%)
Where will interest rates (Fed Funds rate, currently 5.125%) be at the end of 2023?
↓ Lower than now .. 2% probability
(one week ago: 1%, one month ago: 10%)
↔ Unchanged from now .. 28% probability
(one week ago: 11%, one month ago: 39%)
↑ Higher than now .. 70% probability
(one week ago: 88%, one month ago: 51%)
Data courtesy of CME FedWatch Tool. Calculated from Federal Funds futures prices as of Friday.
US TREASURY INTEREST RATE YIELD CURVE ..
The interest rate yield curve remains “inverted” (i.e. shorter term interest rates are generally higher than longer term ones) with the highest rate (5.53%) being paid currently for the 4-month duration and the lowest rate (3.83%) for the 10-year.
The closely-watched and most commonly-used comparative measure of the spread between the 2-year and the 10-year last week rose from 0.88% to 0.91%, indicating a steepening of the inversion of the curve during the last week.
Historically, an inverted yield curve has been regarded as a leading indicator of an impending recession, with shorter term risk deemed to be unusually higher than longer term. The steeper the inversion, the greater the deemed risk of recession.
The curve has been inverted since July 2022 based on the 2 year vs. 10 year spread.
Data courtesy of ustreasuryyieldcurve.com as of Friday.
ARTICLE OF THE WEEK ..
“A game of Russian roulette wouldn’t be so thrilling if you found out it was a full clip”. Don’t trade options.
EXPLAINER: FINANCIAL TERM OF THE WEEK ..
A weekly feature using information found on Investopedia to try to help explain Wall Street gobbledygook (may be edited at times for clarity).
The relative strength index (RSI) is a momentum indicator used in technical analysis. RSI measures the speed and magnitude of a security's recent price changes to evaluate overvalued or undervalued conditions in the price of that security.
The RSI is displayed as an oscillator (a line graph) on a scale of zero to 100. The indicator was developed by J. Welles Wilder Jr. and introduced in his seminal 1978 book, New Concepts in Technical Trading Systems.1
The RSI can do more than point to overbought and oversold securities. It can also indicate securities that may be primed for a trend reversal or corrective pullback in price. It can signal when to buy and sell. Traditionally, an RSI reading of 70 or above indicates an overbought situation. A reading of 30 or below indicates an oversold condition.
As a momentum indicator, the relative strength index compares a security's strength on days when prices go up to its strength on days when prices go down. Relating the result of this comparison to price action can give traders an idea of how a security may perform. The RSI, used in conjunction with other technical indicators, can help traders make better-informed trading decisions.
Periods with price losses are counted as zero in the calculations of average gain. Periods with price increases are counted as zero in the calculations of average loss.
The standard number of periods used to calculate the initial RSI value is 14. For example, imagine the market closed higher seven out of the past 14 days with an initial average gain of 1%. The remaining seven days all closed lower with an initial average loss of −0.8%.
Once there are 14 periods of data available, the second calculation can be done. Its purpose is to smooth the results so that the RSI only nears 100 or zero in a strongly trending market.
After the RSI is calculated, the RSI indicator can be plotted beneath an asset’s price chart, as shown below. The RSI will rise as the number and size of up days increase. It will fall as the number and size of down days increase.
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