Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. - Sir John Templeton
All three of our quant-based signals are green and we are sitting in roughly 40% bonds and 60% equities. We took positions in a few single stock longs and besides getting stopped out of a few names they seem to be holding up for now. We are taking the underperformance in quality names as a buying opportunity.
The S&P 500 is throwing everything at the wall to break through the 4220 level. Should the winds blow favorably, it'll likely take out that level within the next week or so. But the market is now very overbought. A modest pullback should be expected. Any dips in this market should be treated as potential buying opportunities. The trend is firmly up and looks to be breaking out. Once the market takes out the 4220 level our next level of resistance is in the 4325 range.
Mega-Cap Tech Pushes Indices Higher Again
Feast your eyes on the AI hysteria that's been sweeping 2023! This year is being dominated by the performances of the S&P 7, and last week just added fuel to that fire. All the signs are screaming "risk-on" this week, but let's not be naïve; this is the sweet song of the mega-cap growth rally, not a heartfelt ballad from the entire market.
Just look at this YTD performance 👇
Strip away the big 7 mega-caps, and what do you see? The S&P 500 up a meager 1% for the year. Every defensive sector is lagging behind the S&P 500. Cyclical sectors? Same story. Small-caps and dividend stocks are looking as cheerful as a rainy Monday morning. The spotlight is glaringly focused on tech, and nothing else.
Here's a bitter pill to swallow - my opinion - we ARE still in the midst of a bear market. A glance at the market breadth numbers will tell you that the broader market is neither healthy nor rallying.
Earnings season has almost taken its final bow, and it appears that our government will dodge the debt default bullet. So what's on the horizon to shake up this mega-cap infatuation? Nothing immediate, even though NVIDIA remains horrifically overvalued. The tech landscape is looking suspiciously like a bubble to me, and everyone's hopping on the bandwagon like it's the last bus home.
Given the seasonal trends and the imbalance within the equity markets, I wouldn't be surprised if June ushers in a hefty sell off.
Nvidia's recent stellar earnings report has demonstrated an interesting trend, as it served as a remarkable catalyst, boosting the Nasdaq by a solid 1.71% on Thursday. NVIDIA accomplished something truly interesting – it upstaged the maddening political circus in Washington, which is currently tangled up in the debt ceiling debate. Nothing like a shiny set of Q1 results to distract us from real-world economic concerns. The S&P 500 wasn't left out of the party either, climbing a respectable 0.88%, and underscoring a peculiar truth about today's market — a handful of cash heavy tech stocks are steering this ship.
The star of NVIDIA's show was undoubtedly the prophetic forecasts that promise an AI-infused future. The company's management team, playing the role of fortune tellers, vowed to shovel a significant amount of cash into their data center business to feed the insatiable demand for all things AI. And, surprise surprise, the market swallowed the story, hook, line, and sinker. NVIDIA's market cap ballooned by about $200 billion, bringing it tantalizingly close to the coveted trillion-dollar club. Now, you can partake in this fabulous journey by purchasing the stock at 230 times earnings over the past 12 months, or 26 times sales. And let's not forget the cherry on top - a bountiful quarterly dividend of $0.04 per share, translating to a breathtaking annualized yield of 0.05%. So generous, isn't it? If you are not picking up on my tone, this stock is so overvalued that it would likely need to return roughly 35%+ each year over the next few decades to meet its current valuation.
Nvidia (NVDA) and Microsoft (MSFT) are responsible for 80% of the S&P 500's gain on the day of Nvidia's earnings announcement. To put this in perspective, without NVDA and MSFT's contribution, the S&P 500 would have mustered merely a fraction of what it was with these two stocks.
Let's take a pause and take in this rally for a moment. It's certainly something to enjoy, but it's crucial to dissect the gears behind the mechanism. As I've highlighted in the past, the fact is, a select 7 stocks have powered the lion's share of the S&P 500's Year-to-Date (YTD) gains. The common denominator for all five of these stocks? A strong streak of optimism about the potential of artificial intelligence (AI). I have been using AI technology for a few years now so this phenomenon is nothing new and it reminds my of the meme stock rally we had over the last few years and we all know how that played out. This is even scarier to me because they are the biggest corporations in the world that are now trading like penny stocks.
Now, optimism can indeed be a sturdy fuel, carrying us a good distance. But can it drive us far enough to generate a substantial breakout in the S&P above 4,220 and stay there? Can it serve as a robust shield, safeguarding the markets if the bullish assumptions of a Fed rate pause or a gentle economic deceleration seem less probable? I remain a tad skeptical given the current market conditions.
To some, this is an exciting time in the world of tech stocks, with AI optimism acting as a beacon, guiding the market on an upswing. However, it's vital for investors to be grounded, evaluating the true sustainability of this trend. We live in a market that's currently dominated by a select few - the question is, for how long can these high-performers keep carrying the weight of the market on their shoulders?
These mega-cap tech stocks have been on our bullish list since February of this year and we did not buy them directly because these names do not fit the current market cycle and I still stand by that. In order for us to enter these positions, I would want to see a meaningful pull back followed by strong support in the broader indices.
But let's not allow this shiny object to blind us from the real deal. Long-term narratives like these often get derailed by such fleeting short-term distractions. Amidst all this shiny objects, we've still got indicators screaming at us that conditions are breaking down under the surface, and recession and a correction may be lurking around the corner. These red flags span across manufacturing, jobless claims, housing, commercial real estate, corporate credit, and lumber prices.
But who cares about lumber when we can chase the latest AI shiny object?
But let's be real, does anyone actually believe the US government will default on its debt? That our esteemed Congress would trade political power plays for an economic and financial calamity? Sure, the tension has been mounting with the clock ticking, but most were fairly confident a couple of weeks ago that this wouldn't spiral into a disaster.
Once an agreement is reached, this turmoil will be quickly swept under the rug. Unless, of course, Fitch decides to rain on the parade and downgrade U.S. government debt.
In the meantime, we can't sweep away the trajectory of the global economy. Lumber remains the key precursor, suggesting the economic climate is far from sunny. With housing being one of the key drivers, it's not hard to trace the breadcrumbs leading to a global recession.
Success in the game of investing is not being swayed by the siren song of short-term events, but by charting a course that takes the larger, long-term picture into account.
History's echo resonates throughout the history of investing, but it seems that most investors keep forgetting the lyrics. Historical returns on mutual funds, ETFs, and stocks are paraded around like a gospel truth, yet they presume the investor is the rare breed who sticks with their investments no matter what. Unfortunately, reality is far less glamorous - data shows that most investors sell low in panic during a downturn and timidly venture back only when the storm has passed and the rainbow is out - if they even muster the courage to return.
While this is happening the 'smart money' folks are laughing. They revel in these emotional oscillations, as it's their ticket to a roller coaster ride with 'buy low' dips and 'sell high' peaks. They are the puppeteers behind the curtains, creating narratives that make the debt ceiling appear like the Four Horsemen of the Apocalypse, prompting a 'buy lower' opportunity. Likewise, they paint NVIDIA's financial performance as the holy grail, whispering "AI is the next big thing", luring the 'dumb money' to unwittingly inflated asset prices.
It's very easy to get caught up in manias. It's also very easy to go bankrupt in manias.
Sector Rotation vs Weak Breadth vs Macro
The buzz around weakening market breadth these days is as hard to ignore as the seagulls at a beach picnic. Traders who exclusively following technical analysis are calling this narrative a lie. The argument here is that it's not about the breadth of the market. It's a matter of sector rotation, pure and simple. If Tech and other growth stocks are at the forefront, leading the charge, it's a no-brainer that the equally-weighted S&P 500 will trail behind. On the flip side, if Tech and growth are lagging, the Equally-weighted S&P 500 steps up to outperform, just as it did in the latter half of 2022.
This argument carries weight, because it's not rocket science, it's just basic arithmetic.
While I give this argument some merit in the short-term because market watchers tend to chase shiny objects, I prefer to focus on what's going on under the surface.
Small-caps typically lead the the larger more capitalized indices on the way down and they are still breaking down here regardless of what is going on in tech.
On top of small-caps, the macro is starting to catch up to to this market.
US headline CPI year over year projections signal the Fed is not cutting rates anytime soon as inflation will still be above the Fed's 2% target in 2024. Not to mention, it takes about 12 months for each rate hike to start making an impact on the economy so what would be the point of the Fed's most recent hike?
US real GDP is expected to go negative this year.
Real goods consumption has now leaked lower for 20 straight months and May retail Sales made another move lower. Real goods consumption refers to the expenditure or use of tangible goods by individuals, households, or societies. It represents the consumption of physical products such as food, clothing, electronics, furniture, automobiles, and other durable and non-durable goods.
Real Manufacturing Orders have been retreating since June of 2022.
Real Earnings Growth has now been negative for a record 25 consecutive months. America's standard of living has been deteriorating every month for more than two years. 👀
The updated Q1 data shows credit card balances grew at the fastest pace in at least 20 years while the cost of that revolving credit continues to push higher to multi-decade highs.
The consumer foreclosure and bankruptcy cycle has inflected and continues to accelerate higher.
Household expectations around personal financial conditions are at another all time low.
Housing affordability remains just north of all-time lows and new listings are down -19% year-over-year in already narrow inventory conditions in the resale market.
An outright contraction in money available is not a good thing when we are in an inflationary environment where you need more actual dollars to buy stuff or in a situation where credit card debt is growing 3X income growth and more than 2X inflation with record high interest rates and people need increasingly more nominal dollars to service that debt.
The actual hard measures of global trading activity and commerce are mired in a contraction.
A "Bank Crisis" is not the macro point. The point is that credit is tightening meaningfully for both consumers and businesses and that tightening impulse is accelerating.
Credit is both leading and reflexive: when rates increase and available credit drops, this leads to a deceleration in demand, spending, activity, and hiring. Not good.
Oh and to add more fuel do this macro doomsday post, the last time the Federal Funds Rate reached this level, total Debt/GDP was 0.5x turns lower.
Is the Conference Board Leading Economic Index® (LEI) the most wrong it's ever been? You can't find one historical head fake going back to 1960 when the LEI has been where it is right now.
Bank failures in 2023 are have been larger than 2008. $548 billion in bank failures YTD in 2023 vs. $373 billion in 2008. There were 564 bank failures from 2001 through 2023.
The lender of last resort (Fed) has been busier than ever. Fed discount window borrowing just took out the highs set in October of 2008. Interestingly, modest discount window borrowing activity served as a precursor in both late 2007 and early 2008 as well as in late 2022 and now in early 2023.
Bank deposits continue to fly out the door. Banks will tighten lending as their funding constricts. This is not good for consumers or businesses.
Largest Bankruptcies so far in the current cycle: we have seen three major bankruptcies, and the Fed has yet to pause rate hikes, let alone cut them.
Business bankruptcy filings are accelerating. Slowing demand, stubbornly high input costs, and rising debt servicing costs make it very difficult to be profitable.
Enhanced Pandemic Benefits just ended for 30 million households across 35 states.
Student debt repayments are set to resume in three months. Average student loan payments of $393 per month will restart within 3-5 months for roughly 40 million borrowers.
Credit card delinquencies continue to climb.
Severe auto loan delinquencies at the largest US auto lender are the highest since Ally Financial went public in 2016.
U.S. M2 vs. Gold: Gold has broadly tracked the increase in U.S. money supply since 1968. Gold is setting up perfectly for this cycle and I expect it to continue to push higher. I expect Gold to hit $2,000 sometime this year.
I stick to my rational that this rally could extend beyond the 4,220 level, or beyond, but without a series of higher lows and higher highs being realized over a more significant time frame (multiple quarters, not weeks) then I remain skeptical of any sharp rallies as they typically result in sharp declines.
And remember – the one fact pertaining to all conditions is that they will change.
Feel free to reach out to me and use me as a sounding board.
Best regards,
Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President
Direct: 952.828.5336
Email: kurt@ivoryhill.com
—Written 5.28.2023