Here is part of the trade-off with diversification. You must be diversified enough to survive bad times or bad luck, so that skill and a good process can have the chance to pay off over the long term.” – Howard Marks
The Macro View
I took a ride in my ‘way back’ machine recently and revisited how I perceived the market situation back On Memorial Day weekend 2020.
During my investment career, I have been associated with people that have a Ph.D. in this, a Ph.D. in that, and those that have a high school diploma. The successful investor realizes the role that human emotion plays in managing money. It’s not about the number of degrees, it is about common sense. Over and over, we talk about avoiding the noise. The reason is simple. Once that is accomplished it gives you the chance of applying that common sense to the situation.
Our minds take us to a place where we believe in our own experiences. Unfortunately, they make up a tiny fraction of how the world and markets work. Think about it for a minute. Someone who started investing and has seen nothing but improving markets has a far different view from anyone that started investing in 2007 or earlier. Each has a myopic view of the total picture, yet both believe their views ARE the way the markets will evolve. Of course, nothing could be further from reality.
Open Your Mind
Investors also get trapped when they refuse to have an open mind when investing. The cornerstone of economics is that things change over time because as we have seen, the situation doesn’t stay too good or too bad indefinitely. However, the last situation we experience, like the end of a movie will stay with us for a long time. It’s why so many people just could not buy into the fact that the financial crisis was over and things were about to change. The stock market signaled that, but few listened. Then, when there was a rebound that indicated a true change was taking place, many still would not believe or get on board the train. They were convinced the train was going to go over a cliff.
This confirms why an investor has to watch the data, lose emotion, and a closed-mind approach. Once an investor grasps the fact that the data and the market itself will tell them when to change, they give themselves a better chance to be successful. This is very important in today’s market backdrop. A bifurcated scene representing the potential for ‘”change” is also very confusing.
Pessimism is intellectually seductive, and the arguments always sound smarter, because they dovetail with our worries. That has been proven over and over in market history. It sounds smarter. “Sounding” smarter doesn’t necessarily produce positive results. Once we add money and invest in the mix that is filled with pessimism, it takes on a whole different look. In our capitalist mindset, losing money is tantamount to a crime. It’s embarrassing and something no investor wants to talk about, yet losing money is a part of the investment cycle.
This MACRO economic situation is far different from all of the other situations that investors have navigated over time. Unless they focus on what is going on under the surface of the market, at the end of the day, most market prognosticators are proven to be wrong. We are dealing with a bifurcated market that is not in sync, all while attempting to change a trend that has been in place for just over a year now.
So we find ourselves in a complex and perplexing situation, dictating that investors need to walk a very fine line now. When presented with varying and conflicting economic data it becomes easy to conjure up a scenario that fits any preconceived notions. We have already seen how it hasn’t paid to toss in the towel completely, nor can we be confident to say investors should be “all in”. Then again what market are we talking about? Is this still a BEAR market rally in the S&P, a new BULL market in the NASDAQ, and still something else in the DJIA and the Russell 2000?
However, that doesn’t mean we should stop watching the data for other signs. The word “change” is always important as the stock market always seeks out the direction of change. While this was going on my message has been the same. This continues to be a market of stocks that requires an investor to maintain “balance”.
Avoid Catching Euphoria
Many who manage their money rely on conjecture to form their investment strategy. They say they are following a “feeling” they have, rather than listening to the message of the market. We hear that the stock market is seriously overvalued now. No one can decide when a recession will arrive, and some say there is no recession in our future. The problem is no one can tell us that is the way this will play out. There is no mystery, and it is very simple, to have “rallies”, you need to have “declines” and vice versa. Investors need to take this one day, one week at a time.
Mere mortals like myself need to remain flexible, open-minded, and ready to change when change is warranted. We need to avoid emotion at all costs as we assign a probability of any issue that surfaces occurring. As we look ahead there are positives, and keeping them in mind now is important. That said, we all should be aware of the very questionable interest rate scene and its impact on the economy. In a glass-half-full mindset, the latter is at the very least being minimized or completely dismissed. And if growth doesn’t start a sustained upturn, more and more headwinds will strike. Consumers also remain skeptical as confidence levels remain at historical lows that are at 2008 levels.
Late last year the leaders were energy, materials, financials, and industrials, while information technology was the big laggard. Small-capitalization stocks were also doing much better, and the breadth was strong. The bullish narrative revolved around China’s reopening, which was supposed to put a floor for global growth.
However, PRICE rules, and the recent breakouts above the longer-term moving averages in the S&P, NASDAQ, NASDAQ 100, and other sectors have to be acknowledged and followed. Having said that my MACRO view portends a strong probability that the overall trading range has been expanded – therefore, MORE opportunity on the upside.
I caution against joining the crowd that is dismissing the many unknowns that are still present. Therefore, I’ve decided to remain grounded and look for opportunities in a “playable” trading range. That suggests an investor should remain with some protection by yield, in the form of risk-free alternatives. Diversification within the equity market is always key. BALANCE is once again a KEY in any market strategy.
The Week On Wall Street
The S&P 500 entered trading on a four-week winning streak, while the NASDAQ Composite boasted gains for the last six weeks. The entire stock market rallied strongly on Monday despite facing impending inflation reports and a Fed meeting. That’s a strong signal indicating that the market is in full-blown RISK-ON mode. Whether it be a rally or a selloff we’ve seen these periods before where nothing will derail a market move. That is precisely what is taking place now.
Investors went from “buying” to what seemed like “panic buying” as the S&P 500 gapped higher at the open on Tuesday, and never looked back adding another 0.70%. That was good for another new reactionary high. However, the panicked buyers weren’t finished. On both Wednesday and Thursday, the indices went into overdrive, and when the dust settled the S&P, DJIA, and NASDAQ all closed at 2023 highs.
A mixed session ended the week, leaving the S&P extending its winning streak to five weeks. The last time that occurred was November 2021. The NASDAQ made it eight straight weeks of gains and the DJIA has now gone three weeks without a loss. There appears to be no end to this buying stampede.
NFIB Small Business Optimism Index increased 0.4 points in May to 89.4, which is the 17th consecutive month below the 49-year average of 98. The last time the Index was at or above the average was in December 2021.
Bill Dunkelberg, NFIB Chief Economist;
“Overall, small business owners are expressing concerns for future business conditions. Supply chain disruptions and labor shortages will continue to limit the ability of many small firms to meet the demand for their products and services, while less severe than last year’s experience.”
No surprise – There is progress on the inflation front but it remains sticky. On a year-over-year basis, headline CPI was one-tenth lower than expected (4.0% vs 4.1%) while the core reading came in a tenth higher at 5.3% versus the 5.2% forecast.
The 0.1% May U.S. CPI rise with a 0.4% core increase leaves a disappointingly high core price path.
The CPI headline was depressed as expected by a -3.6% energy price drop. The remaining components posted a near-repeat of the April gains.
The PPI report undershot assumptions in May with swings of -0.3% for the headline and 0.2% for the core, leaving a weak path for wholesale prices since January. Final demand in the US rose 1.1% every year in May, down from the 2.3% increase recorded in April. This reading came in lower than the market expectation of 1.5%. It is the lowest level since December 2020. Today’s lean PPI data accompanied a restrained 0.1% CPI headline gain but a disappointingly firm 0.4% core increase.
The N.Y. Fed Empire State index surged to 6.6 in June from -31.8, leaving the index near the 1-year high of 10.8 in April and well above the 3-year low of -32.9 in January. The components also rebounded sharply.
The 0.2% Industrial production drop in May tracked below analysts’ estimates of a 0.1% increase. Capacity utilization fell to 79.6% in May from 79.8%, versus a 15-year high of 80.8% in September of 2022
Retail sales slightly undershot assumptions with May gains of 0.3% for the headline and 0.1% for the ex-auto measure that followed small downward revisions, leaving what is still a respectable “real” consumption path in Q2 after a big Q1 gain.
June consumer sentiment bounced 4.7 points to 63.9 in the preliminary report, better than projected, and erases the 4.3-point drop to 59.2 in May. This is the highest reading since February. Slowing in inflation and the resolution of the debt limit provided support.
Despite the ‘bounce” – Sentiment remains at or near 2008 levels.
The Global Scene
China’s retail sales have started to pick back up after weakness during the winter and spring. Analysts were expecting a 13.6% rise, and they came in at 12.7% missing expectations.
Industrial production did the same, rising rose 3.5% but also missed expectations.
China continues to try and stimulate its economy by cutting its key policy medium-term lending rate from 2.75% down to 2.65%. In addition to cutting lending rates, media reports coming out of CHINA suggest the State Council will discuss further stimulus as soon as Friday; more than a dozen items are under discussion.
That was all this market had to hear to put the global slowdown and possible recession on the back shelf.
The Daily Chart of the S&P 500 (SPY)
Up, Up and Away. The rocket ship has taken off to prices unknown. Once the S&P 500 cleared the August highs it set off a technical explosion, “Shorts” covered, and “BUY” programs were initiated.
S&P 4400 was another ‘line in the sand” that MANY were using as their “pivot” and once that was violated, it set off another round of “cover the shorts” and initiate “BUY” programs. The self-fulfilling momentum trade is in full swing.
We’ve come a long way since the October lows. The S&P 500 is now up 20+% from its lows, but most other US indices are up less than 20%, and only the Nasdaq 100 (QQQ) is up more with a gain just shy of 35%. So far in June, it has been a strong start to the month with every index ETF besides the Nasdaq 100 up at least 2%.
At the sector level, four (Consumer Discretionary, Energy, Industrials, and Materials) are up over 5% so far in June, further illustrating the rotation we have seen to the start of this month. It has taken plenty of energy to get to these levels. With defined areas of resistance in all of the index charts present and a rally running on pure emotion, it sure appears the stage is set for a ‘pause’. Nevertheless, I have seen the market ignore fundamentals and overbought readings before, and stock prices can always go higher than they probably “should.” Since the 4300 range has long stood out to me as a likely target to be challenged and without any real “sell signal,” I have been willing to play along and keep hammering away at new long trades where it seemed the risk was worth it.
The main reason has been the momentum and resiliency of the indices. I’ve kept repeating that the strength in some of the areas of this market won’t dissipate overnight. When it does, sentiment is likely to shift to the laggards, and that is what is starting to occur. That will in turn help avoid any deep correction in the near term. Unfortunately, we are still in a headline-driven market and so a change in the trajectory of inflation, or a change in the Fed’s stance would be a major disruptor on the upside or the downside. The latter concerns have been placed in the background as both the FED and inflation reports are now in the rearview mirror.
This backdrop has prompted many to declare this the start of a new BULL market in equities. In keeping with an open-mind approach I reviewed all of the evidence, and issued the verdict to members of my service last week. I believe it is a MUST-read.
The S&P 500 which is used as the benchmark is up 15.4% this year, and the equal-weighted version (RSP) is up 5.6%. That simply means the “average stock” is nowhere near breaking into BULL market territory when using the same guidelines everyone is focused on today.
The NASDAQ, and NASDAQ 100, have added to their breakout level gains in June, and now the S&P has done the same. The small caps as measured by the (IWM) continue to lag. While the other indices are at their ’23 highs, the Russell 2000 is 8% from accomplishing that feat.
The sector (XLY) continues to outperform everything except technology with a 9.9% gain in June making the YTD gain for the group a bawdy 29%.
Oil prices went on a roller coaster ride recently, leaving investors scratching their heads. U.S. crude prices fell nearly 5% last Thursday after a report of U.S.-Iran talks on a temporary nuclear deal that would allow the Islamic Republic to export more crude. That was denied when a spokesperson for the White House National Security Council called the report “false and misleading”.
After another test of the intermediate low last week the Energy ETF (XLE) was able to mount a mini-rally that brings it back to the trading range. Like everything else it is at resistance levels. However, unlike the other areas of the market, this sector is not overbought. The longer-term trend remains BULLISH so while I don’t see a major upside move for the group, I’m hard-pressed to start abandoning energy stocks. – NEUTRAL
Despite the poor sentiment amid concerns over what occurred at Silicon Valley Banks the sector has found support and did not crater. Perhaps, investors did recognize that not all banks left themselves vulnerable to rising rates and saw value at depressed levels. We’ve seen rallies off the lows, and in the case of the large money center banks and brokerages which make up the Financial ETF (XLF), it has rallied right to strong resistance. That leaves the group in a trading range and a NEUTRAL setting.
Meanwhile, the regional Bank ETF (KRE) has done the same but at least from a technical perspective may have more room to move higher. There is plenty of “white space” between Friday’s closing price and overhead resistance. In the short term – I’d also rate the group – NEUTRAL, but give it a slight lean to the upside.
The rally broadened out and even the commodity complex (DBC) got in on the action. The group has been left for dead this year but has now rallied 6+% in June.
The Healthcare sector (XLV) also tested the lower end of the range a couple of weeks ago, rallied to resistance, and pulled back. Once again a NEUTRAL setting as it sure appears the group will carve out the same trading pattern we saw last year. The (XLV) will more than likely continue to test both the upper and lower end of a wide trading range. From a fundamental perspective, healthcare is always a decent place to have equity exposure during a slowing economy.
This past week UnitedHealth (UNH) dropped like a rock when the company noted pent-up demand has seen surgical procedures spike, increasing their costs. If they are seeing a big increase in “procedures” – that means a boom for medical device makers. Savvy favorites Intuitive Surgical (ISRG) and Stryker (SYK) got a big boost from this news.
Getting back to UNH, I’ll note while the company may have sounded an alarm, they noted the issue was – for now – concentrated in the Medicare outpatient business and that there was no mention of a revision in full-year EPS guidance. I see this drop as an opportunity to get into a CORE Healthcare name.
The group (XBI) is acting like it’s part of the technology craze lately with a 20% move off the March lows. It’s only a minor breakout but the ETF is now above its longer-term moving average for the first time since November 2021. The strength is there and I would use any pullback to follow what could be a larger breakout move in XBI.
The resistance we spoke about at the $193 level that has capped the GOLD ETF (GLD) since March ’22 has proved to be too much for the metal to overcome. It’s now a matter of finding support and stabilizing OR we could easily see a breakdown to the next support level.
Silver (SLV) has taken a slightly different road back to the middle of its trading range. It has overcome the first test of resistance but quickly faces another hurdle.
Both GLD and SLV are in longer-term BULL trends, but the intermediate-term situation looks NEUTRAL at best.
A solid 12% rally off the May lows has the sector challenging the ’23 highs. That appears to be a stiff resistance level as it capped the last two rallies in ’22 as well. I continue to HOLD my investments in Uranium (URA) for the longer term.
The starcraft “Technology” entered a new atmosphere this week. The NASDAQ is up 31% this year, while the Technology ETF (XLK) has recorded a 40% gain in ’23. That gain wipes out the 28% loss the (XLK) suffered last year.
The semiconductor has been the clear winner and leader of this rally, and the DAILY chart tells the tale. The ETF (SOXX) took a shot at breaking above the March ’22 highs but gave way to profit-taking. After that quick ‘pause” the sector got its second breath and set another new closing high on Wednesday.
Like everything else, it is also very much overbought, but it’s also doubtful this strength dissipates quickly. That makes it a very tricky scene for investors to navigate.
Admittedly, I’ll never be the first guy to claim the market has bottomed or a NEW BULL market has begun, and it is certainly not necessary to make that declaration to make money in the financial markets.
What I do care about is making good, consistent, probability-based decisions that can help keep the odds of success in my favor. That means waiting for and playing trends that are clearly defined. We saw that play out with the “Energy” sector last year. Chasing stocks when the averages are all hitting such extremes in a heavy resistance zone and after participation across the market has been diminishing since February is not something that I think puts the odds in my favor.
If the market is going significantly higher, there will almost certainly be setups along how we can more closely define our risk. I’ve been increasing exposure with new positions and added to existing positions that offer positive setups. A total of 18 “additions” since the beginning of April. They range from “Preferreds” to interesting ways to play the AI craze and collect a 4+% dividend in the process.
If similar future setups don’t develop and instead the market suffers the kind of decline that some say is off the table now, then I will be very pleased with my risk management. If the market continues to push immediately higher without me, then I am fine with that, too. I know there will be other opportunities in the future that do not require sacrificing my principles and breaking the rules that have served me well over the years.
So the advice is to await some kind of new setup that interests us enough to take some more risks. I don’t make it a habit to chase stocks when the averages are so overextended, and the recent SAVVY playbook additions are more indicative of seeking out a “setup” that looks attractive. Money has started to rotate to the laggards while the winners remained very resilient. It is the type of price action we will need to see more of to stamp out all of the reasonable doubt that exists today.
Many in this business pay lip service to managing risk and protecting the downside but few do anything about it. When the market is at its most risky – as I believe it to be right now with the averages so extended – most people are not thinking about reducing risk; they only care about not missing out on more profits. Enter FEAR and GREED. Tops are made when all looks good and it seems the only possible path is higher. Based on the anecdotal evidence I see at the moment, that appears to be the case right now.
If the market continues to move higher without really providing a high-probability, low-risk entry in select stocks then I am ok if I miss out. The reason, I already have exposure to equities, and these situations define the reason why no one should ever be totally out of the stock market. Finally, if this is the dawn of a NEW BULL market, then rest assured there will be a tsunami of setups where an investor can make profits.
THANKS to all of the readers that contribute to this forum to make these articles a better experience for everyone.
Best of Luck to Everyone!