It’s Wall Street’s version of an irresistible force pushing against an immovable object. Those heralding a new bull market underway in stocks have some historically undefeated statistical signals propelling their call. Others insisting that a recession surely awaits in the coming months have their own set of never-been-wrong indicators to buttress their stance. And if the recession-foreshadowing “rules” hold up as they always have before, then last October serving as the index low for this cycle would likewise be a first, given that a recession-related bear market has never bottomed before its recession began. The tape readers’ arsenal of bullish signals involve relatively rare market-breadth readings registered since last month, along with improvements in the trend. Sure, the S & P 500 ‘s 50-day moving average crossed above its 200-day, a positive though not flawless input. But along with it, a very specific set of breadth conditions qualifying as “breakaway momentum” was triggered. Ned Davis Research has a volume-based tracker of equity supply and demand that this month saw demand move ahead of supply. This has only happened five prior times since 1981 after supply had been dominant for at least four months. After each of the five prior times, the S & P was up three, six, 12 and 24 months later. And January this year the index was up more than 5%. In every year that stocks gained at least this much in January after the prior year was down (five instances since 1954), the market went on to gains in the new calendar year, with above-average returns. These sound like generally encouraging data points, though perhaps a bit too narrowly drawn and subject to the distortions of small sample sizes and technical quirks. Bearish indicators The confident recession predictors are able to counter with a deeply negative 3-month to 10-year Treasury yield curve, something that has always been followed by an official recession – albeit sometimes with a lag as long as a year. The Conference Board’s Leading Economic Indicators have fallen well beyond the threshold that has reliably preceded prior recessions. And the Federal Reserve’s senior loan officers survey shows the net percentage of those tightening borrowing standards likewise in a zone that has never failed to give way to recession. The lags between such signals and onset of an economic downturn can be long – indeed long enough, and with enough real-time strength in consumer spending and job growth to generate calls for a “soft landing,” as my friend and colleague Kelly Evans details in her newsletter here . Warren Pies, founder of macro shop 3Fourteen Research, has grappled with this apparent conflict between the cardinal rules “Don’t fight the tape” and “Don’t Fight the Fed.” He finds reason to discount the bullish technical markings left by the recent rally mainly because the Fed is still tightening, and bear markets have not ended in history in the midst of rate-hiking campaigns. Here he shows the difference in S & P 500 performance after the S & P 500 pushes above its 200-day average based on whether the Fed is easing policy or not. A clear divergence though also worth noting that even when the Fed was hiking or pausing, on average the index went on to make modest upside progress. Which side is right? There are ways to reconcile some of the conflicting messages here. For one thing, this cycle has been unusual in plenty of respects – a forced stoppage of a late-cycle economy in early 2020, a “flash recession” followed by enormous stimulus to support spending and hold companies unharmed. An inflation shock that prompted one of the most transparently aggressive Fed tightening initiatives in history. Consumer debt obligations remain low compared to history; what looks and feels like retrenchment in goods-producing industries is largely a normalization back to trend. The market, too, has followed an unusual cadence. While it’s true that bear markets have not tended to end while the Fed was still hawkish, it’s also true that the S & P 500 had a 27% setback last year that started – unusually – before the first hike and while corporate profits were still at record highs, and in advance of the Treasury yield curve first inverting. An odd, scrambled sequencing of macro-market interplay. It’s wisest to stay open-minded about the ultimate outcomes and set risk-return expectations with a wide band. Yes, the stock market is a complex mechanism that discounts eventual outcomes inscrutably and with considerable lead time. It’s not as if there is a fixed outcome waiting out there to be discovered and priced. It’s a dynamic, unknowable future. For now, the macro data have been running a bit hotter, allowing for a thaw and – who knows? – maybe a bullish phase for stocks that later gets tested as the lagged recession forces or incrementally assertive Fed test it. For sure, corporate-credit is not ringing any alarms just yet, with triple-B-rated bond spreads over Treasury yields looking tame. They have tended to turn sharply higher at least some months ahead of recession. Citi strategists show that earnings and revenue forecasts by analysts are being revised lower at a slower pace, implying the reduction in profit forecasts could me mostly finished for now. Valuations and higher bond yields keep Citi from believing there is much upside to the S & P 500 from here, but this could mean fundamental support is no longer eroding quickly. Meantime, FactSet reports that this reporting season, companies exceeding forecasts are having their shares rewarded roughly in line with the five-year average. And yet: “Companies that have reported negative earnings surprises for Q4 2022 have seen an average price decrease of -0.4% two days before the earnings release through two days after the earnings. This percentage decrease is much smaller than the 5-year average price decrease of -2.2% during this same window for companies reporting negative earnings surprises.” A hint that a rough 2022 did a good deal of work discounting weakness to come and chopping down expectations? Plenty to chew on for both believers in the recent market breakout and skeptics who see just another bear-market rebound carried only so far on misplaced hope and mispositioned investors. The last week was indecisive in settling this debate, though the action generally benign: a choppy 1.1% pullback in the S & P 500 from a short-term overbought perch even with Alphabet losing over $100 billion in market value; AAII retail-investor sentiment tilting toward optimism but only after a record-long stretch of bearishness; Treasury yields bumping higher with a CPI report coming on Tuesday yet with a fair amount if index hedging underway in preparation for a potential jolt.
