We have two ears, two eyes and one mouth, which according to the old aphorism means we should listen and look approximately twice as much as we speak. Investors heeding this advice by resisting the impulse to tell the market what it ought to be doing and instead listening to it will likely find an upbeat – if hard-to-trust – message. An initial signal is the general resilience of the broad market, finding support last week right where it had to in order to preserve an uptrend while absorbing a fierce move higher in bond yields over the past month. .SPX 6M mountain S & P 500, 6 months Yet the message within the market is if anything more surprising to many, a sprint higher in the “early-cycle” sectors of a kind that typically reflects a recovering and accelerating economy. What the charts say Ned Davis Research keeps an early-cycle composite gauge and here shows that since the October market low it has tracked the average historical path coming out of the half-dozen non-recession bear markets. Did the “soft landing” occur six months ago, at least in market terms? Renaissance Macro Research founder Jeff deGraaf has been saying the tape is back in a broad uptrend and contends, “The most important thing is the characteristics of the rally. Cyclicals are leading this rally to the dismay of an awful lot of bears. They just can’t possibly understand how that could come to be the case. We’re kind of reassured by that.” The leadership profile speaks, perhaps, to an elongated economic and Fed tightening cycle and suggests where within a notably bifurcated market investors should migrate. Steel and hotel stocks ripping, for example, and utility and consumer staples stocks tripping. This all lends some credence that the October low was an important one though stops short of delivering conviction that the indexes are poised for fast and unencumbered gains out of their long multi-month trading range. Yes, the Treasury yield curve remains deeply inverted in typical pre-recession mode, the Federal Reserve’s ultimate destination for interest rates has again been pushed out in time and distance, and valuations never got truly cheap (even if they’re in the zone of “fair” excluding the largest few stocks). Still, it would be hard to script a more textbook plot to embolden the bulls than the one that’s played out since the fall: A classic October bottom just ahead of the uncommonly bullish mid-term-election trigger, on the very day of the last ultra-high inflation reading. High and declining inflation is historically among the most constructive backdrops for stocks. A rally into the New Year that set off multiple rare and supportive breadth and momentum signals, followed by a seasonally ordained February pullback that was routine in magnitude but succeeded in cooling off sentiment and skimming off some market froth. All the while, the corporate-credit market held firm and the Volatility Index was undisturbed, as bond owners and options traders saw no signs of stress or need to panic. What investor sentiment says Retail investors only briefly experienced a brighter mood in January with a burst of optimism, with the American Association of Individual Investors survey last week back to showing twice as many bears as bulls. Outflows from equity funds have been heavy as money shuttles over to generously yielding money markets and high-grade bond funds. And here we see the reversal into this week of the early-year chase for equity exposure among the members of the National Association of Active Investment Managers. This turn in attitudes is surely understandable given the still-vigilant Fed, slippage in earnings forecasts and pockets of deep weakness in housing and manufacturing. But it’s also reassuring as evidence that complacency has not overtaken caution. The fixation on Treasury yields as a determinant of what stocks “should” do makes some sense but is also probably overdone. True, the ramp in the 10-year from 3.4% on Feb. 2 – the S & P 500 high for the post-October rally – to above 4% last week was fast and jarring and brought with it plenty of potential hazards. They reflect in part sticky inflation that could require the Fed to jack rates beyond the economy’s capacity to handle them. With the 10-year now just under 4% and Fed funds rate above 4.5%, the S & P 500 is now higher than it was nearly ten months ago, when the 10-year was 3% and Fed funds under 1%. The interplay between rates and stocks and equity valuations is neither as precise nor as fixed as conventional wisdom would have it. For all the encouraging action we can observe, it’s also not hard to push against the positive inferences. For one thing, the stock market surely can be prone to misapprehending the next macro turn and can overshoot reality in the short term. And the unorthodox character of this compressed, high-amplitude economic cycle should leave minds open to outcomes that stray from the historical templates. What the economic cycle says Leuthold Group notes that a key labor-market gauge within the Conference Board’s Consumer Confidence survey just made an unprecedented turnabout. Last July, the spread between those saying jobs were plentiful and those calling jobs hard to get dropped by more than nine points from its peak. Since 1970, this has only ever happened during a recession or within six months of one starting. But since then, the gauge has turned up by more than nine points, “something that had always confirmed a new economic expansion was underway,” says Leuthold’s Doug Ramsey. To repeat the question, was the “soft landing” last year (with its slight, fleeting uptick in the unemployment rate)? To Ramsey, this suggests the current tight labor market strength could well undermine the calls of a new bull market underway by requiring the Fed to forcibly loosen it up. Another frequent vector of pushback to the market’s early-cycle acceleration message is that we’ve seen very strong rallies that appeared to be decisive yet ultimately broke down to new lows in prolonged bear markets. This has often occurred when the Fed was or would soon be finished tightening and the economy appeared, for a short time, to come through in decent shape. BCA Research here shows the sobering harmony in the current market trajectory and that of the early-2000s post-tech-bubble bear market. It always pays to be aware of the potential traps, for sure. We can note, though, that the S & P 500 back then never spent as much as a month above its 200-day moving average as it has this year. And credit conditions have remained healthier this time, the triple-B-rated corporate yield spread over Treasuries never dropping below two percentage points from early 2000 to 2003; it is now around 1.5 percentage points. The next wave of the early-2000s meltdown also coincided with the 9/11 attacks and the massive corporate accounting and fraud scandals of Enron, WorldCom and others that wiped out huge portions of prior years’ reported earnings. Sure, things could again break in treacherous ways. But the market’s message at the moment contains no real hints of that, even if you listen closely.
