Two weeks in, the year’s first act is playing pretty close to the bull-market script. After a nine-week sprint higher to finish 2023, bull and bear alike pointed out the tape was overheated and stretched, and it has duly cooled off with a two-week pause that’s kept the S & P 500 just a half-step below its record high of two years ago. There has been some payback for the November-December rip below the surface. The small-cap Russell 2000 has dropped close to 4% against a fractional gain in the S & P 500 year to date. ARK Invest , proxy for lower-quality high-beta tech, is more than 12% off its late-December high. This was necessary, predictable, and very likely unfinished. What we know about the kind of rare breadth and momentum scores achieved by the surge off the October lows are this: The forward-return implications going out several months or a year are quite positive based on history, yet the near term often features some backsliding and sloppy profit-taking. This chart from Ned Davis Research shows that the all-in rally to end 2023 was a worldwide affair, taking 92% of all national stock markets above their 50-day average, and during the recent market pause “hardly a dent has appeared in the breadth numbers that entered the year indicating decisive improvement in global participation,” says NDR chief global strategist Tim Hayes. The equally weighted All Country World Index has appreciated at a 24% annualized pace since 1998 when this gauge is above 75%. As Tony Pasquariello, head of hedge fund coverage at Goldman Sachs, put it late last week, “The setup is neither all good, nor all bad,” with the economy resilient but stocks far less depressed and hated than they were a year ago. He believes we’re operating in “some form of bull market,” so it’s right to expect further upside progress, though “2024 will bring a lot of bump-and-grind and much less velocity than we saw circa 2019-2023.” In broad terms, the S & P 500 could retreat to 4600 or so – about 4% down from here – and still be in a routine technical check-back to its latest launch point in early December. New year’s rally pause The negative return for S & P 500 over the year’s first five trading days isn’t meaningless but neither is it a loud alarm, history showing it essentially has cut the odds of a positive calendar year from around 70% to about 50%. The week of January monthly options expirations, which is next week, also has a tendency to be weaker for stocks. Remaining mindful of such tactical hazards and potential indigestion, a broader framework has stocks having made a two-year round trip during which they absorbed 500 basis points of Fed tightening, a mild earnings retreat and constant foretelling of recession to emerge into 2024 with the soft economic landing thesis intact (if unproven) and disinflation unfolding as hoped. .SPX mountain 2022-01-10 S & P 500, 2 years Henry McVey, KKR’s head of global macro, leans on the fact that October 2022 was a bear-market bottom, and after such a low stocks tend to deliver above-average returns over the next few years. “We think that too many investors are still locked into the paradigm that the S & P 500 is trading at lofty headline valuations and the U.S. economy is topping out and headed for a hard landing,” says McVey. “We do not see things this way.” While not penciling in gaudy gains at the index level for this year or U.S. GDP growth to be brisk, McVey notes reasonably valued equities away from the anointed glamour mega-caps, and importantly points out that none of the top 25 central banks are tightening compared to 85% in 2022. Meantime, the combination of merger-and-acquisition, IPO and high-yield debt issuance relative to GDP is running at the lowest level since 2009. Mergers and IPOs missing Morgan Stanley keeps a leading indicator of M & A activity which has recently raced higher, suggesting dealmaking – a recent plot hole in the bull-market script – should reawaken before long. Is it likely a bull market would end before animal spirits get mergers and IPOs rolling, with the average Wall Street strategist forecasting no S & P 500 upside this year and with the index having gone nowhere for two years? Whether the recent anecdotal upturn in acquisition activity (visible in biotech, energy and software) picks up and helps smaller-cap companies resume their catch-up move versus the giant growth names is far from clear yet. Much celebration greeted the late-2023 ramp in small-caps from multi-decade relative depths. And, sure, greater confidence in the economy averting recession with rates coming down should be a prop. Big money betting on a broadening But the Russell 2000 in two weeks has already surrendered about half its outperformance over the Nasdaq 100 racked up over the prior two months. And I can’t help noting again that if this market begins favoring the majority of stocks over the Magnificent Seven names, it would represent the consensus getting exactly what it wants – something markets don’t tend to serve up on command. Todd Sohn of Strategas notes that the Invesco S & P 500 Equal Weight ETF (RSP) saw inflows go vertical last year to $13.5 billion, 30% above its prior 12-month record. The fund’s asset total is now $49 billion, so the new money betting on a broadening tape is a hefty chunk of the total. It makes sense to expect less dominance from the largest seven index leaders perhaps, but markets don’t have to be zero-sum. None of the Mag7 has a forward P/E higher than two years ago. And, helpfully, they’re not moving as one, with Apple and Tesla diverging to the downside lately. Betting on ‘peacetime’ Fed cuts Right or wrong, the market debate right now can never get far before turning into a Fed-policy-path discussion. Last week’s CPI and PPI data added to the market’s collective conviction that inflation’s downside momentum is strong, opening the way for “peacetime” Fed rate cuts. We know Fed Chair Jerome Powell has acknowledged there would be easing well before the 2% PCE inflation target is met, to ensure policy doesn’t grow too restrictive with a current Fed funds rate of 5.25-5.5%. We know the Fed views 2.5-3% Fed funds rate as “neutral,” and that its members median forecast pencils in three quarter-point rate cuts this year even though they did not foresee the 2% target being reached until at least 2025. All of this points to easing ahead. Now, the Fed funds futures market is pretty sure it will start in March and now prices in a total of 150 basis points of cuts by the end of 2024. (1 basis point equals 0.01%) This is the supposed mismatch in Fed-vs.-market expectations that more cautious or hard-to-please observers cite as a major possible source of market dislocation. But beyond a couple of months Fed funds futures pricing is pretty unreliable, capturing a wide range of potential hedging and speculative scenarios that get priced along a spectrum, and the market will tend to over-extrapolate at times. For now, though, the reassuring trend of inflation ebbing more quickly and convincingly than the labor market and consumer are weakening remains. The Fed’s stated willingness to try to accommodate a soft landing (such as in 1995 with just a couple of rate cuts as the economy reaccelerated) is also a psychic backstop. A lot can go wrong, including deeper consumer fatigue (discretionary stocks have traded poorly for three weeks) or a gathering layoff wave that imperils the growth side of the soft-landing thesis. But just because the S & P now trades near 4800 again and the Fed funds futures market contemplates six rate cuts this year, doesn’t mean that the former has occurred because of the latter.
The stock market has cooled off to start 2024, but it’s still checking most of the bull market boxes
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