Inside The Stock Market ...trends, cross-currents, and outlook

In a simple test of 15 yield-curve variants, we found that the 2s10s spread ranks second to last, based on its correlation with one-year-forward real-GDP growth since 1978. The three best measures employed the 3-month bill as the “short” rate. The spread between the 5-year note and 3-month bill showed the strongest correlation with subsequent economic growth.

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In late March, the S&P 500 rallied to within 3.5% of its January high, likely prompting producers at CNBC to put in an order for “S&P 500 5,000” hats. But we think that 4,000 will be undercut before 5,000 is topped, and action in key indexes (with the notable exception of the S&P 500 itself) reinforces our view.

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They are simple measures, but our “NOPE” Indexes capture (as well as anything) the escalating inflation squeeze on businesses and consumers. To recap, the NOPE is the spread between the ISM New Orders Index and the Price Index, which can be calculated for both the Manufacturing and Services sectors.

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An already-low unemployment rate has dropped another 0.3% YTD (to 3.6%) and stocks’ rebound in the second half of March took the S&P 500 to within 3.5% of its all-time high. Yet Consumer Sentiment has sunk to 59.7—a reading that’s 15 points below the average seen at the last six NBER business-cycle troughs. Why the long faces?

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If earnings’ nearly vertical ascent continues for another six months, 12-month trailing EPS will intersect the 6.9% long-term-growth trend line connecting the five major EPS peaks between 1974 and 2007. The “New Normal” has given way to the “Good Ol’ Days!”

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NIPA’s “all-economy” profit margin declined a bit in Q4—which typically peaks before SPX profits—and that falloff coincided with the economy officially reaching full employment, based on the CBO’s Nominal GDP Output Gap. When the Output Gap has flipped positive (like in Q4), corporate profit margins usually come under immediate pressure.

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Next month kicks off the seasonally-weak phase of the stock market’s Annual Cycle: May-October. Overlaid on that is the statistically vulnerable stretch of the four-year Election Cycle: the “mid-point” of the Mid-Term Year. There’s a positive way to spin this mid-term malaise: The cycles imply that an ideal window for a major low is about to open.

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Like Gonzaga in the NCAA basketball tournament, stock market bulls are set for their first real test in a very long time.

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Washed-out investor sentiment and “oversold” stock market oscillators are usually good reasons to get more invested in stocks. But in the case of super-oversold conditions, it is commonly a forewarning that another wave of selling is yet to come.

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The concept of “mean reversion” used to help build massive fortunes. Of late, a better mantra has been “maximum attraction,” as valuations and bullish psychology have matched or surpassed excesses of the Y2K Tech bubble. Meanwhile, corporate profit margins, once dubbed “the most mean-reverting series in finance” by Jeremy Grantham, have now topped those seen near the Y2K top by more than 50%.

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PPI and CPI inflation reached levels that were “too hot to handle” last April and July, respectively, yet the blue chips kept going up through year-end. Large Cap investors who trimmed stocks in response to the violation of these long-time inflation speed limits, however, haven’t missed out on much, and Small Cap investors who did so are happy.

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For months, we’ve argued there are two ways of thinking about the current economic cycle. Economist types are likely to side with their brethren at the NBER, who say the recovery has entered its 23rd month. But those observing the broad range of economic and financial gauges might view this cycle as a  single economic expansion dating back to mid-2009.

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Those who want validation to buy aggressively with the market down 10% can reference two historically reliable, intermediate-term sentiment measures with fresh BUY signals—and there’s a third one that’s also very close to triggering a BUY. The problem is that boundaries defining extreme psychology change over time—with a key inflection occurring as the market transitions from bull to bear.

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Many investors will instinctively salivate at lower prices, whether or not they represent good value. Is there a better way to temper this Pavlovian impulse and improve results? We found it’s better to wait 25 days before re-entering the market after a 10%-correction threshold is breached.

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Prior to the Russian invasion of Ukraine, 10-year Treasury yields bumped above 2% for the first time since July 2019. While that level may strike seasoned investors as insanely low, a 2% yield is now within a few basis points of the ten-year moving average of 2.04%.

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Longstanding concerns over the stock market’s lofty price tag are frequently dismissed with the observation that “valuations are not helpful timing tools.” We don’t disagree. In that spirit, then, let’s review three simple trend-following models that have been useful timing tools.

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In late January, the S&P 500 was down so much (almost 10%!) that it revived talk of investors’ favorite “safe” security. No, not T-bills—and not even Amazon or Apple common stock—but the Fed “put.” Years ago, we called it the “hypothetical” Fed put. But by now, we’re believers.

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Senator Rand Paul’s annual “Festivus” report on wasteful spending makes for sobering reading to the dwindling few who care about federal finances. The “low light” for 2021 was a $465,000 grant to the National Institute of Health for a study of pigeons playing slot machines.

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The economic expansion officially entered its 22nd month in February. In dog years, that translates to an age of 13—the same age the recovery might have reached this July if not for the COVID disruption. The late-cycle characteristics displayed by a recovery that’s statistically so young dissuade us from issuing a high-conviction forecast for 2022.

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One might have predicted that big beneficiaries of war-time-style levels of federal spending, financed by money printing, would be Small Cap stocks. And from March 2020 until March 2021, they were. But the larger picture is sobering. 

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