Despite Resilient Stock Markets, Uptrends are Preserved as they Find Support at The Right Time

We have two ears, two eyes, and one mouth, which implies we should listen and gaze twice as often as we speak, according to an old adage.
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Investors who follow this advice by rejecting the urge to tell the market what it should do and instead listen to it will likely discover a positive - if difficult-to-trust - message.
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One early indicator is the broad market's general tenacity, which found support last week exactly where it needed to maintain an upswing while absorbing a ferocious rise upward in bond rates over the last month.

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The message in the market, which many find even more unexpected, is a sprint upward in the "early-cycle" sectors, which normally signify a rebounding and expanding economy.

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Since the October market bottom, Ned Davis Research's early-cycle composite indicator has followed the typical historical route out of the 12 non-recession bear markets, as seen above. Did the "soft landing," at least in terms of the market, happen six months ago?

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The creator of Renaissance Macro Research, Jeff deGraaf, claims that the rally's characteristics are what matter most and that the tape is once again in a wide upswing. So many bears are disappointed that cyclical is driving this rally. They simply aren't able to comprehend how anything like that could happen. It kind of gives us comfort.
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The leadership profile reveals where investors should go inside a market that has become noticeably divided and may hint at an extended economic and Fed tightening cycle. For instance, stocks in utilities and consumer staples are down, as are those in steel and hotels.
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This all gives validity to the fact that the October bottom was significant, but it falls short of conveying certainty that the indices are prepared for rapid and unfettered increases out of their 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 have once again been pushed out in time and distance, and valuations have never been truly cheap (even if they are in the "fair" zone when the largest few stocks are excluded).
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Yet, it's difficult to imagine a more perfect plot to bolster the bulls than the one that's been unfolding since the fall: a traditional October low just before the unusually bullish midterm-election trigger, on the same day as the most recent ultra-high inflation figure. High and decreasing inflation has historically been one of the most favorable backgrounds for stocks.
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A rise into the New Year triggered a slew of uncommon and supportive breadth and momentum signals, followed by a seasonally scheduled February retreat that was little in scale but succeeded in calming emotions and removing some market froth. The corporate-credit market remained stable, and the Volatility Index remained unchanged, as bond owners and options traders saw no reason to worry.

What the investor outlook says

Retail investors only temporarily experienced a surge of euphoria in January, with the American Association of Individual Investors poll last week showing twice as many bears as bulls. Outflows from stock funds have been significant, as money has shifted to high-yielding money markets and high-quality bond funds. And here we see the reversal of the early-year rush for equities exposure among members of the National Association of Active Investment Managers into this week.

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This shift in sentiment is reasonable given the Fed's continued vigilance, revisions to profit projections, and areas of severe weakness in housing and manufacturing. Yet it's also heartening as proof that complacency hasn't trumped vigilance.

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The obsession with Treasury rates as a predictor of what equities "should" do makes logic, but it is also likely overdone. Indeed, the 10-year bond's rise from 3.4% on Feb. 2 - the S&P 500's high for the post-October surge - to above 4% last week was quick and abrupt, bringing with it a slew of potential pitfalls. These represent sticky inflation, which may force the Fed to raise rates beyond the economy's capacity to bear them.

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The 10-year is currently slightly around 4%, and the Fed funds rate is above 4.5%; as a result, the S&P 500 is higher than it was almost ten months ago when the 10-year was at 3% and the Fed funds rate was at 1%. Contrary to popular belief, there is some flexibility in how rates interact with stock and equity prices.

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Despite the beneficial actions we can see, it is also not difficult to argue against them. For starters, it is possible for the stock market to short-term exceed reality and be susceptible to misreading the next macro turns. Also, because of the unconventional nature of this compressed, high-amplitude economic cycle, it is important to be open to results that deviate from the norm.

What the economic cycle says

Leuthold Group noted that the Conference Board's Consumer Confidence survey's primary labor-market indicator recently saw an extraordinary reversal. The gap between those who said there were plenty of jobs and those who said it was difficult to find them decreased by more than nine points from its peak in July of last year. This has only ever occurred since 1970 during a recession or within six months of its beginning.

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But, since that time, the gauge has increased by more than nine points, "something that had always signaled a fresh economic growth was starting," according to Doug Ramsey of Leuthold.

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Was the "soft landing" last year (with its minuscule, transient increase in the jobless rate)? Ramsey believes that by needing the Fed to artificially loosen it up, the current tight labor market strength may well contradict predictions of the beginning of a new bull market.

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We've seen extremely powerful rallies that seemed to be conclusive but ultimately broke down to new lows in protracted bear markets, which is another regular vector of pushback to the market's early-cycle acceleration message. This has frequently happened when the Fed was nearing or had just ended tightening and the economy briefly seemed to be recovering well.

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Here, BCA Research demonstrates the startling similarity between the present market trend and the bear market that followed the early 2000s tech boom.

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Indeed, it helps to be aware of any possible pitfalls. Yet, it should be noted that the S&P 500 back then never stayed above its 200-day moving average for as long as it has this year. The triple-B rated corporate yield differential over Treasuries never fell below two percentage points from early 2000 to 2003; it is presently around 1.5 percentage points, indicating that credit conditions have stayed stronger this time. The 9/11 attacks and the large corporate accounting and fraud scandals involving Enron, WorldCom, and others, which completely erased past years' recorded earnings, also occurred during the following wave of the early 2000s meltdown. Well, dangerous things may happen again. Even if you pay close attention, the market's message at this time does not include any indicators of such.

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