Why'd You Have to Go and Make Things So Complicated?
While the major US equity indexes seem to have convincingly reclaimed the north side of their 50-day moving averages, the rally in defensive sectors and gold raises questions. Let's dig in...
While it definitely seems as though the equity markets have provided the follow-through (above the 50-day moving average) that we sought to declare the April correction over, imbalances remain.
On Tuesday, we noted that the Fed and Treasury had, in the words of Dan Clifton from Strategas, “laid down a security blanket of liquidity into the 2024 election.”
We have highlighted the Pavlovian response of equity markets to liquidity.
With 8 straight days higher in the Dow Industrials (including today) since the Fed and Treasury announcements last week, it seems the pattern of the equity market response has been consistent.
That said, we have been careful to emphasize that this years equity market is not the 2023 market.
While it has been broader in general (more shares moving higher, not just the magnificent 7), what has been emerging recently is strong performance in Utilities and Consumer Staples (only two sectors at 52-week highs) (charts 3 and 4).
These defensive sectors are not necessarily where you want to see strength in the equity market.
Is this simply the “Everything Rally” that we wrote about at the beginning of March (here) driven by Stealth Liquidity and Fiscal spending or are equity investors seeking out those sectors that they tend to emphasize when storm clouds gather?
While we continue to watch imbalances in what we consider to be a fragile market (valuation elevated, particularly given 10-Year Yields, inflation and Fed policy), we remain invested but vigilant.
Our view remains that the S&P 500 can hit 5500 this year as investors ascribe a 20x multiple to the $275 in 2025 expected S&P 500 earnings, but continue look for possible cracks beneath the surface.
1. Back Above the 50-Day Moving Average
Source: TradingView. Through year-to-date 2024.
The Nasdaq 100, the S&P 500, the Dow Industrials and the Russell 2000 Small Caps have all recaptured the north side of their respective 50-day moving averages (the curved green line in the chart above).
The 50-day moving average was a key indicator in our call for a possible correction down to the 4800 area on the S&P 500 and as each of the major indexes now seems to have meaningfully (looks somewhat meaningful to me) moved above, we are backing off of our cautious call.
That said, we would note that the Nasdaq 100 relative to the S&P 500 remains in a downtrend having peaked in late January and just below its 50-day moving average. (We showed this here and will show it again next week).
What this means to us is that Technology, Nasdaq 100 and the Growth shares that led US equities higher in 2023, have not been the leaders in 2024 and that portfolio diversification has and will continue to be an important strategy for 2024.
We have highlighted our exposure to commodities, energy (not great recently), financials and industrials. In other words, typical cyclical value sectors.
However, what we have noticed lately (and we show below) is that defensive value sectors - Consumer Staples (chart 3), Utilities (chart 4), and Healthcare have been rallying along with the uncertainty hedge, Gold (chart 5).
Is this a warning? We’ll see.
For now, we are taking the ascent of the major indexes over their respective 50-day moving averages at face value and acknowledge that the combination of liquidity and earnings that we highlighted on Tuesday is supportive of higher prices.
(This is not a recommendation to buy or sell any security and is not investment advice).
2. Fear the Cut
Source: Strategas. Through year-to-date 2024.
Given the US fiscal deficit, growing debt burden and other imbalances that we have shown, some readers have asked how long the current equity market (and economy) can keep blissfully moving higher.
The first and easy answer is that both bull and bear markets go further than most think they will.
The second answer is that we look at moving averages and sector leadership for clues of cracks under the surface.
While we have recently been focused on the 50-day moving average, for longer-term allocators, the 200-day and / or 10-month (approximately 200 trading days) moving averages are often trustworthy signals.
When I was younger, my mother would warn me that nothing good happens after midnight (I might still debate that). Similarly, some say that nothing good happens under the 200-day moving average (regardless of the asset).
A final, somewhat counter-intuitive, indicator to consider as a “risk-off” signal is a Fed rate cut. (chart above)
While we are proponents of liquidity as a driver of equity markets, generally, by the time the Fed cuts, the cracks in the economic windshield have already begun to spider out.
On average, from the last rate hike to the first rate cut (the period we are in now), equities move higher (5% over 100 days). (Past performance is not indicative of future results).
The last Fed rate hike in the current period was in July 2023, nearly 200 trading day ago. Since then, the S&P 500 is up over 15%.
In terms of both magnitude and duration, the current period is most comparable to 2006-2007 when the S&P 500 was up nearly 20% over 300 trading days between the Fed’s last hike and first cut.
While there is the possibility that the Fed’s first cut of the current cycle will put the economy on a glide path to a soft landing, historically, that has been the exception rather than the rule.
In the meantime, we will continue to watch for a confluence of signals as a possible indication of economic volatility.
(This is not a recommendation to buy or sell any security and is not investment advice. Please do your own due diligence).
3. Consumer Staples are Booming - Is that Good?
Source: TradingView. Through year-to-date 2024.
While the Consumer Staples sector is not making a new all-time high, it is one of two sectors (the other is Utilities - next chart) that are making 52-week highs.
Consumer Staples are a defensive value sector.
This is one of the corners of the equity market that portfolio managers go to when they see a slowdown coming. The idea is that in a slowdown maybe people will reduce discretionary purchases of Nike, Apple, Teslas, Starbucks (as we’ve seen this earnings season) but people will still need to eat, brush their teeth, use paper towels etc.
That said, we want to be open minded and we could look at the rally in Staples from a different perspective.
After dramatically underperforming the S&P 500 during 2023, the Consumer Staples sector may be merely bouncing a little to keep pace with index. In terms of relative performance, the Consumer Staples sector has not even retraced 20% of its 2023 relative fall.
Looking at the chart, it is important to note that there appears to be both a longer-term bullish “cup and handle” pattern and a shorter term bullish inverse “head and shoulders.” (I’ve drawn these in).
Both of these suggest higher levels for the Consumer Staples sector.
We will watch to understand whether this is a harbinger of volatility or simply a “catch-up” after significant underperformance and a part of what we have called the everything rally.
(This is not a recommendation to buy or sell any security and is not investment advice. Please do your own due diligence).
4. The Other Defensive Value Sector…Utilities
Source: TradingView. Through year-to-date 2024.
We first began to monitor the ascent of Utilities in early April here.
At the time, we wrote “Utilities may be joining the “Everything Rally” that we’ve been highlighting.
It also may also simply be a recognition on the part of investors that AI is going to have significant power requirements that Utilities will aim to fulfill.
It also may be more complicated.”
Why would it be more complicated?
Because, similar to the Consumer Staples sector, equity investors often migrate to the Utilities Sector when they are sensing a slowdown.
While Utilities look like they could pause after their 3-week 15% move higher, we will watch to see where the sector goes from here and what it might mean.
(This is not a recommendation to buy or sell any security, please do your own research).
5. Where Does Uncertainty Express Itself…Gold
Source: TradingView. Through year-to-date 2024.
We showed a longer-term chat of Gold about 5 weeks ago (chart 3 here).
While we didn’t present a possible target level, in looking back at that pattern, it looks as if Gold could trade to $3000 / oz. at some point in the future.
The chart above of the Gold ETF (ticker: GLD) (the ETF price is approximately 1/10 that of the Gold price) shows a nearly perfectly resolved inverse “head and shoulders” pattern.
The reason I’m highlighting it is because of the velocity of the move higher from February 15 to April 15.
21% in two months for an asset that has no earnings, dividend, income are even much industrial use.
Was this China buying, inflation fear, an uncertainty hedge or a combination of all?
While we wouldn’t be surprised to see a pause after the aggressive move, the combination of Utilities, Consumer Staples and Gold all rallying says to us that investors have their antennae raised.
In other words, while we are optimistic that the S&P 500, Nasdaq 100 and Dow Industrials have reclaimed the north side of their respective 50-day moving averages, our excitement is tempered by the rally in defensive sectors and the uncertainty hedge (gold).
Have a great weekend.
(This is not a investment advice and is not recommendation to buy or sell any security).