You Spin Me Right Round...
The rotation from the Nasdaq 100, Growth, Tech, Magnificent 7 to the "real economy" Equal Weight S&P 500, Value, Small Caps has gained momentum. Will it continue? Let's dig in...
After a week of vacation, I am approaching the the last five months of the market with fresh eyes.
That said, in looking back over what I’ve written since the start of the year and particularly over the past month, I believe that I’ve been able to highlight some important and timely themes.
We asked “will investors begin to question AI spending?” (here and here) near the recent Mag 7 peak and we presented accurate price objectives for the S&P 500 (here and chart 1 below) and the Nasdaq 100 (chart 1 here and here).
As we look out over the next five months, our focus will be on:
Will the rotation from the Magnificent 7 to the “other 493” continue? (see here and here and charts 2 and 3 below).
Will the Treasury continue to provide “stealth liquidity”? (see here, here, here, chart 4 here and here). We believe that the “stealth liquidity” that has supported US equity valuations over the past 16 months and may be required for further upside.
Treasury yields - will rate cuts, slowing growth and falling inflation expectations lead 10-Year US Treasury yields lower or will the US debt outstanding and financing needs push them higher?
Earnings and earnings growth? Will the S&P 500 be able to achieve 17% earnings growth in Q4 and 15% in 2025? Will it matter or will analysts simply continue to push higher estimates into the future (see chart 3 here and here).
The Fed - we will see how today’s statement is priced in. (see chart 2 here as a current baseline).
If there are topics or themes that are unaccounted for, of course we will do our best to identify and highlight them.
1. The S&P 500 ETF Reversed at Our Target. What’s Next?
Source: Trading View. Through year-to-date 2024.
The chart above shows the S&P 500 ETF (ticker: SPY).
We last showed this chart over two months ago (here).
At the time, we highlighted our 5500 year-end expectation on the S&P 500 (550 on the SPY) with upside to 5600 and a possible “melt up” to 5800.
What has happened is the ETF went exactly to its 1.618 Fibonacci extension of its January 2022 to October 2022 sell-off at 560 and has now reversed.
The ETF (and the index) is now sitting on a shelf (the dashed blue line) at around 541.
In our view, if the ETF falls below this level, the next target lower would be around 525 (5250 on the index).
However, it should be noted that “underneath the surface” conditions are improving.
While the sell-off in the Magnificent 7 has been dragging the ETF (and the Index) lower, several stocks have been improving.
We see this both in the number of shares advancing vs. declining and the percentage of S&P 500 companies trading above their 200-day moving averages (improving).
In other words, while we were concerned about the lack of breadth as the S&P 500 moved higher, as it has sold off, breadth (or positive participation) has actually improved.
Finally, when we last showed this chart, we wrote:
“Despite the fact that we continue to see higher US equities in 2024, we believe 2025 will be a very difficult year.
This view is predicated on our belief (highlighted here), that the Fed and Treasury have provided stealth liquidity that will sustain through the election.
We believe equities can likely run on seasonality and “animal spirits” through the end of the year, but the check will come due in 2025. We’ll see...”
As we look out, we continue to be concerned about the combination of slowing economic growth and earnings expectations in a period of above average earnings.
But the real question for us is whether this rotation from mega-cap growth shares (the Magnificent 7) to the other 493 is a longer-term trend or a simple near-term correction after the outperformance in the Magnificent 7 became too pronounced. (See charts 2 and 3 below).
(This is not a recommendation to buy or sell any security and is not investment advice. Please do your own research and due diligence).
2. This Rotation Has Become Serious
Source: Trading View. Through year-to-date 2024.
The chart above shows the Nasdaq 100 relative to the Equal Weight S&P 500. We showed this chart here and here.
In our view, this relationship is a great way to capture the overall market character and what types of shares investors are favoring.
With the increased expectation that the Fed easing cycle is nearly here, the US equity market has rotated away from the Magnificent 7 (Nasdaq 100) and into the “real economy” (the Equal Weight S&P 500).
The view that is being priced in is that the Fed rate cut cycle will lead to a soft landing (in other words, no recession).
While that view would argue for the trend of Nasdaq 100 under-performance to continue for a longer period, it is also possible that the Nasdaq 100 outperformance over the average stock simply became to extreme and that the current move is a temporary rotation.
When we look at the chart, all of the outperformance of the Nasdaq 100 over the Equal Weight S&P 500 from April to July has been erased.
With the relationship back where it was in February, we need to see if that was “enough” or if there is further to go.
If there is further to go, the 2021 to 2023 ceiling of the relationship could be tested.
As noted on the chart, that ceiling was breached with the emergence of the AI theme (Nvidia’s May 2023 earnings).
A drop back below that ceiling would perhaps be a recognition by investors that AI spending with no clear path to profitability went too far (a topic we covered here and here).
(Past performance is not indicative of further results. This is not a recommendation to buy or sell any security and is not investment advice. Please do your own due diligence).
3. Maybe the Current Rotation is this Simple to Explain
Source: Trading View. Through year-to-date 2024.
The chart above shows the Technology sector relative to S&P 500 over the past 25 years.
We last showed this as chart 3 here.
While we recognize that not all of the Magnificent 7 shares or the Nasdaq 100 are in the Technology sector, this chart may be a key guide to the Nasdaq 100 to Equal Weight S&P 500 rotation.
It is easy to see that the relationship between the Technology sector and S&P 500 hit its March 2000 high in January 2024 and again this month. Both times it quickly reversed (technology began to underperform).
While the battle with the March 2000 highs will be an important one to watch, in our view, at some point, this relationship will make a new high (Technology should continue to outperform over time) and we want to participate when it does.
(Past performance is not indicative of future results. This is not a recommendation to buy or sell any security and is not investment advice. Please do your own due diligence).
4. The Bank Index May Be at a Good Place to Pause
Source: Trading View. Through year-to-date 2024.
The chart above shows the Bank Index, a sub-industry of the Financial Sector.
After hitting its post-regional banking crisis low in May 2023, the bank index rallied only to revisit the low in October.
From October 2023 to January 2024 (the double horizontal line in the middle of the chart), the Bank Index rallied 37%.
After a 3-month pause at the 2022 floor, in late March 2024, the Bank Index was once again able to move back up to its 2022 trading zone (between the double horizontal lines and the top horizontal line).
The Index “tested” that floor a few times before taking off in June for a 16.5% one-month move.
Now the Index finds itself at its August 2022 / February 2023 ceiling, and we expect at least a pause.
(Past performance is not indicative of future results. This is not a recommendation to buy or sell any security and is not investment advice. Please do your own due diligence).
5. Monthly Performance for the Last 10 Years
Source: Carson Investment Research / Ryan Detrick. Through year-to-date 2024.
The good news is that the S&P 500 during July was consistent with its recent history.
It has closed higher for the month for the 10th straight year and will have closed higher for 12 of the last 13 years.
However, if August and September are consistent with their character from the last 10 years, there may be a challenging two months ahead.
This would be somewhat aligned with the revised election year seasonality chart that we showed as chart 5 here.
(Past performance is not indicative of future results. This is not a recommendation to buy or sell any security, please do your own research).