Good is good ... is good?

Do you fear you’ve missed out? Chasing the Fed pivot has garnered a notable momentum trade—quality, size and beta have all traded in tandem with rates over the last 6+ months. Indeed, the goings-on in the 10-year Treasury bond yield explained two-thirds of stock returns in 2023. Empirical Research analyzed periods when bonds explained at least 60% of returns, going back to the mid-1950s. The following year’s returns were nearly universally positive, with an average return in the mid-teens. Nice odds! Further, the stocks which most benefited were value and small caps. If so, it’s high time—small caps are currently even more out of favor than during the dotcom bubble of the late 1990s. Could the AI-driven tech rally continue? Yes! Sentiment may be bullish these days, but it hasn’t reached the level of euphoria associated with peaks. Indeed, strategists in January lowered their equity allocations. At the peak of the tech bubble, the Nasdaq reached a P/E well above 100; it’s at 27 today. It was only when tech spending declined in the face of recession that the bubble burst, and recession worries have been put to bed after last week’s jobs report. As for inflation, the Atlanta Fed’s wage growth tracker indicates moderation from the elevated levels seen recently. That may be one reason why the Fed seems unfazed by the robust January jobs data.

Do you fear the narrow market? Strategas observes that when, historically, the market was up 13 out of 14 weeks, as is the case now, it was long-term bullish but did signal a near-term consolidation. Also prompting near-term concern, stocks and volatility have been rising together—a rare occurrence. The two times it happened this century (2018 and 2020) both led to market corrections. In such a fevered environment, stocks are being rewarded extravagantly for beating expectations and punished severely for disappointing. Not good. And the nagging problem of breadth—Leuthold notes a mere 26% of S&P 500 stocks outperformed the index in the 12 months ending January 31. Thus, the equal-weighted S&P 500 underperformed the main index by fully 23% over the past year. Leuthold adds that this year’s Russell 2000 underperformance vs. the S&P 500 is the most ever for the first 24 trading days of the year. Bad breadth! Although the S&P 500 is at all-time highs, 52-week lows outnumbered highs. This can’t be good?! Perhaps we are seeing green shoots of broadening, though, with the equal-weighted S&P 500 at its highest level in nearly two years and the MSCI World making new all-time highs. Fundstrat is of the view that the tech rally is bullish (likely consolidation notwithstanding) and that breadth can come in due course. Tech and industrials are at all-time highs, but most sectors are not even close, with many still well below 2022 levels (not to mention energy, which is a decade removed from its all-time high). Last week, outflows from equities rose to their highest levels since 2014, a sign that institutions were taking profits from Magnificent Seven stocks even without prompting due to technical weakness.

Good is Good. After a long stretch of good news is bad news (and of bad news is good news), the market seems to be focusing on fundamentals and the profit-generating implications of the economy’s resilience, rather than looking only at the Fed’s response. The job market serves to undergird the economy, as an emboldened consumer spends money. Consumer debt remains manageable, both in terms of debt-to-income and the debt/service ratio. If the consumer and the market feed off each other, we may continue to defer Fed rate cut expectations, and so what? Gavekal reminds us that current short and long-term rates are modest by historical standards, particularly in light of wage growth or expected corporate earnings. If the Fed stands pat in March, it will be their second-longest pause. As Fundstrat points out, markets like such environments. Pauses longer than 100 days have been associated with an average 13% stock market gain. The longest Fed pause, that of 2006-2007, spurred a 22% gain. BCA Research notes that the U.S. has continued to outperform global markets and that tech and the American economy’s overall resilience should help that outperformance continue through this business cycle. In the end, it is profits, not Fed cuts, that move markets higher. It’s good now that, finally, good is good—isn’t it?

Positives

Good news could become bad news The ISM services PMI rose more than expected in January. New orders rose and remained in expansionary territory for the thirteenth straight month. Unfortunately, the Prices Paid Index rose substantially, with 15 of 16 industries reporting that prices paid have gone up.

Tight but less so The Fed’s senior loan officer survey showed a notable lessening of the share of banks continuing to tighten lending standards. This metric tends to lead economic activity historically. Still, demand from households and businesses remains weak.

Another reason the Fed was unfazed Last week’s jobs report showed total hours worked down 0.9% from a year ago while new jobs were up a mere 0.3%. These are not the sorts of numbers seen at the peak of any of the last dozen business cycles, but they also appear to be distorted by January weather, which depressed the hours worked.

Negatives

What is R* if even the Fed doesn’t know? A debate is emerging within the Fed as to just how restrictive the central bank’s rates really are. While Minneapolis Fed President Kashkari argued recently that robust growth is a sign that rates are not very restrictive, FOMC Chair Powell in his remarks at the January press conference maintained that current Fed policy is indeed quite restrictive.

Young and in debt The New York Fed’s Quarterly Report on Household Debt and Credit showed that that the overall rate of new delinquencies (30+ days) is 3.6%, below the 4.7% rate seen in December 2019. Some are faring worse than others, however, as people aged 18-39 are moving into serious credit card delinquency at rates beyond that seen in late 2019.  

Far fewer “Made in China” labels The trade deficit rose to $62.2 billion in December, in-line with estimates. Notably, however, the trade deficit fell by 18.7% on the year, the biggest decline since 2009, while the goods deficit with China fell 27% to $279.4 billion, the lowest since 2010.

What Else

“Big immigration” Strategas posits that recent waves of immigration may be contributing to strong economic growth and weaker inflation in the U.S. This may partly account for the U.S.’s outperformance relative to other countries—and given the ageing Boomer generation, it may help meet a long-term need.

Six trillion on the sidelines Since the mid-1990s, money market funds have grown when fed funds are in the 4.5-6% range. It’s likely that the rate would need to come down towards 3% before competitive yields elsewhere induced a rush out of cash.

The rise of India The IMF reports that India enjoyed the highest GDP growth rate of any major country last year (6.7%), outpacing a China (5.2%) whose reputation and reliability have been rocked by COVID and the war in Ukraine. India’s GDP dominance looks set to continue this year, and the country may become the world’s third-largest economy as soon as 2027.