Do you remember when big tech was the ONLY place to invest?
Let’s rewind to the days before half the world closed its doors. From the end of 2018 to the pre-pandemic peak, the S&P 500 Information Technology Sector rose 65%. The Communication Services Sector, which sported 20% weights to both Alphabet and Facebook, jumped 40%. The S&P 500 itself climbed 35%. Not a bad year for investors, right? So long as they had their money in the right place, that is.
Over that 13 month period, every other sector underperformed the index.
Every market historian knows that the bulk of historical index returns are generated by a handful of names (that’s why we focus so much on identifying relative strength). Rarely, though, has that phenomenon been so readily apparent as it was that year, when more than 80% of sectors lagged the index.
Stocks rebounded last week, rising more than 1%. The NASDAQ Composite continues to be the leader in 2023, up nearly 13% for the year. The Dow Jones Industrial Average, meanwhile, remains in negative territory. Interest rates fell modestly, and the US Dollar had its largest weekly decline since January. Oil prices rose 3.8%, offsetting some of the prior week’s 13% drop. Gold slipped 0.6%, and Bitcoin rose 1.9%.
The Federal Reserve raised its benchmark interest rate for the ninth consecutive meeting last Wednesday. The 0.25% hike was smaller than what most analysts expected prior to the failures of Silicon Valley Bank and Signature Bank, but turmoil in the financial sector was not enough to make the inflation-focused Fed keep rates unchanged. Notably, the FOMC statement, along with the quarterly Summary of Economic projections, implied that rate hikes will soon be in the rearview mirror. Markets are priced for more extreme reversal, including a series of rate cuts by year-end. Federal Reserve Chair Jerome Powell, however, reiterated at his post-meeting press conference that containing inflation was his top priority, and the Fed wouldn’t hesitate to reaccelerate the pace of policy tightening if needed.
Market Internals
Less than half of all S&P 500 stocks are in an uptrend, and that’s true whether you’re looking at them on short, intermediate, or long-term timeframes. Recent weakness has been most pronounced in cyclical sectors – Energy, Materials, Industrials, and Financials. Those sectors were the leaders in 2022. Now they’re the clear laggards.
Trends within the Information Technology sector are the healthiest. Nearly two-thirds of stocks in that sector are above their 100 and 200 day averages. And more than half are above short-term averages. Health Care, Consumer Staples, and Utilities all benefited from risk-off action within the last week.
What’s Ahead
Here’s the key economic data scheduled for this week.
I was talking to a financial advisor awhile back about their firm’s investing philosophy, and they told me they couldn’t imagine giving their clients a significant allocation towards gold. Over the long-term, they assured me, stocks will invariably generate better returns.
Ironically, that shiny yellow metal has outperformed stocks by a pretty handsome margin over the last twenty years, which is probably about when they started investing. In my book, twenty years is a long time.
Don’t get me wrong, for most of the last decade, gold has been a pretty terrible place to be. An investment in gold at its 2011 peak and held until today would have yielded a whopping 3.7% return. For those keeping score at home, that’s 0.31% per year. Yikes.
Over that same period, an investment in the S&P 500 returned 322% – more than 13% per year. Being a gold bug is equally as dangerous as casting the metal aside simply because you don’t believe in its fundamental merits. There’s a time and a place for everything in investing.
More and more, it’s starting to look like the time and place for precious metals has returned.
Price action was mixed last week, as markets digested the failures of Silicon Valley Bank and Signature Bank. The Dow Jones Industrial Average declined for the sixth time in seven weeks, dragged lower by cyclical sectors like financials, industrials, and energy. Both the S&P 500 and the NASDAQ, however, rebounded sharply, helped by their exposure to growth stocks. Crude oil dropped nearly 13%, falling to its lowest level in more than a year. Commodities not exposed to economic activity, though, rallied sharply. Gold rose 6.5%, and Bitcoin jumped by a third to its highest point since last June. Interest rates were volatile during the week, falling sharply on Thursday and Friday. The US Dollar Index declined 0.9%.
Investors will be watching closely this week, as they wait to see how Fed Chair Jerome Powell and his peers respond to recent turmoil in the banking industry. On Wednesday, the FOMC will decide whether or not to continue hiking interest rates in their battle against inflation. They’ll also release an update to the Summary of Economic Projections, which details members’ internal forecasts for future activity and policy actions. Just two weeks ago, it seemed another hike of 50 basis points was inevitable. Now, even a 0.25% increase is questionable. In any case, expect Powell to face some difficult questions at his post-decision press conference. It will be his first opportunity to publicly address bank failures.
Relatively Speaking
Information Technology and Communication Services are the only two sectors that managed to gain ground over the last month, as the S&P 500 index dropped 4%. Losses were led by Financials, which dropped more than 15%. Other economically sensitive sectors also lagged, as Energy, Real Estate, and Materials each underperformed the index.
Year-to-date performances are largely the same. Growth-focused sectors like Information Technology and Communication Services are outperforming the broader index, with each up by double-digits. Energy and Financials, thought, are each down by double-digits. It’s the inverse experience of 2022, when tech-like stocks led the market selloff.
What’s Ahead
Here’s the economic calendar for the week ahead. Market watchers will be most focused on the Federal Reserve interest rate decision, scheduled for Wednesday afternoon.
US large cap stocks erased their hot start to the year, declining more than 5% over the past month. The S&P 500 Index has dropped back below a falling 200-day average. The Dow Jones Industrial Average is down just 2.4% over the last year, but it’s been the laggard so far in 2023. The NASDAQ Composite, meanwhile, has been the best performing major index over the last month and quarter.
Bond prices continue have risen dramatically over the past week, after turbulence in the banking sector spooked investors. Still, the 10-Year Treasury note remains below a falling 200-day moving average – clear evidence that a downtrend still exists. While yields are down from their October peak, the threat of continued policy tightening by the Federal Reserve remains a risk for fixed income investors.
Were you able to keep up with everything that’s happened over the last week?
If you weren’t, don’t worry. In a year or two, you’ll be able to read all about it in a book that’s number one on the New York Times Bestseller list. And better yet, it’ll probably be riddled with insider accounts of how one of the largest bank failures in history came about.
The week seemed to begin like any other. The most interesting thing on the agenda was Fed Chair Jerome Powell’s semi-annual testimony in front of Congress – an occasion where he’d have the opportunity to adjust expectations for the upcoming FOMC meeting.
For his part, Powell lived up to the hype. In testimony before the Senate Banking Panel, he said that recent economic data would likely require a higher terminal Federal Funds Rate and could force the committee to reaccelerate the pace of interest rate hikes. Powell attempted to walk back those remarks somewhat on Wednesday when he appeared before the House, saying no decisions had been made about the upcoming FOMC meeting. But the damage was already done.
When the week began, the S&P 500 stood near 4050, 2-year Treasury yields were at 4.85%, and markets were pricing in a modest 0.25% hike at the March meeting. By the time Powell finished on Wednesday afternoon, though, stock prices were 2% below their Monday highs, that same 2-year Treasury yield was above 5% for the first time in more than 15 years, and a 50bps hike was fully baked in.
If the week had ended there, it might’ve been among the most eventful of the year. Instead, Powell’s words were a forgotten footnote just two days later.
On Wednesday evening, Silicon Valley Bank surprised investors by announcing plans to sell additional stock. They’d been forced to liquidate some holdings at a loss, and needed additional capital to fill the hole. By Friday morning, SVB was shut down and placed in FDIC receivership – the biggest bank failure since Washington Mutual in 2008.
The stock selloff that began in February has continued into March. Each the S&P 500 Index, the NASDAQ Composite, and the Dow Jones Industrial Average declined more than 4% last week. The S&P 500 is now up less than 1% on the year. The Dow, meanwhile, has fallen nearly 4%, while the NASDAQ is still up more than 6%. Crude oil dropped 3.8%, and Bitcoin fell 7.8%. Gold managed to shake off a weak Monday and Tuesday to end the week 0.6% higher, while the Dollar was mostly unchanged. Interest rates declined.
Any attempt to summarize last week’s market action will fail to do it justice. Things got off to a hot start, when Fed Chair Jerome Powell sat before the Senate Banking Panel and testified that recent economic data would likely require a higher terminal Federal Funds Rate and could force the committee to reaccelerate the pace of interest rate hikes. Financial markets responded in no uncertain terms – stock prices cratered, the Dollar index jumped to its highest level in 4 months, and short-term interest rates moved to new 15-year highs. Powell attempted to walk back those remarks somewhat on Wednesday when he appeared before the House, saying no decisions had been made about the upcoming FOMC meeting. All of that was overshadowed by what happened after the market closed. Silicon Valley Bank, one of the country’s largest regional banks, announced plans to raise capital on Wednesday evening. By Friday morning, the bank was placed into receivership with the FDIC. It’s the largest bank failure since 2008. Expect those 48 hours to be the basis of a collection of books.
Monitoring Macroeconomics
GDP grew at a healthy pace in the final quarter of 2022, helped by a surge in inventories and strong net exports. Economists widely believe that a recession will hit the United States sometime in the latter half of this year, as the Federal Reserve’s battle with inflation heats up and financial conditions tighten. The odds of a ‘soft landing’ – a scenario where the Fed successfully contains prices without creating widespread economic hardship – declined after February data showed the US economy continues to run hot.
Measures of inflation remain well above the Federal Reserve’s 2% target, but CPI has decelerated for 7 straight months, and measures of core price changes have dropped below 5%. Unemployment, meanwhile, remains near 50 year lows, and job creation to start 2023 has been well above the level needed to keep pace with population growth.
What’s Ahead
The SVB saga will continue to dominate the headlines on Monday, as investors grapple with the risk of contagion spreading across the financial system. On Tuesday, though, the narrative and focus could shift, when the BLS unveils its consumer price index for February. We’ll get additional inflation data on Wednesday with the producer price index, along with retail sales, business inventories, and the NAHB housing market index. On Thursday, look for updates on housing starts and import and export prices. The latest University of Michigan consumer sentiment survey results are scheduled for Friday, and so is industrial production. Additional business surveys are scattered throughout the week, including NFIB’s Small Business Optimism, the Philadelphia Fed’s Business Outlook, and the New York Fed’s Services activity.
The return of high-flying growth stocks has stolen the show this year.
The NASDAQ Composite, which lagged throughout all of 2022 and ended the year 35% from its all-time highs, has risen more than 11% in 2023. That far outpaces gains in the value-oriented Dow Jones Industrial Average (+0.7%) and the benchmark S&P 500 Index (+5.4).
Slipping under the radar, though, have been small cap stocks. They’ve quietly gained 9.8% to start the year, and that run of outperformance could continue. Compared to the S&P 500, the Russell 2000 bottomed last May.
It’s been all higher highs and higher lows since then.
Last year’s back half outperformance was largely attributable to differences in sector weights. The Russell 2000 has more exposure to Financials, Health Care, Industrials, and Energy, (all areas that outperformed) and is underweight Communication Services and Tech (sectors that lagged).
But that isn’t the story this year. On a like-for-like basis, small caps have simply been better.
Stock prices rose last week on the back of continued leadership from the NASDAQ Composite, which climbed 2.6% to push its year-to-date gains to 11.7%. The S&P 500 Index rose 1.9%, and the Dow Jones Industrial Average, which has lagged so far in 2023, rose 1.75%. Crude oil volatility continued, as it jumped 4.4%. For the year, it’s relatively unchanged. Gold rose into positive territory for the year, while Bitcoin dropped 5.4%. Interest rates rose, and the US Dollar Index declined.
Layoff announcements have filled the newswires of late, but that hasn’t seemed to dampen the US labor market. In fact, jobs growth during January surged to more than 500,000, the highest level in six months. We’ll see whether that strength continued in February. The Bureau of Labor Statistics will release their latest payrolls data on Friday, where investors will be watching for signs that the Federal Reserve’s war on inflation is starting to take effect. Another strong report would likely raise the odds of a 0.50% hike at the Fed’s March meeting. Today, markets are pricing in expectations of a more mild quarter-point hike instead.
Earnings Expectations and Valuation
The equity selloff in 2022 was not driven by a deterioration in corporate earnings. Though stock prices dropped well over 20% from their peak to trough, expected future earnings remained stubbornly high. That divergence pushed the S&P 500 forward price-to-earnings ratio from more than 20x (a level previously seen only during the late-1990s) to 15x (a level in-line with historical averages).
So far, 2023 has been the opposite experience: stock prices are rising, but earnings are not. In fact, consensus expectations for future earnings are falling. At the beginning of the year, analysts expected 7% EPS growth in 2023. Now they expect earnings to decline. The result is that valuations are elevated once again. The S&P 500 currently trades at a forward multiple of more than 18x.
What’s Ahead
The labor market will be in focus this week, with the BLS announcing February jobs data on Friday. ADP’s estimate of jobs growth arrives on Wednesday morning before the opening bell, followed by January job openings a few hours later. The final estimate for January durable goods orders is released on Monday morning. On Tuesday and Wednesday, Fed Chair Jerome Powell will have ample opportunity to reshape expectations for the upcoming FOMC meeting, when he testifies in front of the Senate Banking Panel and the House Financial Services Committee.
February lived up to its reputation as one of the worst months of the year. Since the inception of the S&P 500 Index in 1950, stocks have averaged a negative return during the month. Only September has a worse track record. This year, stocks followed their seasonal pattern, as the S&P 500 dropped 2.6%, the Dow Jones Industrial Average fell 4.2%, and the NASDAQ Composite fell just more than 1%. Let’s take a look at how things are shaping up for March.
US Equities
Each month, we start our journey from the top, looking at the market from 30,000 feet up and focusing only on the biggest indexes. In just a handful of charts, we can see exactly the type of investment environment we’re in. Are stock prices rising or are they falling? Should we be erring on the side of buying or selling stocks?
Last month, our view was that stocks had made significant progress toward ending the bear market that began in 2022. Here’s how we put it:
We aren’t out of the woods yet, but we think we see the light at the edge of the forest.
The beauty of technical analysis is that prices offer us clear risk levels – we know exactly where we’re right and where we’re wrong. We entered the month with a clear view of what we needed to keep an eye on:
Small Caps are the ones to watch. With the last few days of gains, the Russell 2000 is above its own key area of resistance. That’s a good sign – small caps were the first to find a bottom last year and could very well lead us higher in 2023. But if IWM is back below 190, expect the rest of the major US indexes to be failing, too.
Well, the IWM fell back below 190. And the rest of the major indexes fell, too.
(Editor’s note: If you’re having trouble seeing any chart in this report, click on it to view a larger version)
We still aren’t out of the woods.
For months, we’ve been talking about resistance near 4100 for the S&P 500. That was our line in the sand – if prices were above that, we wanted to be buying stocks. If they weren’t, we believed a cautious approach was more appropriate.
Nothing changed during February. Stocks failed once again at 4100, and the bears still have the upper hand.
It’s the exact same situation for the NASDAQ. The level here is 12000.
These aren’t just numbers we’re pulling out of a hat. 12000 is the 161.8% Fibonacci retracement from the entire COVID selloff. The market respects these Fib levels, so we do, too.
But it’s not just weird rabbit math that has us watching that level. It’s also where growth stocks peaked relative to value. In September 2020, growth stocks ended a near 15-year run of outperformance. The NASDAQ, which is dominated by those same growth names, is paying attention.
There’s no reason to be aggressively buying stocks as long as we’re below those key levels. We know exactly where we want to be more bullish. So what would it take for us to shift from neutral to outright bearish on US stocks?
We’d need to see more indexes acting like the Dow.
The Dow Jones Industrial Average did more than just fail at overhead supply during February: it ended the month by breaking its December lows. This chart is the biggest threat to the bull case for stocks. If the index that’s been the leader for more than a year is now setting new lows, how can we be buying stocks?
The Dow needs to get back above 33000 in a hurry. If it does, that failed breakdown could be the catalyst that sends prices through that tough overhead resistance near 34500. The longer we’re below 33000, though, the more likely it is that stock prices overall will retest their October lows.
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