Don’t Bet the Farm

By Pete Biebel, Senior Vice President, Senior Investment Strategist The stock market again reaped bountiful gains last week. The NASDAQ Composite Index (COMP) brought home the bacon with a gain of just over 2%. The S&P 500 Index (SPX) gained exactly half as much. But, where COMP wasn’t quite able to get back to the prior week’s high, SPX sprouted a new recovery high last Thursday. Communication Services led all S&P sectors with nearly a 5% gain for the week. More than half of that sector’s weight is in the stocks of two companies: Meta Platforms and Alphabet. Both companies reported earnings last week; shareholders were happy as pigs in mud as the stocks spiked higher following the news and also reached new recovery highs. Before plowing ahead, I want to briefly focus on some specific market action from last week. Last Thursday morning brought a bushel of positive economic news[1]. The major averages all gapped higher, and most of them reached new recovery highs. Unfortunately, those opening highs generated no follow-through buying, and the market faded through the morning. Then, around midday, the Bank of Japan unexpectedly increased the upper limit of the target rate on its 10-year bonds; announcing that 0.5% is now a “reference point” not a ceiling, and a rate as high as 1% could be tolerated. U.S. Treasury rates shot higher on the news and the downward skid of stock prices steepened. The major indices ended the day with big losses and at new lows for the week. A reversal of that significance, especially following new highs, was the most negative technical event in several weeks. The bulls could have had a cow; the market could have bought the farm, but all that was forgotten Friday morning when a benign Personal Consumption Expenditures report had the market rallying again in two shakes of a lamb’s tail. In recent weeks, the stock market has given the impression that it can rally ‘til the cows come home. Down days and losing weeks have become as scarce as hens’ teeth.  A few weeks ago, I wrote that whether the market could weather the several approaching storms in July, including inflation data, U.S. Federal Reserve meeting and earnings season would tell us a lot about its potential through the balance of the summer. So far, so good: None of those potential threats has cast a shadow over stocks and the market has been able to make hay while the sun shined. Every earnings season presents another opportunity to separate the wheat from the chaff. Now, several weeks into the new reporting season, companies representing nearly two-thirds of the S&P 500’s market capitalization have already released results. Again, so far, so good: The announcements have produced more than the typical percentage of better-than-expected results, and the decline in overall earnings has been smaller than had been anticipated. Where early in the year, the probability of the economy avoiding recession was the economic equivalent to finding a needle in a haystack, the odds have greatly improved over the past several months. The economy remains surprisingly healthy, even to the point where it may be able to weather any of the potential shocks on the horizon. In recent months, several additional factors have combined to encourage investors to go whole hog in the stock market:

• Market sentiment was probably overly cautious and leaning bearish following the banking issues in March.
• In late May, news from semiconductor companies on the development of artificial intelligence chips sparked a rush into anything AI. The new technology is seen as sowing the seeds for significant future gains in efficiency and productivity. The feeding frenzy that followed in a relative handful of mega-cap tech stocks rallied them enough to make it seem as though the overall market was doing great.
• The continuing decline in the rate of the inflation, with no sign of weakness in the labor market, has convinced many participants that a soft landing is a real possibility.
• Over the previous six to eight months, investors had ratcheted up their allocations to money funds and Treasury Bills and were probably under-allocated to equities. “Fear of Missing Out” took over and sideline cash chased the rally higher.

That FOMO buying seems to have been a significant factor in recent weeks. I don’t want to look a gift horse in the mouth, but one development that could threaten to kill the goose that lays the golden eggs is excessive optimism. A week ago, the American Association of Individual Investors bull/bear spread hit its highest (most bullish) level in more than two years. Such extreme bullishness has been a fairly reliable contrary indicator. It is now signaling that the market may have a hard row to hoe going forward. Given the extreme bullishness, the already extended valuations, the relatively high interest rates (that make higher valuation less likely); and with the Fed’s clearly “higher for longer” policy, investors might be well advised to harvest some gains. Perhaps the area that is most ripe for the picking is in some of the stretched-out stocks in the Technology, Communications Services and Consumer Discretionary sectors. For redeploying those funds, look for green shoots in some of the lagging sectors like Financials, Healthcare and Staples. SPX closed Friday at 4582, its highest weekly close in a year and a half and within about 5% of its all-time high. It may be beating a dead horse, but I expect the averages to trade flat to lower in the coming weeks as some sort of timeout phase is long overdue. SPX is currently nearly 19% above its 50-day moving average, so a pullback of even as much as 5% wouldn’t set off any alarms. The most significant economic data will come late in the week with the employment numbers: Initial Claims, Continuing Claims, Non-Farm Payrolls and the Unemployment Rate. The ADP Private Payrolls report will also come on Thursday morning. Last month, when ADP payrolls came in more than double expectations, stocks sold off. The headline names on the earnings calendar this week are Amazon.Com and Apple on Thursday. We’ll also hear from a variety of healthcare and pharmaceutical stocks through the week.

Economic Calendar (7/31/23 – 8/4/23)		Previous	Consensus
Monday 7/31/2023	Chicago PMI, July	41.5	43.5
	Dallas Fed Manufacturing Survey, July	-23.2	-22.5
Tuesday 8/1/2023	PMI Manufacturing Final, July		49.0
	ISM Manufacturing Index, July	46.0	46.5
	Construction Spending, June, M/M	+0.9%	+0.6%
	JOLTS – Job Openings, June	9.824mm	9.650mm
Wednesday 8/2/2023	ADP Employment Report, July, M/M	+497K	+185K
	Motor Vehicle Sales, July, SAAR	15.7mm	15.6mm
Thursday 8/3/2023	Initial Jobless Claims	221K	225K
	Continuing Claims	1,690K	1,723K
	Non-Farm Productivity, Q2, SAAR	-2.1%	+1.3%
	Unit Labor Costs, Q2, SAAR	+4.2%	+2.6%
	ISM Services Index, July	53.9	53.0
	Factory Orders, June, M/M	+0.3%	+1.7%
Friday 8/4/2023	Non-Farm Payrolls, July, M/M	+209K	+200K
	Unemployment Rate, July	3.6%	3.6%
	Average Hourly Earnings, July, Y/Y	+4.4%	+4.2%

  Links to previously published commentaries can be found at benjaminfedwards.com/Latest Investment Insights/Weekly Market Commentary/Market [1] Second-quarter GDP was estimated to have grown at a 2.4% annual rate; orders for durable goods in July increased 4.7% more than double the expected gain; and the number of both initial jobless claims and continuing claims decreased again.