Houston, We Have a Parabola

By Pete Biebel, Senior Vice President, Senior Investment Strategist
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Coming into the end of the previous week, the trajectories of the major market averages had steepened to the point that they were near-parabolic. A Fed rate hike pause, along with favorable economic data on inflation and employment, enabled the market to escape the gravitational pull of the threat of a recession. The NASDAQ Composite Index (COMP) had rocketed higher by more than 11% in the previous five weeks. The S&P 500 Index (SPX) was up nearly 7%. The Technology sector soared nearly 15% higher in that same period. The popular averages had all hurtled into overbought conditions.

Not so coincidentally, the overall mood among investors had also gotten much rosier. In increasing numbers, they seemingly looked to the heavens and chanted, “To infinity and beyond.” For more than 35 years, The American Association of Individual Investors has published a weekly update on the bullishness and bearishness of investors. As of Thursday, June 15, the bull/bear spread had climbed to its highest (most optimistic) level in more than a year-and-a-half. Extreme levels of investor bullishness or bearishness are reliable contrary indicators. The survey indicates that investors are now more bullish than they were at the other two recent peaks in that indicator: The February rebound high (which preceded a near 100% retracement of the December/January rally) and at the August 2022 rebound high (which was followed by an eight-week downtrend to new lows for the year).

So, coming into last week, there were several blips on the radar indicating that the market’s flight had reached, at least temporarily, an apogee. In light of the averages’ stratospheric rise, the overbought condition and the excessive optimism, some sort of timeout, at a minimum, was likely. And that timeout essentially began on the Friday of the previous week when the market averages all registered losses for the day after printing new rally highs that morning.

That selling pressure continued through the four sessions last week. Each morning suffered a gap-down opening and each successive morning chalked up a new low for the week. It’s worth noting that despite the weak openings, most indices survived the balance of their sessions without making a lower low on the day. It was action typical of a market that was just catching its breath as opposed to a rush for the exits.

In the holiday-shortened week, the major averages all lost something between 1.25% and 1.75%. Again, not exactly a rush for the exits. All eleven S&P industry sectors had losses for the week. They ranged from a mere 0.2% loss in Healthcare to losses of between 4% and 5% in Energy and Real Estate. The losses in Energy were across the sector though the companies that focus on exploration and production had the largest losses.

The Real Estate sector is comprised primarily of REITs, or Real Estate Investment Trusts. All the REITs in the sector had losses last week. But where concerns over declining office occupancy had already compelled many investors to vacate the office REITs, a new threat arose out of the debt ceiling hijinks. With the passage of the debt ceiling legislation, the moratorium on paying student loans will expire in a couple months. Because many of the occupants of higher-end rental properties are also the same demographic that has outstanding student loans, there is now an increased potential for defaults and late payments. That new fear was evident last week as many residential REITs were among the hardest hit.

Another development last week that comes under the “Things to Watch” heading is widening credit spreads. With the debt ceiling behind us, with relative comfort regarding the Fed’s future intentions, and with the new earnings season a few weeks away, the market’s biggest current fear seems to be the potential for a credit crunch. Indications of widening credit spreads would signal that that fear is increasing. Last week, even though Treasury note prices across the board were generally firmer, prices on junk bonds and direct loans were lower. So, at least last week, credit spreads expanded.

SPX ended last week near 4366, about 1½% below last week’s high. As long as the index doesn’t fall much below the mid-4200s the mission to higher rebound highs would stay on course. Four months ago, in my article “Take a Peak,” I wrote, “… I believe there’s a good chance that the 2/2/23 high may have been the market’s high for many months if not for the year.” It turns out that the early-February peak was the SPX high for many months, though clearly not the high for the year. The same is true for COMP. However, the early-February highs on DJIA, the New York Stock Exchange Composite Index and the Russell 2000 Index, at least to date, remain their highs for the year. If SPX can climb a mere 2% or so from Friday’s close, it will exceed last week’s high and will likely launch a wave of capitulation from even the staunchest bears.

In the midst of its May/June rally, SPX left a gap in the 4230 area. I suspect that’s the low limit of the levels to which SPX could slip in the coming weeks and still retain a strong possibility of a higher rebound high. However, if SPX sees sustained trading below the 4200 level, then last week’s highs on SPX and COMP could well turn out to be their highs for the year.

This week’s rather lengthy economic report calendar could provide plenty of fireworks. Though most of the reports are relative duds, there are several that could spark a market reaction. The Durable Goods data on Tuesday could fizzle if the numbers come in as expected, but a big miss one way or the other might produce some oohs and aahs. The unemployment numbers on Thursday morning are always prospective catalysts. The most potentially explosive data comes Friday morning in the form of the PCE inflation data, which is reported along with Personal Spending and Personal Income. Another bit of pyrotechnics comes midweek when the Fed will release the results of its most recent round of bank stress tests. While not a big deal for the overall market, for the banking sector in general and individual bank stocks in particular, it could prove to be their big bang.

Links to previously published commentaries can be found at benjaminfedwards.com/Latest Investment Insights/Weekly Market Commentary/Market