Peaceful Easy Feeling

Jun 5, 2023

By Pete Biebel, Senior Vice President
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Everybody’s happy. With news of a debt ceiling compromise and bullish employment data, traders were suddenly eager for action, hot for the game. The stock market soared like an eagle last Thursday and Friday. The three major averages ended the week with net gains of about 2%. The S&P 500 Index (SPX), which had repeatedly struggled to clear the 4200 level, rocketed from just below 4180 to a bit above 4280 over those two days. That’s the highest closing level for SPX in more than a year. The NASDAQ Composite Index (COMP) and its even more tech-heavy cousin, the NASDAQ 100 Index (QQQ) were already gone; they had been printing new highs for the year for the past few weeks. It was the sort of rally that could turn the most pessimistic bear into a desperado.

With many analysts and investors expecting a recession and declining earnings, the recent stock market surge has them questioning their outlook. Is this market performance confirmation that a new bull market is underway? Or is this the last gasp of strength before the bear market resumes? This could be heaven, or this could be hell. Is it time to take it easy or time to lighten up while you still can?

Despite the new year-to-date highs in SPX and COMP, there are still plenty of reasons to be suspicious of the rally. One big reason is the lack of breadth in the rally. The gains in SPX and COMP have been concentrated in a relative handful of mega-cap tech stocks. While those indices are up about 11.5% and 26.5%, respectively YTD, the less-tech-heavy Dow Jones Industrial Average (DJIA) and the Equal-Weight S&P 500 have nets gains of less than 2%. Both indices are trading well below their January/February highs.

That disparity in performance is also evident on a sector level. The three sectors that include those mega-cap stocks have chalked-up impressive YTD gains: Technology, +34.1%; Communication Services +32.6%; and Consumer Discretionary, +21.6%. Only two other sectors have net gains for the year though those gains are relatively meager: Industrials +2.4% and Materials, +1.2%. The other six of the eleven industrial sectors are all showing negative returns YTD, from -0.3% in Real Estate to -8.7% in Energy.

One factor that has greatly contributed to the concentration in leadership is the new kid in town: Artificial intelligence. Since the announcement of the program Chat GPT, there’s been an insatiable appetite to gobble up shares in companies that could be the greatest beneficiaries of artificial intelligence and machine learning. Stock prices of some of the largest players in semiconductors, software and search engines (i.e., mega-cap tech stocks) have gained the most. The rush into AI stocks has reminded many of how the market went gaga over internet companies about 24 years ago. Some market professionals are of the opinion that the AI frenzy has already gone too far.

Another reason to be suspicious of the market’s recent strength is that virtually all of the gains are due to expanding valuation multiples. In other words, traders have been willing to pay more and more for the leading stocks even though their revenues and earnings are not increasing substantially. That’s not unusual in an environment with relatively low and declining interest rates, but with the current level of interest rates, we shouldn’t expect to see price/earnings and/or price-to-sales ratios expand much further.

With regard to interest rates: The debt ceiling and employment news late last week greatly increased the odds that the Fed would pause its “take-it-to-the-limit” interest rate policy at its June meeting. The probability of another 25-basis point hike had been creeping higher in recent weeks. That shift to a lower probability in response to the news late last week contributed to the stock market’s late week rally. But the debt ceiling news may be a negative for stock prices going forward. The reason is that the U.S. Treasury has been injecting liquidity into the system by running down its cash balance since early this year when it first hit the old debt ceiling. With the suspension of the debt ceiling, Treasury will be issuing hundreds of billions of dollars in Treasury securities to restore its reserves. That’s likely going to be a headwind for both stock and bond prices.

A Wall Street Journal article over the weekend was headlined “Wall Street Turns Most Bearish on S&P 500 since 2007.” In addition to providing some statistics on the concentration of leadership in recent months, the article described how short interest in S&P futures contracts held by hedge funds has been increasing steadily this year. The same article also reported that much of the highest short interest in individual stocks is in some of the big tech stocks that have been leading the market higher. I guess every form of refuge has its price,

SPX ended last week near 4282, almost exactly 1% below its August rebound high. However, that index is approaching overbought status; COMP and QQQ are already overbought. That suggests that we shouldn’t expect much additional upside immediately. One factor to watch over the next week or two will be the degree to which the averages retrace their recent gains. A nice quiet timeout phase that doesn’t take SPX much below the 4150 – 4200 range would be the best set-up for additional gains through early summer.

This week’s economic report calendar promises nothing likely to disrupt the peaceful, easy feeling.

Date Report Previous Consensus
Monday 6/5/2023 PMI Composite, May 54.5
Factory Orders, April, M/M +0.9% +0.8%
ISM Services Index, May 51.9 52.0
Tuesday 6/6/2023 No Reports Scheduled +0.4% +0.4%
Wednesday 6/7/2023 International Trade, Trade Deficit, April $64.2B $75.4B
Consumer Credit, April, M/M +$26.5B +$21.0B
Thursday 6/8/2023 Initial Jobless Claims 232K 240K
Continuing Claims 1,428K
Friday 6/9/2023 No Reports Scheduled


Links to previously published commentaries can be found at Investment Insights/Weekly Market Commentary/Market