Trademark Financial Market Update – March 2, 2023
I am inclined to see the stock market as a tug of war between bullish (upward) and bearish (downward) impulses. During a bull market, the upward impulses drive us to new highs whereas the downward ones always fizzle out at a level higher than the previous downward impulse. In a bear market, just the opposite would be true. Today we are in neither. December’s failure to generate a lower low followed by January’s surge above November’s high suggests that at least for the time being the bear market is over. That said, one modestly higher high and one modestly higher low does not scream trend change. If the mid-August high around 4315 were to be broken through, then I believe we can talk about being in a bull market again.
At the very least, every impulse needs to fulfill a minimum objective or else it becomes suspect. The recent downturn took us under 4000 on the S&P 500 and under its 50-day moving average, so even though we’re less than 5% off of highs so far, it does not count as a failed breakdown (which would have bullish implications). That said, it has failed to meaningfully reverse the very sharp outperformance of growth over value in January which itself has bullish implications. Thus, while the balance of technical indicators are neutral right now, I’d lean to the bullish side.
Changing over to the fundamental side, I am less optimistic. The yield curve is inverted and becoming more so, and the trend of interest rates is higher. In an environment where the supply of goods and labor is more constrained than it was in the 2010s, and demand is greater, it is difficult to believe that consumer prices will both fall and stay at lower levels absent a full-blown recession (which I don’t see right now). Earnings are estimated to have fallen -4% year over year (the bulk of 4th quarter reports are already in). If estimated 2023 earnings are in the $215 range, today’s S&P 500 at 3985 implies a P/E of 18.5 – historically rich for a 4%+ inflation environment. Let’s put fundamentals and valuation in the mildly bearish camp.
If there were a sector I expected to do well in this environment it would be financial services – more specifically, banks. Their cost of deposits is low as savers are still generally willing to accept fairly meagre rates while they (banks) can turn around and receive much higher rates lending it out. In order not to like banks you would have to believe this unusually large funding spread is going to be offset by pending large loan losses, and I just don’t see that. What the market does think it wants today is semi-conductors. Partially due to AI, and partially due to the idea that the current drop in chip demand (relative to supply) won’t last, this area has done very well (19%) this year. Consider me a skeptic, because in my view those stocks have run too far ahead of fundamentals.
I am also surprised at how much investors seem to hate “risk-off” industries like utilities and health care so far this year. Higher interest rates are a headwind for utilities because it increases the cost of their debt and it makes their dividends less valuable, but to offset these costs they will likely ask regulators if they can charge customers higher rates and receive this request. Although investors have thus far punished managed care and pharma stocks, I don’t see a bear case for them that would result in continued underperformance.
Lastly, I feel ambivalent about foreign stock and bonds right now. They had a very good 4 month move due to the weaker dollar but as the dollar has firmed up this month, foreign outperformance has stalled. Not reversed, just stalled. Europe is still doing slightly better than the U.S., but Asia has been underwhelming. Too much in the latter area depends on guessing what China is going to do.
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