@theMarket: Melt-up in Markets Fueled by Momentum
Stocks are climbing, scaling new heights while euphoria abounds. Momentum is pushing the technology sector, and AI stocks in particular. How long can it last and how high can it go?
It is the question on the minds of many on Wall Street. At this point, the consensus opinion is that we are due for a pullback. Even the bulls are getting worried as valuations become stretched.
However, valuations are in the eye of the beholder. While the price-earnings ratio of the market is about 21 percent, if you remove a handful of mega-cap stocks the average is only 17 times earnings. That handful of stocks has accounted for more than 50 percent of the gains this year in the S&P 500 Index. The Magnificent 7 (Meta, Apple, Amazon, Alphabet, Microsoft, Nvidia, and Tesla) have long held leadership positions within the equity market. Recently, however, a few additional stocks have joined this pack of champions.
The "AI 5" (Nvidia, Microsoft, Advanced Micro Devices, Taiwan Semi-Conductor Manufacturing, and Broadcom) are companies that Wall Street analysts believe are leaders in the development of artificial intelligence. All but one (Microsoft) are semiconductor stocks. Momentum in these stocks as well as most of the Mag 7 stocks is through the roof. The last time we saw momentum at this level was in November 2021.
Market momentum, for those who are not aware, is the capacity for a price trend in a stock, stocks, or markets to continue and sustain itself (either higher or lower). As the AI movement picked up steam this year, for example, prices rose, traders jumped on the bandwagon, volume increased, prices climbed even higher, and more and more buyers piled into this group of stocks. A herding mentality has taken over and the chase is on!
There are plenty of money managers and traders who make a living buying and selling momentum. The idea is to buy the asset when it is rising and then sell after it has peaked in price. Don't be fooled; this is a dicey business. It is a trading maneuver that relies on a greater fool theory and has nothing to do with the fundamental value of the underlying security.
In today's market, many investors are marveling at how high prices Microsoft Nvidia or any of the other Mag 7 and AI 5 stocks have reached. The same momentum trend helps explain why the stock markets, and particularly the technology sector, are pushing higher and higher. There is nothing new in this behavior. It has happened many times in the history of the stock market.
What happens next? At some point, the trend of chasing these stocks peters out. Momentum traders will usually be alerted by technical and computer programs that it is time to reverse positions. The highflyers will be sold and/or shorted. Those unfortunates that purchased at the peak will be left holding the bag.
Unfortunately, given that the market capitalization of these stocks is in the vicinity of several trillion dollars, the impact on the overall market will be quite large. It is one of the reasons that I believe the coming pullback in stocks could be between 7-10 percent. That may sound like a lot, but it would only be a normal correction in the history of the S&P 500 Index.
But before you rush out to sell everything, let me caution that no one knows how far the momentum game can carry stocks. This week we hit 5,000 and beyond on the S&P 500. That is a nice round number but has little significance otherwise. Given the right circumstances, we could see 5,150 or even higher in the weeks ahead. What I wouldn't do is add more money to the Mag 7 or AI 5.
@theMarket: Jobs Jump But the Fed Disappoints
It was one of those weeks. A gauntlet of data had investors working overtime to figure out where stocks and the economy were going. At the same time, the Fed told investors that a March rate cut was off the table. And then the job data was announced.
The non-farm payroll report for January came in at almost double market expectations. Economists were expecting 185,000 gains, but the U.S. economy created 353,999 jobs. That was a blowout number that had traders torn between selling the market (because of the inflation implications) or buying it due to what it might say about future growth.
Strength in the job market and wages would mean the Fed will delay cutting interest rates while further growth in the economy could be good for future earnings. The Wednesday FOMC meeting illustrated that dilemma and what the Fed planned to do about it. In one word — nothing — no rate hikes, and no rate cuts either. The outcome was a disappointment.
I thought Fed Chairman Jerome Powell did a good job explaining the present state of the economy and the reasons the Federal Reserve wants to wait a little longer to ease monetary policy. He expects the economy to continue to grow and at the same time the progress toward reducing inflation will continue. The Fed has been watching the labor market for signs of weakness but slowing wage growth is more important than the number of unemployed workers. Given the huge gain last month in the payroll data, his decision to wait for the data to confirm the Fed's next move seems correct to me.
I had warned readers that those bulls who were expecting a March interest rate cut by the Federal Reserve Bank were roaring up the wrong tree. And yet, going into the meeting, almost half of the market was betting on a cut. The news triggered a wave of selling that sent all three main averages down by more than a percent. Since I was not on the side of any Fed cut until May or even June, the sell-off felt overdone in my opinion. We regained much of those losses by Friday.
Beyond the Fed, the most important event was the fourth quarter earnings reports of five of the Mag 7. By Friday's close, the scorecard stood at three wins and two whiffs. Microsoft had decent earnings, but the stock sold off anyway at first, while Google disappointed investors. Meta and Amazon scored, and Apple whiffed.
Last week, I warned readers that all these stocks were priced for perfection and only stellar earnings and guidance would be able to justify further gains. Three out of five did just that and the markets reacted by hitting new highs.
There was good news on the U.S. Treasury financing front as well. The government announced it will need to raise less money via Treasury auctions this quarter. The mix between short-term notes and bills and longer-term bonds is tilting a little more toward the long end. That should keep the yield on U.S. Ten-year bonds supported.
I expect stocks will continue higher, but the journey will be marred with sharp pullbacks. My target is still 5,000 -plus on the S&P 500 Index. Stepping back, however, I see these gains as part of an interim topping process that will end at some point this month or next in a stiff pullback.
@theMarket: Economic Data Buoys Market Gains
Strong growth in the economy in the last quarter of 2023 helped support equity markets this week. The U.S. economy grew 3.3 percent in the fourth quarter, which was much higher than the estimates of 2.2 percent growth. For last year overall, the economy grew 2.5 percent.
At the same time the core personal consumption expenditure price index, which excludes food and energy, increased by 2.9 down from 3.2 percent from the prior month, and moved below 3 percent for the first time since March 2021. Investors liked those numbers enough to keep the S&P 500 Index making new highs.
Technology continued to lead stocks higher. The Magnificent Seven (Apple, Amazon, Alphabet, Microsoft, Nvidia, Tesla) garnered the lion's share of buying. Tesla, however was the downside exception. This has been the trend for most of last year and continues to be the case so far in 2024. Six of the seven accounted for 80 percent of the SPX gains in January, Nvidia and Microsoft alone represented almost 50 percent of that move.
The problem with this action is that with only a few stocks pushing the averages higher, I question the underlying health of the markets overall.
Under the market's hood, rotation into one sector and out of others for a day or two says to me that most of the market is going nowhere. The bears argue that this kind of action can't continue much longer. My answer to that is the Mag Seven carried the market for most of last year and continue to do so at least into February.
That does not mean I would rush in to buy more of these big-cap tech stocks. They are "holds," right now. Most investors already own these seven stocks in their portfolios anyway. In addition, they are top holdings in hundreds of exchange-traded funds and mutual funds. As such, they represent a huge portion of U.S. investments. The entire market capitalization of the small-cap, Russell 2000 Index, for example, is less than the market value of Apple or Microsoft. These large-cap, liquid stocks are supporting the markets.
There have been times in the past, for example, in the latter half of 2022, when these darlings were out of favor. When they are, this usually leads to a sell-off in the overall market. Could this happen again? It certainly can.
Take Tesla as an example. For years, this electric vehicle pioneer could do no wrong. But sentiment has changed. The mounting competition of dozens of EV manufacturers entering the market is reducing prices and causing profits to decline. Recently, one Chinese company, BYD, has dethroned Tesla as the leading EV company in the world. Tesla's stock price has plummeted in recent weeks and earnings were disappointing.
Most of the Mag Seven companies will be reporting earnings in the coming week or two. Thus far, fourth-quarter earnings have been pretty good. About 25 percent of the S&P 500 Index have reported. Overall, 70 percent are beating estimates by about 7 percent. Given how high these individual stock prices have been bid up, most are priced for perfection. Netflix earnings did surprise to the upset, while Tesla did the opposite. The Bulls are hoping the remaining five surpass expectations.
Next week, we will also be treated to another Federal Open Market Committee (FOMC) meeting. Investors expect the Fed to hold the line on interest rates. No rate cuts or hikes are expected. Possibly even more important than the Fed will be the U.S. Treasury's quarterly refunding announcement on Jan. 31. The more long-term Treasury bonds the government plans to sell at upcoming auctions, the more pressure there will be on bond yields to rise. That will have consequences for the equity markets.
We are still in that last move up that I had been forecasting. And it is not over yet. How much higher could we go? The S&P 500 could climb 100-200 points higher to 5,000-5,100. My timing for this market's short-term top was off a bit. I was expecting that we would have already hit the top by now. However, it still looks like a pullback in February into March before moving higher sometime in the spring.
@theMarket: Is January's Action Preview of the Year Ahead for Stocks?
The stock market has been a chop fest over the last two weeks. Yet, that has not stopped the technology sector from making new highs and the S&P 500 Index is not far behind. Are there more gains ahead for the averages before the end of the month?
Yes, as I wrote last week, I think there is at least one more good bounce in the markets before all is said and done. After that, I suspect we will all have to pay the piper for a while.
Has anything changed in investors' thinking to warrant these erratic moves? Much of the volatility over the last two weeks can be explained by the rise in bond yields and the strength in the dollar. Both instruments have made an abrupt turnaround from their downward trends that supported equities since October 2023.
I can identify two major concerns weighing on markets. The direction of inflation, and whether the U.S. economy is heading for a hard or soft landing. Neither of these outcomes will be known for several months. Until investors have a definitive answer, I believe markets will make little progress from here.
From all I have read and heard, not even the Fed knows if they have inflation licked. Sure, we have made progress towards a 2 percent inflation goal, but are still 2 percent above that rate. I can commiserate with the Fed’s position every time I go food shopping.
As for the economy, we are still seeing strength, and while economists continue to predict a softening of growth, it has not shown up in the data. The bears believe growth will fall off a cliff in one of these quarters and unemployment will spike at the same time. The Bulls say it won't happen. They believe that the economy and employment will maintain its present course upward and, at worst, we may have a soft landing if they are wrong.
Few are talking about a middle course, stagflation. That is where inflation remains sticky or strengthens a bit, while the economy slows at the same time. That could happen, if inflation remains stuck, and the Fed simply maintains tight monetary policy as a result. The longer they do that, the harder the landing for the economy will be.
But wait, you may ask, what happened to the bond market's conviction that the Fed will begin cutting rates in March and then five more times before the end of the year? The last two weeks have seen the chance for a March cut dropping from 90 percent to about even now. The number of expected cuts is also dwindling.
What if the economy does begin to slow? In an election year, any guess on what the Biden Administration might do? In an extremely tight race where the economy is a central issue, a healthy dose of increased fiscal spending would be no surprise. That has happened many times in the past.
In case you don't know, most of the growth in the economy over the last few months has been the result of government spending and not the private sector. There are still billions of dollars that are part of the Inflation Reduction Act that have yet to be spent. Believe me, that is no accident. It is one of the main reasons why the Republican House, in my opinion, has been so adamant about cutting fiscal spending now.
So where does all of this leave the stock markets? In the short-term, as I predicted we are in bounce mode until the end of the year. That would require both yields and the dollar to behave. If I were a short-term trader I would sell into that bounce. Profit-taking after the gains of the last three months would be a no-brainer.
I maintain my belief that sometime in the weeks ahead, probably February at this point, stocks will face a stiff pullback of 6-7 percent, possibly more. This consolidation period will linger through April and into May. At that point, I could see a spring-into-summer rally that would recoup those losses if the Fed does cut interest rates, the election draws closer, and we have a better understanding of where the economy and employment are going.
@theMarket: Market Volatility Rules the Day
January is turning out to be a roller coaster of ups and downs for investors. Last year's fourth-quarter gains have reversed somewhat, and the future is becoming murkier as the day progresses. Hold on to your seatbelts.
The economic data is certainly not cooperating with the bull's scenario of slowing job growth, a fast decline in inflation, and a continued decline in bond yields. The reverse has happened. The benchmark Ten-Year Treasury bond has risen back above 4 percent. The dollar has strengthened, the week's jobless number declined, and the Consumer Price Index for December came in slightly hotter than economists were expecting. On the other hand, the December Producer Price Index was a tad cooler.
As such, the wildly bullish expectations that the Fed will begin to cut interest rates as early as March, and continue cutting all year, is going the way of the dodo bird. That disappointment has soured the mood and investor sentiment is beginning to turn less positive. That is probably a good sign if you are a contrarian.
The geopolitical scene has also failed to inspire confidence. The Houthi rebels have been stepping up their game in the Red Sea. The U.S. and its allies are responding with naval and air strikes in Yemen. This could further embroil the U.S. in the ongoing Middle Eastern conflict between Israel and Hamas, Hezbollah, and the Houthis.
The Ukraine/Russian conflict does not help. It seems to be stuck in a stalemate. Oil and gas prices are rising because of all this turmoil. As is precious metals. Supply chain issues are also causing pressure on prices and that hurts expectations for further declines in inflation.
Washington has still not figured out a way to keep the government from shutting down. The Republican-controlled House continues to shoot itself in the foot time after time. The 118th Congress is one of the most unproductive in modern history. Their members have been paired down to a razor-thin majority. Legislation has ground to a halt. At best, it appears that the most we can hope for is another continuing resolution that solves nothing and continues to leave the country hostage to a tiny, group of politicians.
This week, the long-awaited Securities Exchange Commission approval of 11 issuers that applied for bitcoin exchange-traded-funds (ETF) finally occurred. It looked like a classic sell-on-the-news event. After an initial pop, bitcoin lost almost 4 percent on Thursday before rebounding by the end of the day.
Interest seems high but the jury is still out on whether investors will embrace these ETFs with open arms. I think it will take a few weeks before things shake out. The good news for investors is there is a race to the bottom as far as fees charged for these ETFs are concerned.
It is the beginning of earnings season with the multicenter banks kicking off results on Friday. Investors will be focusing attention on overall results to see if the present stock market valuations are justified or not. Prepare for company misses to be penalized heavily, while beats may not be rewarded all that much given the run-up in many stocks over the last few months. Corporate guidance for future sales and earnings will be key.
Beginning next Wednesday, global money flows into financial markets, which have supported markets for weeks, will begin to taper off. This will have a negative impact on prices overall, regardless of asset class. Short term, I expect the markets will remain volatile with maybe one more bounce before some serious downside begins over the next few weeks.