Investment Insights

 — Steve Orr 

The few

Not much new over the past week in markets. All the action is literally overseas. At this writing, the Ring of Fire strategy Iran tried to build around Israel is up in flames. Germany’s government will fall this week, and snap elections will be held in February. Canada’s government appears wobbly, etc., etc. Since events can shake markets, but rarely change the trend, let’s stay with the trend.

We wrote last week about how U.S. stock markets were narrowing. Think of standing in line to get into the Positive Returns Nightclub. It used to be open to all comers, but lately has gone “upscale,” only admitting the Magnificent 7 and few choice friends. And these would be big friends. Household names with market caps under $500 billion may as well get back in the car; perhaps they can get into the Flat or Negative club over on Downer Drive.

After the election last month, Wall Street rushed to remind investors that value stocks should turn the corner and small cap stocks do well late in the year. Their bloviating did briefly help those forgotten corners of the stock market. From election day until November 11, the Russell 2000 small cap index rose 7.7% and the S&P Mid Cap index was up 5%. So, for a few days they were right — note that we were in there with them philosophically. Our indicator dashboard that drives client allocations made a few feints toward small and mid, but our overall signals said “stay put.” We take what the market gives us, not what we think the market should do; we “sat tight” with our overweight-to-large cap. Good thing, too.

The following four weeks were a rebound back into mid-2024. Traders bounced the little guys back to the curb and the Mag 7 were back in the Positive Returns club. Traders and wannabees follow the excitement, so fund flows the past couple of weeks have been all to stocks and mostly to the Mag 7.

Feelings

Investing and spending share a need for optimism. Improving investor and consumer feelings about the future do lead to more spending. Since the election, investor optimism has risen week over week. Sentiment at frothy levels usually results in lower returns down the road. Lots of good news is built into stock prices right now. Optimism needs the actual support of Congress cutting regulations next year. Lowering regulatory burdens, especially in construction and power plant approvals, would be very helpful for earnings growth.

Feelings do not help market internals, however. Breadth, or more stocks up than down, is one of many barometers of market health. Through Monday, the S&P 500 posted 11 straight days of more down stocks than up. That has not happened since 1996, so there is not much precedent to build on. Most of the action the past couple of weeks appears to be tax loss selling combined with managers tossing out laggards and replacing them with winners (Mag 7) to look good in year-end statements. The percentage of S&P 500 members making a new monthly low has increased to almost a third of the index. The index itself is basically unchanged this month in performance, confirming that the mega-tech giants are dragging the index along. This was a long-winded (written?) way of saying the consolidation continues. More than 60% of the S&P 500 members remain above their 200-day moving average, so the longer-term uptrend is firmly intact. We wonder if traders are waiting on the Fed, Santa or both. 

One more time

Yes, this is Fed week. Wednesday’s press release should show the FOMC voted with one dissent (Bowman) to cut rates another quarter of a percent. Post-meeting, since Labor Day, short-term rates will be a full 1 percent lower while long-term rates have pivoted about a half of a percent higher. Usually, long rates drop in tandem with Fed cuts on the short end. Not this time.

The current administration has pushed more than $624 billion in deficit spending out the door since the end of September. This unheard-of speed of spending has unnerved some traders and is causing inflation memories of 2021 and 2022 to resurface. We have talked ad nauseum about inflation coming in waves, and government deficit spending is a great way to cause inflation to rise. Mind you, these waves take a year or two to develop, but our periscope is up.

Powell’s press conference Wednesday afternoon will be the highlight for economists. For traders, this Friday’s quad expiration of options and futures will set the tone for December profit and loss. Output from Powell will bleed over to Thursday which will be the last trading day before Friday’s expiration. Buckle up for a bumpy week.