Investment Insights

 — Steve Orr 

Correct, it’s a Bear.

Did you pull out your winter coat? Ours are covered in Bear fur, thanks to markets in correction. The best number for us Bulls is zero but as of Monday, the number is now six for the S&P 500. That is six days’ trading below its 200-day moving average. Last week’s downdraft pulled the big index decisively below that primary trend indicator, signaling an intermediate trend change. From the July 31 close at 4,588, the S&P 500 was down 10.25%, breaking the “10% drop” into correction territory. Mid cap stocks broke down into correction territory in mid-October and Small cap back at the end of September.

Fed speakers keep talking about returning to “normal” and “pre-COVID” conditions. Putting entire countries on lockdown is only the most important economic event in our lifetimes. We are not sure how the economy returns to pre-shutdown levels. The broader relative of the S&P Small Cap Index, the Russell 2000, has not only given up all of its gains this year, but it is also now below its pre-shutdown high of January 2020. If we throw in 5% interest rates and roughly 4% inflation, in real terms the Russell is even further behind Large cap stocks and other asset classes. 

1 for 6

Our breadth indicators use advance/decline line, momentum, and moving averages, to name a few. Of the six, five are in negative territory. After the last two weeks of chart damage, only the 200- and 50-day moving averages remain in the green. Note that the S&P 500 Index has now closed below the 200 day and is pulling the 50-day average down to the 200. Even if stocks consolidate in this area, this signal will roll over from green to neutral in the coming weeks. Portfolio managers understand the red, yellow, green sequence. It’s like stoplights. From a technical perspective, most stock indices are mildly oversold, and sentiment is negative, but neither indicator set is so negative as to show capitulation and “throw-in-the-towel” selling. They are suggestive of a bounce in the next couple of weeks. We are down enough from the July highs that good earnings or some other outside event would have to happen to get a solid fourth-quarter performance.

At first glance most of the damage last week appeared concentrated in the Mega Cap 7 tech stocks. Despite blowout numbers from Microsoft, less than inspiring numbers from Alphabet (Google) and Meta (Facebook) caused traders to hit the sell button. Digging into the rest of the equity stack, most stocks fell between -2% and -3%. In other words, the selling was across the board. A reminder: The Magnificent 7 led on the way up over the last year, and they can lead on the way down. Any further excitement for earnings this week will have to come from Apple. Monday night there is a new product review and then Apple reports before the open on Thursday. More on earnings in a moment. 

Drivers

There is rarely one reason for markets to move. Stocks love to climb a wall of worry and the spring/summer rally was a great example. Economists for the last two years have repeatedly called for a recession starting next quarter. Or two quarters. The Most Anticipated Recession Ever continues to be two more exits ahead on the GDP freeway. Persistent inflation, exhaustion of savings and a Fed committed to higher rates should take their toll on growth in the coming weeks. Gosh, we sound like consensus. But wait, there’s more.

The country’s Gross Domestic Product grew 4.9% in the third quarter, according to the government bean counters. This raises average growth this year to 3%, faster than a MARE. We wonder what conversations the Fed members will have later this week. Their traditional reaction to a 4% handle is that the economy is growing too fast and interest rates must rise. They have telegraphed staying on hold in recent speeches. If 4.9% is a correct level, then at the least we expect the Fed to keep rates higher than the market expects through 2024.

To paraphrase Wayne Gretsky, we build portfolios to where the economy and earnings are going, not to where they were. That impressive GDP report was over a month ago. Indeed, one could argue that the bulk of the third-quarter activity was in July and August, as September data was generally lower. Year-over-year employment growth has fallen by half, excess savings are now below pre-shutdown levels, consumer borrowing is at record levels and manufacturing is at best flat. Consumers say they are okay at the moment, but their expectations for six and 12 months continue to decline month after month. Inflation as measured by the CPI is half the level  of a year ago, but surprisingly the Michigan Survey’s inflation expectations a year from now are rising.

A tapped-out consumer, 8% mortgages, flat manufacturing and 4% inflation are a recipe for the economy downshifting from second to first gear. Not necessarily a recession in 2024, but do not be surprised if we write about 1% growth next year.