Hello guys,
Let’s get into a brief revision of the last couple of weeks in the markets. The US and EU yield curves stay heavily inverted, and though liquidity is available and the cost of government money and corporate debt still historically low (though real rates have been on a rise since 2021/2022 due to lowering inflation metrics), risk assets thus far still remain broadly out of favor. This might change soon if the recently witnessed rotation into micro-, small- & mid-caps following on the heels of the latest CPI print will continue. Well, no one knows if it will – the internet is full of pundits who keep telling you what will happen, but the markets cannot be predicted in a determinant fashion, only in a probabilistic one. Merely going with consensus and stating that things will improve because there is yet another lower inflation print is folly and simplistic.
The data says the US economy is not following in lockstep with the 2023-24 index (or rather the extremely selective large- & megacap tech rally) – Manufacturing-, Services-, Construction-, Small Business- and Consumer sentiment surveys are all pointing to at least a slowdown if not a contraction in GDP, which would point towards being last week’s move being more of a knee-jerk than anything else. We have definitively witnessed this in the EU where real GDP has been only borderline positive for a while now, and the US Q2 print is only days away. In any case, GDP is a severely lagging indicator, and the markets are always looking 6-12 months ahead. Since inflation is still the main concern overall for small business and the Services sector though, there is a case to possibly see a lift in sentiment soon and perhaps the micro-/small-cap rally to have strong foundations, so at this point the picture is opaque and the markets over the next 1-2months or so will give the best indication themselves.
Let’s look at some charts:
Shown above are the SP500 (US large-caps, SPX), Russel-2000 (US small-caps, RUT), the Stoxx 600 (EU cap-weighted, SXXP) and the Nikkei 225 (Japan cap-weighted). Prominent are the significant breakout of the Russel (mirrored by the Russel microcaps IWC and the SP400 midcaps), as well as the hard pullback in the Nikkei after a failing move into new Highs.
On a more granular view (i.e. if you go to see daily charts) you will notice that almost all European indices have been stalling for many weeks, and some have pulled back already (case in point the French CAC40 or the Euronext 100), which is indicating a trend of at least profit-taking across asset classes in the Western sphere, also starting to become visible in the SP500 & Nasdaq Composite over the last few days, though not on a level that would pose a hazard to the established uptrend (… at least yet!!).
The pullback in Japan is quite substantial (10.6% off the Highs so far, straight into secondary correction territory), but comes after now years of strong gains and central bank liquidity & yield-curve control. The absence of strong leaders as compared to 2023 and early 2024 is a clear sign that money is not loving risk-on in Japan anymore, and the market likely starting to price in BoJ tapering and potentially changes in their rate environment. In any case, few leading stocks stand out, and those that do are suffering from distribution/lack of volume at critical junctures.
Back to the US, some whipsawing is starting to become apparent and the market is reacting to what might have been a state of “having gotten ahead of itself a bit” in relation to composite earnings power. The tech rally was real, but has so far been largely benevolent to large- or mega-cap tech stocks only (e.g. the ‘Magnificent 7’). Earnings have been quite disappointing excluding this space for a while, and Bob Farrel’s “thin blue-chip-only markets are weak markets” will come to pass should earnings disappoint in this arena. And we are starting to see some potential signs of this (e.g. recent reports in TSLA, GOOG), which might yet set a change of trend in motion.
Again – we don’t need to predict accurately, but be in the ballpark while being ready for anything. Conservatively that could mean sitting in cash while strong leaders are whipsawing (e.g. the recent Utility leaders of CEG and VST are now falling on heavy selling) and waiting for a new wave of strong issues to arise out of this potential money rotation into ex-large caps – which yet has to prove that it can stand on its own legs – but on the other hand, why not profit from both sides of the market? Flexibility pays off in financial markets, and right now a smart selection of the strongest and weakest equities in a long/short portfolio is I believe the best way to deal with this environment of uncertainty.
Take it easy and so long,
TGS