Market Review: View from Colombia. Airlines are flying high.
Fed speaks this week. Why flights prices are going up.
Hope you all had a great weekend. Writing to you from Cartagena, Colombia this weekend where I am attending a wedding. Beautiful country but wow was it humid! Thank heavens for linen. If you are coming to Northern South America/Latin America soon, wear linen!
Now back to the US.
Summary
The markets continue to rise. We are likely going to see a continuation of the run into small caps that we saw last week. There are many alarms in the market about valuations (meaning it is too expensive). These are likely correct but for now valuations just don’t seem to matter. In fact, people are now convincing themselves that valuations will catch up. What is true is that there is a massive gap in performance in different parts of the market (table below). The Nasdaq has erupted on a record setting run and S&P 500 is now officially in a bull run.
I think it is best to not overthink this. Some (larger) parts of the market may pullback. When markets are in a bullish trend, they stay that way until something new and meaningful knocks them off path. Until then the basic game of investing is optimism. We mentioned last week and will discuss this week, there still a good amount of ignored stocks or sectors for investors who understand them. I discuss airlines and homebuilders…read on.
The Week in Review
What Price is Telling Us
The market continued its small cap rally through the week. Small caps as measured by the Russell 2000 (IWM ETF) and equally-weighted S&P 500 (RSP ETF) exceeded the performance of the 3 major indices (these are focused on large cap stocks). The equally-weighted S&P 500 reduces the impact of large/mega cap stocks.
The S&P 500 is now officially in a bull market. In May, I mentioned the market was without direction until the range was exceeded. It has now been exceeded.
What Sentiment is Saying
Some well followed measures of sentiment show investors stampeded in last week and perhaps too excited.
The American Association of Intelligent Investors survey shows a massive jump in bullishness. With 44.5% in the survey bullish, this is a long term trend above the 37.5% average:
The CNN index is pointing us in extreme greed territory:
What does this all mean? The market went up as investor are getting excited. Healthy markets can stay greedy for some time. So maybe we go from “extreme greedy” to “greedy” or “neutral”. And maybe the S&P and Nasdaq fall a little bit. That is not enough reason for markets to plummet 10-15%.
We need more evidence of a sell-off before listening to the doom and gloom you will hear on the news this week.
Where are we going? 👇
Where to next?
What about the recession? It looks like it is baked in. Two important things to keep in mind:
The stock market does not time perfectly with the economy. It can lead or lag. People only figure it out after the fact.
Only surprises drive the market down. Investors are usually optimistic and that is why the long term trend of the market is up.
The narrative is shifting and that will drive prices. This quote shows that bad news investors KNOW about is NOT bad news. It is the bad news that investors DO NOT know about that scares investors. Now more and more strategists are talking about a pullback happening somewhere off into the future.
“The 2023 EPS recession is known,” says Victor Cossel, a macro strategist at Seaport Research Partners. “As the year progresses into the second half, the market will shift to discounting an EPS rebound.”
This point is worth repeating. The Nasdaq and S&P are made of large cap stocks. Investors keep buying large caps again and again. Could these indices pullback? Sure. But betting on a decline has been a losing bet. When and how much is hard to forecast this year. For the last few weeks every pullback has only lasted 1-2 days.
Markets come down eventually but no one ever made long term wealth trying to anticipate when that will happen. It only makes for good headlines.
Bull Market Trends
Here are some important bull market trends to keep in mind from LPL Financial:
Forward returns after a bull market is confirmed have historically been strong. The S&P 500 has posted average and median gains of 18%-19%.
How long does a bull market last? The duration of a bull market can vary significantly, but historically they have been longer-term. Since the 1929, the average is 39.4 months.
Resistance doesn’t care about bull markets. The S&P 500 is retesting key resistance near 4,300, which marks a major retracement level of last year’s bear market and the August highs. At the same time, the technology sector—the main engine of this year’s rally—has become overbought. A consolidation and/or pullback in technology could make 4,300 a challenging hurdle to clear on a sustainable basis.
If the market can sustainably break out above 4,300, fear of missing out and short covering could accelerate price action to the upside. Money market funds are also at record highs (this a very very large pile of cash).
At the sector level, leadership is broadening. Which means more stocks other than massive technology names are going up. This is a very promising sign combined with recent small cap strength.
Here are two more sectors to consider:
✈️ Airlines and companies that sell to airlines: I am in Cartagena and I am talking to travelers. Airlines don’t have enough capacity and doling out $700k packages to pilots. Will they need to buy more planes and other supplies to run their businesses (Boeing comes to mind)?
🏠 Homebuilders: Every time I hear about the real estate market, I hear about doom and gloom. Maybe things are bad but markets and all investments look at future value. I also know there are not enough homes in America. This chart of homebuilders caught my eye…because it is close to an all time high! If homebuilding is doomed why are the large investors driving this higher and higher?!
The Fed Report & The Market Implications
With the Fed reporting next week, it will be important to watch high yield names (bonds that high rates of interest because issuing companies are riskier). Ryan Detrick makes a good point here that small cap bullishness is highly correlated to high yield names. Small caps are very sensitive to economic conditions and are very resource constrained.
The big event for the week is the Fed report. Fed governor Philip Jefferson telegraphed a pause in June. The CME FedWatch site confirms this view as well. The market is most interested in future projections for July and any visibility on when rates hikes will have a more permanent pause.
The most recent inflation data is expected on Tuesday. A large surprise could move the market in either direction.
Are fundamentals overstretched? From Barrons: “The S&P index trades at 18.6 times 12-month forward earnings, down from 21.5 times at the end of 2021 but still above its 20-year average of 15.7. If the Fed pauses, it would allow price/earnings ratios to stabilize and perhaps even grow.”
It seems the market has switched its mind again. The Fed is now its friend. There is a lesson here. Headlines don’t mean anything.
If you have any questions, leave a comment. Thanks for reading Embrace the Chaos! Sharing perspective that makes sense.
Much effort and research went into making this 7-minute read. If you found it insightful, please help me out by clicking the like button and sharing this article.
- Vikas Kalra, CFA
Enjoy Cartagena!