The way to scare away a bear, according to experts, is to make a lot of noise while rising up to make yourself appear bigger. Sure enough, a loud equity rally to start the year — amplified by ferocious gains in some of the riskiest and most-hated stocks — has indeed sent bears running and made the bulls seem more powerful than might be expected with only half the total bear-market losses now recaptured. A week ago, the setup was something like this: “The S & P 500 is up more than 6% in the first four weeks of the year, benefiting from a reversal of deeply defensive positioning and now sitting right at the downtrend line from the record high, with daunting tests ahead in a Federal Reserve meeting plus earnings coming from most of the biggest stocks in the market.” Consider those tests passed, for now. The S & P gained another 1.6% last week even after slipping back 1% Friday. Fed Chair Jerome Powell conveyed a willingness to let the economy prove it can land softly without forcing unemployment much higher, declining explicit opportunities in his press conference to scold the market for its upwelling optimism about such a prospect. Friday’s glaringly strong jobs report lifted Treasury yields a bit and caused a rethink of some bets that the Fed would be cutting rates later this year. Yet the bigger picture is that all last year the bears were able to lean on a Fed tightening into a slowing economy and stocks tracking bond prices in a persistent grind lower — while now they face a Fed coasting slowly to its anticipated destination near 5% short-term rates in an economy that’s acting firmer than feared, and stocks and bonds breaking tentatively above those declining channels. It’s all a delicate interplay, the growth-policy equation can certainly swing either way from here. But the fact is, inflation in decline from very high levels is among the more favorable backdrops for equities through history, and in a market that may have bottomed in classic fashion during October and ahead of a midterm election. Market technicals strengthening Along the way, the technical characteristics of the market are winning converts for the bullish cause. The S & P 500’s 50-day average crossing above its 200-day average , the index has made a new “higher high,” the percentage of stocks at a new 20-day high finally surging to trigger some fairly rare signals of a possibly important advance. Reassuring, even if the market could use a rest and cooling-off phase in the short term. Some chart readers are now giving the market the benefit of the doubt on this basis, and even those who aren’t are duly noting it. .SPX 1Y mountain S & P 500, 1-year JPMorgan technical strategist Jason Hunter, who got more bullish late last year near the market low yet became more cautious as the S & P 500 neared 4100, said: “From a pure chart-based perspective, the accelerated S & P 500 Index rally leg into the upper end of our anticipated resistance zone and recent bullish longer-term momentum signals like the golden cross obviously are not the types of things we expected or want to see in the early weeks of 2023 given our outlook.” Yet the makeup and atmospherics of the rally have been such that almost no one is comfortable with the move: unprofitable and heavily shorted stocks bursting from the wreckage of two years’ worth of demolition; last year’s winners chopped down; a stampede into speculative upside call option buying. The crash of the iShares MSCI US Momentum Factor ETF (MTUM) relative to the broader market shows part of this dynamic. The crucial detail here is what sorts of stocks ended up in this momentum basket: recent relative winners, which coming into 2023 meant, overwhelmingly, defensive-style stocks. The MTUM is now 60% healthcare and energy. It has a massive underweight in tech and consumer cyclicals. Too much garbage? So quantitative investors riding this factor – often while shorting low-quality stocks – have been whipsawed mightily. Goldman Sachs reports that Thursday saw the single heaviest day of short-covering activity by hedge-fund clients in a decade. The reawakening of once-bubbly unprofitable speculative-tech stocks this year along with the excitable options trading has brought out the “Tsk-tsk” crowd lamenting the return of recklessness and fun. Fair enough, healthy markets are not dominated by such action for long. Here Deutsche Bank shows net call-option buying in mega-cap growth and tech stocks ramping above any readings from 2022, though still unremarkable by the manic standards of 2020 and 2021. But any market rebound strong enough to attempt escape velocity is going to have a high-beta “garbage-stock” rally associated with it, so in itself this “last shall be first” element doesn’t disqualify a rally from serious consideration. There is also more-quiet outperformance by industrial-metals, homebuilding and other consumer-discretionary stocks, as well as continued leadership from the equal-weighted S & P 500 , a clue that the broad list of stocks is acting better. Tight credit spreads also offer reassurance that the macro picture is not eroding quite quickly enough for bears to cash in their bets on a buckling economy just yet. Of course, in order to log these gains, the market had to seize on pessimistic sentiment and positioning, meaty declines in bond yields and the dollar, and muted expectations on earnings that have allowed the tape to shrug off largely unimpressive corporate results. Arguably, a lot of that fuel has been burned, though sentiment is hardly giddy by most longer-term measures. Still top heavy Valuation is surely a factor that’s hard to paint as a weapon of the bulls after the recent index appreciation. Surely at the S & P 500 level, above 18-times forward profit estimates is a demanding bogey implying so-so returns. Yet I continue to point out how top-heavy the market remains. The six largest stocks by market value (Apple, Microsoft, Alphabet, Amazon, Berkshire Hathaway and Nvidia) are a combined 21% of the index and have an average forward price/earnings ratio above 30. The equal-weight S & P is closer to the longer-term average at 16, and mid-cap stocks still modestly valued compared their history. For sure, the risk/reward assessment here at the midpoint of the entire 2022 bear market decline appears a bit more balanced, with the tape more vulnerable to unwelcome news at 4136 on the S & P 500 than it was 600 points lower in October. The S & P 500 is compounding so far in 2023 at a 120% annualized rate of return so yeah, expect some give-back and gut-checking. A new trading range developing well below the all-time highs would be unsurprising. The confusion and debate around the leading indicators of recession won’t be going away soon. Markets often convey relief as a “soft landing” appears plausible even when one isn’t ultimately achieved. Jay Powell speaks on Tuesday and could easily choose to sharpen the edge of his rhetoric on “higher rates for longer.” Yet it’s hard to dismiss that when the S & P was at this exact level nine months ago in early May, it was before the latest 400 basis points of Fed tightening, prior to $500 billion (and counting) rolling off the Fed balance sheet and ahead of a 10% reduction in S & P 500 projected profits for this year and next. No doubt the worst-case outcomes are not priced in, but for now it’s the bears who need to regroup.
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