Despite the universally negative macroeconomic evidence, the stock market has seen surprisingly positive technical developments recently that are worth careful consideration, observes Jim Stack, money manager and editor of InvesTech Research.
One of these is a bullish Breadth Thrust — one of the most reliable signals of a potential rally or new bull market. Generally, a Breadth Thrust is representative of broad and strengthening participation in the stock market.
While there are differing interpretations, our technical research has led us to define this as any time the 10-day total of advancing stocks on the NYSE exceeds declining stocks by a ratio of 2.0 or greater.
After a Breadth Thrust over 2.0, the average 12-month return exceeds 20% and maximum drawdowns are quite small on average. The minimum 9-month return is a respectable +9% and both the 6-month and 9-month post-signal returns are batting 100% for positive numbers.
While forward returns 6+ months out are enticing, it pays to remain patient. So while 2023 is off to a better start, the negative weight of the evidence suggests that we may not be out of the woods just yet.
There are more than a few reasons for remaining cautious about jumping on a new bullish bandwagon in 2023. By almost any measure — including earnings, sales, or market cap-to-GDP (Warren Buffet’s favorite) — current stock valuations are not overly attractive. In fact, comparing today’s estimated figures with valuations at past bear market bottoms leaves us notably concerned.
While many of the major bank economists have belatedly joined the “potential recession” camp, the overwhelming consensus is that any recession will be mild or even avoided entirely. We know historically that when the consensus is universal, it is often wrong. And in this case, all the potential surprise is to the downside.
Given our Recession Warning Indicators and the latest warning flags still dropping into place, the real recession is yet to come. There has been virtually no significant turn in any of these warning flags, and once an economic trend is in motion it tends to continue until an opposing force (e.g., Fed easing) reverses it.
The Federal Reserve’s favorite inflation gauge (PCE Personal Consumption Expenditure Index) has eased from 7% last June to 5.5% in the latest reading. But their target is 2%... enough said!
With the recent improvement in technical data, we recently exited our inverse index fund position. This holding proved to be a useful hedge last year, but even without it, the InvesTech Model Fund Portfolio remains defensively positioned with a 50% invested allocation and a 50% cash buffer. We will reman vigilant and objective as the evidence continues to unfold and today’s dichotomy starts to resolve in the weeks and months ahead.
