US Strategy Weekly: Earnings, the Fed, and Russia/Ukraine

Last week we pointed out that the 2000 resistance level in the Russell 2000 index (“Russell 2000 at 2000” February 15, 2023) could be pivotal for the near term. Similar to the less delineated DJIA 34,000 level, the RUT’s 2000 resistance level presented the first real challenge for the advance initiated from the October 2022 low.

The market also revealed signs of exhaustion with daily NYSE volume falling consistently below the 10-day average and sentiment indicators reaching short-term extremes. The AAII bull/bear sentiment indicator had a sizeable 7.6% jump in bullishness to 37.5%, the highest level in over a year. Bearishness fell 9.6% to 25%, its lowest level since November 2021. It was too much, too soon in terms of a sentiment switch. Not surprisingly, in this week’s first session, the Dow Jones Industrial Average fell 697.1 points, or 2.06%, to 33,129.59, and wiped out its year-to-date gains. The S&P 500 lost 81.75 points, or 2.00%, to 3,997.34; the Nasdaq Composite dropped 294.97 points, or 2.5%, to 11,492.30; and the Russell 2000 fell 58.14 points, or 2.99%, to 1888.21. These indices shaved previous gains but remained positive for the year.

There were numerous reasons for the market sell-off, but the main catalysts have not changed: concerns about earnings growth, the risk of more-than-expected Fed rate hikes and worries of an escalation of the Russia/Ukraine conflict. As the fourth quarter earnings season draws to a close, it is the results of retail companies that now come into focus. To date, these results have been less than stellar. More importantly, forward guidance has been sobering as corporate leaders warn of an earnings slowdown.

Earnings Growth

On page 15 we display our quarterly and annual forecasts for S&P 500 earnings as well as those from S&P Dow Jones and IBES. It is worth noting that the S&P Dow Jones 2022 earnings estimate for 2022 is currently $196.31 and for 2023 it is $220.16. As recently as July 22, 2022, the 2022 estimate was $220.70, or higher than the current 2023 estimate. IBES currently estimates this year’s earnings to be $222.85, but as recently as October 7, 2022, it showed a consensus estimate for last year’s earnings of $223.34. In sum, earnings estimates are coming down, but the question is how much further might they fall? This is a difficult question since economic signs are mixed and to a large degree, confusing.

More Fed rate hikes

There are some worrisome signs for the economy. The Conference Board Leading Economic Index slipped 0.3% in January to 110.3 and represents the 11th consecutive monthly decline in the LEI. A long steady decline in the leading indicators has been a good predictor of a recession in previous cycles.

On the other hand, the latest S&P global flash PMI composites are telling a different story. The January US PMI Composite index rose from 46.8 to 50.2 to an 8-month high, led by strength in the service sector. The rise above 50 indicates an economic shift from contraction to modest expansion in the PMI indices. February’s Eurozone flash PMI rose for the fourth consecutive month to 52.3, indicating the strongest business activity since May 2022. The UK flash PMI for February also rose sharply from 48.5 to 53.0, registering the strongest expansion since June 2022. All in all, these flash economic surveys depict a rebound in economic activity in both the US and Europe.

An improvement in economic activity is usually good news, but when it is coupled with recent inflation data, it is a recipe for further Fed rate hikes, and this is upsetting for those who were expecting another “one and done” rate hike in March. It has been our view that the Fed would have to raise rates higher and keep them there longer than the consensus was expecting.

In January, the CPI rose 6.35% YOY, down fractionally from the 6.44% YOY rise in December, yet a major improvement from the 9.1% YOY seen in June 2022. Still, prices are not falling as quickly as some had hoped. The PPI for finished goods rose 8.7% in January, down only 0.2% from the 8.9% reported in December. Wages rose a healthy 5.4% YOY in January but after adjusting for inflation, household purchasing power declined 1% YOY in January. We have been concerned about the disparity between inflation and wage growth for the last year. The spread is narrowing but it has not closed, and the consumer remains under pressure. See page 3.

Nevertheless, households continue to spend. Total retail & food services sales rose 6.4% YOY in January, and sales excluding motor vehicles and parts, rose 7.3% YOY. However, when nominal retail sales are adjusted for inflation, real retail sales only grew 0.2%. This is down from 1.1% in December, but up from the 1% decline seen in November. See page 4. Total vehicle unit sales rebounded strongly from December’s 13.9 million (SAAR) to 16.2 million in January, and this makes the 7.3% YOY rise in January’s retail sales excluding autos, and 7.4% rise in sales excluding autos and gas stations, even more impressive. The 25.2% increase in food services and drinking places was noteworthy. See page 5.

However, this spending comes at a cost. The latest Quarterly Report on Household Debt and Credit from the New York Federal Reserve showed total debt balances grew by $394 billion in the fourth quarter of 2022, the largest nominal quarterly increase in twenty years. The increase in credit card balances between December of 2021 and December of 2022 was $130 billion, the largest annual growth in balances seen in the data history which began in 1999.

In terms of debt and mortgages, housing remains in a slump. December’s new home sales totaled 616,000 annualized units, down nearly 27% YOY. Existing home sales fell to 4 million units in January, a decline of nearly 37% from a year earlier. See page 6. The NAR housing affordability index improved from 94.3 in November to 101.2 in December, yet it remains at one of the lowest readings since 1986. This is not favorable. Nonetheless, in February, the NAHB housing index reflected a bit more optimism about the next six months and rebounded from the year-end 2022 cyclical lows. See page 7. 


Our view has not changed. We expect a trading range market until inflation is clearly under control, a process that is apt to take another 12 to 18 months. In terms of the indices, we anticipate a 12-to-18-month range as high as the January 3, 2022 peak of SPX 4796.56 and the October 12, 2022 low of SPX 3577.03. The February overbought reading in our 25-day up/down volume oscillator is in line with this forecast. To date, the rally has been led by large-cap technology stocks, but we do not believe technology as characterized by FAANG stocks, will be the leadership of the next bull market cycle. Typically, a long-term trading range market will see leadership rotate throughout the year.

Keep in mind that the popular stock indices have a history of spending 50% of the time in flat trends. These trends are not boring; they can include several bull and bear market moves of 20% or more. However, these cycles are defined as “flat” since market rallies are unable to sustain an advance above the previous market peak. In short, the days of “buy and hold” may have ended for a while.

Gail Dudack

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Value… It’s in the Eye of the Beholder

                                                                                                                                    DJIA:  33,697

Value… it’s in the eye of the beholder.  And the eye of the beholder, that’s likely a function of the market’s trend.  What they call fair value is a function of many things, but in the end does it really matter?  Stocks sell at fair value twice – once on their way up and once on their way down.  The rest of the time they are overvalued or undervalued, and the trick is to figure out whether they’re on their way to becoming more overvalued or more undervalued.  In other words, figure out the trend which determines as much as three quarters of the movement in individual stocks.  Then there’s group or style rotation.  Most of Energy was up 50% last year, with virtually nothing to do with the market’s multiple.    The best performing individual names indeed are about earnings, but earnings which surprise.  What multiple do you put on earnings that you’re not expecting?  Seems easier to go with trend versus valuations.  Money is made in the stock market when for the S&P the 50-day moving average is above the 200-day moving average.

If you believe history of sorts repeats, there’s plenty of reason for optimism.  As we pointed out last time, there’s a pre-election seasonal pattern that’s quite positive, even for the usually not so wonderful month of February.  And from February through July it’s quite positive.  Tom Lee of FundStrat published a note regarding the first 25 days of the year.  When up 5% or more the market was higher at year-end 16 of 17 times.  And finally, the Nasdaq Composite has outperformed the Dow Jones Average to an unusually large degree, the greatest since 2000.  Over the next six months there was never a negative return for the S&P, according to  Obviously this time could be different, though we cringe to say that.  Those words have cost many of us more money than we’d like to remember.

If it’s true this time is not different, the numbers seem to back that up.  Stocks above their 200-day moved above 70%, historically indicative of bull markets.  The level of 12-month New Highs seem to say the same.  That said, this is unlikely your 2009 bull market, or others of that ilk.  The washout this time was last June, so while the numbers so far have been good, they lack some of the drama of past bull markets.  Even last week saw a little glitch in the rosy scenario, as some reversals took NYSE stocks above their 200-day from 74% to 64%, a not so insignificant drop in just one week.  In turn, this made Monday’s rally all the more important, not for its 300+ Dow points but for its 3-to-1 A/D numbers.  Following what you might call a sloppy week, it’s important not to rebound with what we call a weak rally – up in the averages with poor A/Ds.

Recent data seems to confirm getting inflation under control will be, as the Beatles once suggested, a long and winding road.  Recent data also seems to confirm the economy is in his own world, one which seems more than fine with things.  Bull markets come around when stocks become sold out.  And as has been the case recently, new uptrends see stocks down the most turn to up the most.  That said, there also seems a new leadership has evolved in old industrial names like Parker Hannifin (355), Eaton (174), Dover (155), and names sensitive to economic growth like Cintas (441) and Grainger (670).  Obviously, there’s some contradiction here, as continued Fed tightening does not bode well for the growth story.  So what is the market missing, or is it what are we missing?  Rather than overthink it, for now, we will just go with the charts.

Our comments above notwithstanding, a common complaint is about leadership.  This can be pretty much summed up in saying Cathie Wood is having a good year finally, or at least so far.  While short covering seems a part of this rally, what bull market ever started without short covering?  We find it a bit upsetting that stocks like Deere (403) and Caterpillar (247) have not done better, but Boeing (212) and GE (84) at least have held their own.  Commodity-related stocks also have been disappointing, though oil equipment/drilling stocks look poised, so to speak, more than the exploration names. Cyber and defense stocks, to look at their respective ETFs, CIBR (42) and ITA (116), are much improved — wonder what that’s about?  Last year’s winners like Staples and Pharma are going through and out of favor phase, but this too should pass.

Frank D. Gretz

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US Strategy Weekly: Russell 2000 at 2000

Technical Indicators in the Spotlight

The easy part of the 2023 rally may now be behind us. We are concerned that daily volume on the NYSE has been consistently lower than the 10-day average for seven consecutive trading sessions. It is a sign of fading demand. More importantly, the Russell 2000 index, which was an excellent leading indicator at the 2021 peak and has been a decent leader at the October low, is now facing stiff resistance at the 2,000 level. The Russell index has the most attractive technical pattern of all the major indices and if it can better the 2000 level, the Russell could rally another 10%. However, in our view, it is more likely that the equity market is extended, a consolidation process has begun, and part of this process could include a retest of the lows. See page 10.

Another warning sign is found in the American Association of Individual Investors (AAII) survey which had some surprising shifts last week. The AAII readings showed a 7.6% increase in bullishness to 37.5%, its highest bullish reading in over a year. It is also the first time in 58 weeks that bullish sentiment is at or above its historical average of 37.5%.

Investors who indicated they were neutral, neither bullish nor bearish, rose 2% to 37.5%, and were also at the highest level in over a year. Conversely, a huge 9.6% decrease in bearishness took the bullish ratio to 25.0%, its lowest reading since November 11, 2021, or 15 months ago. Bearishness is now below its long-term average of 31.0%. The Bull/Bear Spread remains positive but it is moving toward neutral for the first time since January 2022. Sentiment readings were most extreme on September 21, 2022, and equity prices tend to be higher in the next six and/or twelve months following such extreme readings. Nevertheless, last week’s readings are a display of too much optimism appearing too quickly and it is a negative omen for the near term. See page 13.

Some technical indicators continue to be positive. The 10-day average of daily new highs is 130 and new lows are 26. This combination remains positive since new highs are above the 100 benchmark that defines the trend, and new lows are well below 100. The NYSE advance/decline line is currently 28,517 net advancing issues from its November 8, 2021 high, which is further away than it was a week ago. In general, the AD line is negative, but it has been improving since the end of the year. See page 12.

Inflation, the Fed, and PE multiples

January’s CPI data, on a non-seasonally adjusted basis, showed prices rising 6.4% YOY versus the 6.5% YOY reported for December. Core CPI rose 5.6% versus 5.7% a month earlier. This was slightly worse than the consensus expected, but not bad enough to change the outlook for Fed policy. Inflation is slowing, but at a slower pace than some had expected. The energy component of CPI rose 8.7% YOY in January versus 7.3% YOY in December, which was a surprise because the price of the WTI future fell 10.5% YOY in January versus a 6.7% YOY gain in December. The good news is that the energy component of the CPI remains well below the peak of 41.6% YOY seen in June 2022. See page 3.

Many inflation watchers like to exclude the owner’s equivalent rent component from the CPI to moderate inflation, however, the OER has been a part of the CPI for decades and without controversy prior to this cycle. What is interesting to us is that when we compare the OER and the fed funds rate, it is clear that the Fed had been far more aggressive in terms of fighting inflation in the past. The Fed typically increased rates ahead of any significant rise in the OER, or at the first sign of inflation. Today, the Fed remains well behind the curve and behind the rise in the OER. More importantly, housing is not the problem for the Fed since interest rates have had, and will continue to have, a significant impact on mortgage rates, housing demand and housing inflation. The problem has switched to the service sector where inflation is rising broadly. In January, service sector inflation rose from 7.5% to 7.6%. See page 4. All told, inflation may be more entrenched than previously thought and the Fed will need to keep interest rates higher for longer than many expect.

Lowering inflation is critical for many reasons, but in terms of equity valuation, high inflation usually translates into lower PE multiples. The current trailing PE for the S&P 500 of 20.9 times and the forward PE is 22.3 times based upon our 2023 estimate of $180, or 18.8 times based upon the current S&P Dow Jones estimate of $220.31. All of these PE multiples are extremely high with inflation over 6% YOY. The risk in the market is that equity valuations can only be supported if inflation is 2%. Unfortunately, that is unlikely to materialize this year. In other words, breadth has improved on this rally, but valuation has not.


There was a small increase in the University of Michigan consumer sentiment survey for February and it was due entirely to the present conditions component, which rose 4.2 points to 72.6. Ironically, the present conditions index is now more than 10 points above the expectations index. More confusing is the fact that this is in complete contrast to December’s detailed survey on personal finances, where personal finances were falling throughout 2022, but expectations rose in the final months of the year. The University of Michigan consumer sentiment is a timelier survey, so hopefully, this improvement in present conditions will be sustained.  See page 5.

The NFIB small business optimism index rose 0.5 points to 90.3 in January but remained below the long-term average of 98 for the 13th consecutive month. Eight subcategories improved this month and five deteriorated. However, even though the outlook for business conditions rose from -51 to -45, it lingers well below the zero line, although 16 points above its June 2022 low of -61. See page 6. Plans to increase capital expenditures or inventories declined in January while plans to increase employment and expand rose modestly. Small businesses were gloomier about the prospect of real sales increasing even though plans to raise prices also rose in January. See page 7. There were small increases in actual sales and earnings in January which may have contributed to the rise in the uncertainty index to 76, up 5 points for the month and up from the June 2022 low of 55. See page 8.

Summary We expect the equity market will remain in a broad trading range until inflation is clearly under control, a process that is apt to take another 12 to 18 months. In the interim, we expect the broad indices will be contained between the January 3, 2022 SPX high of 4796.56 and the October 12, 2022 low of SPX 3577.03. The improvement in our 25-day up/down volume oscillator is in line with this forecast. To date, the rally has been led by large-cap technology stocks which we do not believe will be the leadership of the next bull market cycle. Technology stocks had been at the center of heavy short selling, and it is likely that short covering contributed to the current advance. If we are correct about a trading range market, leadership may rotate throughout the year. Keep in mind that historically, the popular stock indices have spent 50% of the time in flat trends. Flat trends can include several bull and bear market moves of 20% or more, but we define them as “flat” since rallies are unable to sustain an advance above the previous market peak. In short, the days of “buy and hold” may have ended for a while.

Gail Dudack

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Stock Charts Tell a Story… and For Now, That Story is a Good One

DJIA:  33,699

Stock charts tell a story… and for now that story is a good one.  Clearly not all charts tell a story, and when they do it’s not always a good one.  We’ve come across a couple where the story not only seems a good one, it also seems an important one – with important implications for the economy and by extension the stock market.  Take for example WW Grainger (661), where one of their segments is called “endless assortment.”  In other words, they sell “stuff,” and they sell it to everyone.  Then there’s Parker Hannifin (352), whose engineered solutions go to a range of businesses.  The company was used by Alan Greenspan as an economic indicator.  Both of these stocks are in long-term uptrends, and came through the bear market reasonably well.  The real point is their recent significant breakouts.  The stocks of these companies, who seem to have their finger on the pulse of the economy, are telling a very positive story.

Investor psychology has shifted from pessimism to skepticism.  It’s apparent the market is acting better, but this better action isn’t really trusted.  The distrust, of course, relates to earnings which seem likely to disappoint.  And therein lies the point of the matter.  How disappointing can earnings be when even we technical analysts know earnings will be disappointing?  One of our long held tenets is that when it comes to the stock market, what we all know isn’t worth knowing.  What we all know already is priced in.  And if you insist earnings are your big worry, how is it last year‘s earnings were good and the market went down?  Why can’t earnings this year be bad and the market go up?  Amidst the media’s onslaught of warnings, it’s easy to forget that these forecasts likely will prove old news.  Market averages make their lows some eight months ahead of the news.

The anecdotal positives aside, the numbers also have turned positive.  The percent of NYSE stocks above their 200- day reached 74% last week.  Historically readings above 60% have been followed by above-average forward returns in the S&P, and spikes toward 70% marked new bull markets in 1995, 2003, 2009, 2013 and so on.  Last week also saw more than 10% of NYSE issues traded reach a 12-month New High.  And more than 8% did so on the NASDAQ.  It’s difficult to argue numbers like this fit with an ongoing bear market.  Because this was in its way a different kind of bear market, with a washout in the middle rather than at the end, a bull market likely will be different as well.  Rather than eleven months like January, we expect more of a trudge higher.  We have likened last year to 1962, and would liken this year to 1963 – up some 18%.

February can be a difficult month, especially when January is a good one.  The numbers go something like up only 46% of the time, with losses far outweighing gains. points out, however, those and other numbers change rather significantly in pre-election years, with February up some 68% of the time.  Even more impressive is what follows in these years.  The period from February to July has a success rate of close to 85%.  The top performers in this pre-election period are Materials, Consumer Discretionary and Tech.  We favor the Materials ETF (XLB-82) and there is a Consumer Discretionary ETF (XLY-150).  The good news/bad news there is that Amazon (98) is 23% of the holdings.  As for Tech generally, our feeling is stay away from last cycle’s names, including the FANGs.

Winston Churchill once remarked Americans always do the right thing, once they’ve tried everything else.  We were reminded of that watching Tuesday’s market following Powell‘s remarks.  The market had a great day, after doing all that it could to have a bad one.  We always find it impressive when the market has its chances to go down, but does not.  Still, after January’s run it seems reasonable to expect some flattening out.  While Tuesday’s reversal in price was impressive, the reversal in the A/Ds was at best adequate.  And Monday was the first bad day of the year – 3-to-1 down against a loss of only 35 Dow points.  Bad down days, however, are not the worry.  It’s the bad up days that get markets in trouble – up in the averages against lagging A/Ds.  The elephant in the room for now is leadership – always difficult this time of year and during changing market cycles.  A rising tide lifts all ships, but some of these were sunken ships – Carvana (12) from 5 to 20?  These “January Effect” bounces are nice, but keep in mind they’re not called February Effect.  We expect Commodity leadership to return, but they have lagged so far.

Frank D. Gretz

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US Strategy Weekly: Technical Upgrade

There were a number of developments in economic, fundamental, and technical data over the last week, but the most significant change was technical and the performance of our 25-day up/down volume oscillator. In our last strategy report, we indicated that it would be important to monitor this indicator because it could be close to making a positive shift. That is what it did this week. The oscillator has now been in overbought territory for ten consecutive trading sessions. Ten is an important number because bear markets rarely have rallies that can sustain an overbought reading for five to ten days. The initial advance in a bull market will have an extended overbought reading and it usually includes an extreme reading of 5.0 or greater. Currently, the oscillator has been as high as 4.81 but it has not exceeded the 5.0 reading generally seen at the start of a new bull cycle. Nonetheless, this long overbought reading is a positive change in this indicator. See page 12.

And there are other positives in the technical arena. The 10-day average of daily new highs has been over 100 for the last week and the 10-day average of daily new lows has been below 30. This combination is bullish since 100 or more defines the trend. The current rally also carried the popular indices above their 200-day moving averages, including the lagging Nasdaq Composite Index. And as we noted recently, the Russell 2000 has an attractive technical chart after bettering the 1900 resistance level. The move above this resistance price is a good near-term sign for small cap stocks and the market overall. However, the 2200 level in the RUT represents significant resistance for the advance which means, the current advance may be a good trading opportunity, but investors should be cautious. 

Our longer-term view is that the market is apt to remain in a broad trading range until inflation is clearly under control. We believe this will take another 12 to 18 months. But in the interim, we expect a broad trading range to contain stock prices with the January 3, 2022 SPX high of 4796.56 as a ceiling and the October 12, 2022 low of SPX 3577.03 as a probable floor. This signal from our 25-day up/down volume oscillator is in line with this forecast. And even though this is a better outcome than we expected earlier this year, we would not chase the current rally. Much of the shift is taking place in large capitalization technology stocks which we do not believe will be the leadership of the next bull market cycle. Technology stocks have been at the center of heavy short selling, and it is likely that short covering is contributing to the current advance.

Nonetheless, the technical improvement seen in recent sessions implies that the underlying bear cycle is diminished, and a neutral range is ahead. We reviewed our concept of a flat market trend last week (“Reviewing Flat Trends” February 1, 2023) and showed that historically, the popular stock indices have spent 50% of the time in flat trends. Flat trends can include several bull and bear market moves of 20% or more, but we define them as “flat” since rallies are unable to sustain an advance above the previous market peak. Note that flat cycles tend to be linked to periods of inflation or deflation. In our opinion, this is why it is critical that the Fed deal firmly with the current inflation cycle. History shows that inflation is difficult to control once it exceeds 7% YOY and it has only been resolved with a series of recessions. We believe the Fed understands this issue and is attempting to be a slow and steady force to undermine inflation without igniting a recession. It will not be easy.


As we expected, fourth quarter earnings season is tempering expectations for 2023 earnings. Last week the S&P Dow Jones earnings forecast for 2023 fell $2.62 and the Refinitiv IBES consensus earnings forecast fell $1.70. This brought the consensus 2023 full year estimates to $219.29 and $224.31, respectively. What is interesting in our view is that these 2023 estimates now match the estimates analysts had for last year’s earnings back in May 2022. See page 10.


Some economic data releases also suggest corporate margins may be under severe pressure this year. Labor productivity fell 1.3% in 2022. This followed a 2.4% increase in 2021 and a 4.4% rise in 2020. Keep in mind that falling productivity often means a rising cost of labor. Total labor compensation costs rose by 5.1% YOY in June 2022, the highest pace since June 1990. And the compensation cost index remained consistently high at 5.1% YOY at year end. Labor costs increased across the board, for both wages and benefits. See page 6. What may keep the Fed awake at night is the fact that while inflation peaked at 9.1% in June of 2022, the employment cost indices have not declined, and they remain high for both private and government workers. This will have two negative impacts: it will encourage the Fed to keep interest rates high long enough to reduce this trend and, in the interim, it will erode corporate profits. See page 7.

Total nonfarm payroll employment rose a surprisingly large 517,000 in January, and the unemployment rate was slightly lower at 3.4%. Job growth was widespread, but it was led by gains in leisure and hospitality, professional and business services, and health care. However, there were a number of reasons to not place too much emphasis on this report.

As seen on page 3, the seasonally adjusted payroll employment rose to a new cyclical high, whereas the not-seasonally-adjusted employment number fell well below the high recorded in November 2022. Nevertheless, there were underlying reasons for the inconsistencies in January’s release. The BLS introduced its annual revision of the establishment survey in January. This is a once-a-year re-anchoring, based on March 2022 data, of employment estimates from the unemployment insurance (UI) tax records filed by nearly all employers with State Workforce Agencies. As a result of the adjusted estimate for March 2022, total nonfarm employment had an upward revision of 568,000 or 0.4%. The not-seasonally adjusted total nonfarm employment estimate was revised by 506,000, or 0.3%. Over the prior 10 years, these benchmark revisions have averaged 0.1%, with a range from −0.3% to 0.3%. In short, this was a very large revision that “technically” erased January’s outsized job gain.

The household survey also had an annual update to total civil noninstitutional population based upon revised Census data. This impacted the participation rate and the employment population ratio modestly. Lastly, there were changes to the North American Industry Classification System (NAICS) which resulted in some work categories being delisted and others added. These changes are typical of most January reports, but this year the revisions were larger than normal. See page 4.   The ISM surveys will be important to monitor in coming months. In the December reports, the weakness seen in the manufacturing sector appeared to be spreading and the service sector fell below 50, reflecting a contraction. But in January, a rebound in the ISM nonmanufacturing index reversed most of December’s weakness. The recovery in the service sector could be significant and has the potential of boosting economic activity, perhaps even in manufacturing. In sum, it is worth monitoring the ISM indices in the months ahead. The rate of change in the manufacturing index has been highly correlated with the rate of change in the S&P Composite. It could be pivotal. See page 9.  

Gail Dudack

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Do You Trust Your Thinking … Or Do You Trust Your Eyes

DJIA:  34,053

Do you trust your thinking … or do you trust your eyes?  Logic suggests there’s unfinished business on the downside.  After all, as the Fed just made clear, it seems hell-bent in its serial tightening, unlikely to stop until the market drops.  Then there’s the matter of earnings which, to the surprise of no one, likely will be less than stellar.  Yet despite what might seem a logical expectation of lower prices, the market action has been quite impressive to the upside.  As of last Friday 67% of NYSE stocks were above their 200-day average – 70% says bull market.  Weekly 12-month new highs were 269 on the NYSE versus 31 new lows, on the NAZ 382 versus 128.  We just don’t see these numbers fitting in with the ongoing bear market thesis.  Without meaning to be too convoluted semantically, a big new leg down here would almost seem a new bear market, rather than a continuation of the old one.  Meanwhile, the possibility of a new bull market is certainly there, though it may not look as most might expect.

A few weeks ago we compared last year to 1962.  We don’t believe any two years completely match, but last year and 1962 are pretty close.  Moreover, it’s the pattern of buying and selling that seems of particular interest.  Both years saw declines pretty much from the start, and both saw those declines end in June, down 20%+ in both cases.  We don’t have numbers from 1962, but last year the number of weekly new lows totaled almost half the issues traded that week, or what you have to think were washout numbers.  In other words, that was the low for most stocks with later numbers not coming close.  In both years there was what seems a period of base building, a selloff in October both years, and a rally in December.  What followed in 1963 was an orderly but not dramatic sort of uptrend, leading to a year-end gain of about 18%.  No washout drama after the June low, and no upside drama in ‘63.

If you’re bearish, you’re thinking the Fed/earnings eventually will get to the market, stocks will leg down and then wash out.  It seems to us we’ve been there, done that – that being last June.  Without the downside drama, however, there likely will be less drama on the upside.  Why are the banks not rallying, how can a leader like CAT sell off, there always will be something to make you wonder.  Then, too, price leads and news follows – markets bottom some eight months before good news.  We have no dog in this hunt.  We are more trading than investing oriented.  We do understand that most are just the opposite, and we are simply trying to lay out here what we see in terms of bull versus bear, a longer term perspective.  From a short-term perspective, indicators like the A/Ds and new highs turned negative mid-October, positive again mid-December.  They remain positive.

When they say hope springs eternal, they might well be referring to spending on infrastructure.  To look at some of the relevant stocks, rather than the rhetoric, the reality just could be at hand.  We are thinking here of names like Granite Construction (43) and Sterling Infrastructure (36) where the names pretty much say it all.  There’s an ETF here, Global X US Development, PAVE (30).  This includes one of the market’s stronger stocks of late, United Rentals, URI (456).  The largest position is Nucor (177), where if you haven’t looked lately will surprise in a positive way.  The same can be said of Steel Dynamics (126), like Nucor almost tech-like.  There is also a Steel ETF, SLX (68), and, in this general area, you might also look to XME (58).

The bull/bear debate aside, a new year often presents challenges in terms of leadership.  In other words, it’s often confused.  Last year’s leaders have lagged, and laggards like Tech have led.  The ratio of Consumer Discretionary Stocks to Consumer Staples has risen by more than 20% over the last four weeks.  This is quite a change and can be construed positively as it suggests investor confidence has risen.  In the past this has led to gains in the S&P, though we tend to think of this more benignly – down the most becomes up the most temporarily.  We have been a bit negative on Tech but by no means all Tech.  There’s plenty of good if somewhat obscure names acting quite well, and the Semis are acting well.  It’s the winners from last cycle, the FANGs despite META (189), and the stay-at-homes that seem unlikely to repeat.  Think of the “Dot-coms” and the “Nifty Fifty” before them.

Frank D. Gretz

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US Strategy Weekly: Reviewing Flat Trends

The month of January ended with a gain of 2.8% in the Dow Jones Industrial Average and a 6.2% gain in the S&P 500 Composite. See pages 3 and 4. This was the 25th best January in the DJIA and the ninth best January for the SPX. January’s performance has been significant over the decades, and since 1950, a gain in the DJIA has correctly predicted an annual gain 89% of the time. In the SPX, a January gain has resulted in an annual gain slightly less than 79% of the time.

Technicals Improve

And at the same time, the January rally has generated several improvements in our technical indicators. The biggest change is the improvement in the 25-day up/down volume oscillator. It is currently showing an overbought reading of 4.49, and more importantly, has been overbought for five consecutive trading sessions. In addition, the month of January ended with a strong 90% up-volume day. This is an upgrade from the overbought reading recorded in November, off the October low. That reading was not sustained. The current reading needs to remain overbought for another week to be truly convincing, however, bear markets rarely reach overbought territory, and if they do, the reading is typically brief. An overbought reading that persists for at least five to ten consecutive trading days – and reaches a new overbought high reading — is significant and is an indication of a shift from bearish to positive, or at least from bearish to neutral. This week will be pivotal for this indicator. See page 14.

As a result of this broadening rally, all the popular indices are presently trading above their 200-day moving averages, including the Nasdaq Composite. This is another solid improvement in the technical arena. And as we noted last week, the Russell 2000 has an attractive technical chart, having bettered the 1900 resistance level, which is a good near-term sign for small cap stocks and the market overall. See page 13.

Flat versus Trending Markets

Given the strength of the January rally we believe this is a good time to review the long secular outlook for equities in order to put the current advance into a broader perspective. First, it is important to remember that a study of historical stock performance shows that equities spend only half their time in a persistent “trending market” i.e., a bull market with modest intervening corrections of 10% or more. When stocks are in a trending market a “buy and hold” strategy is beneficial and profitable. And in most trending cycles the economic backdrop is favorable for most industries and corporate profitability is good. In sum, it is an environment that “lifts all boats.”

However, the other 50% of the time the equity market and the economic backdrop are not as favorable. Usually this is due to the impact and/or aftermath of either inflation or deflation; as a result, the market vacillates in what we call “flat trends.” These flat trends can include several bull and bear markets that rise and fall of 20% or more, but the key distinction is that the benchmark indices usually fail to sustain an advance that moves higher than the previous peak. In short, the market tends to have a ceiling price near the peak of the previous bull market. We believe the inflationary cycle we are currently experiencing is the catalyst for such a market. What is important is that this means a “buy and hold” strategy will be less profitable and instead, investors should be alert to unique buying and selling opportunities when they arise. In most cases, the stock market is driven by a rotation of leadership among industries, value and/or growth at a reasonable price tend to be solid strategies, and taking profits and reinvestment becomes a preferable tactic over “buy and hold”. Also note that history shows that these flat trends tend to last for more than a decade. See page 5.

Another way to analyze the stock market’s “flat trend” phenomenon is to monitor the 10-year compound annual growth rate in the S&P 500. We do this on both a simple price basis and on a total-return basis. As we have pointed out in recent years, it is unusual for the S&P’s 10-year compound annual growth rate to exceed 13%; and when it has reached this level it typically presages a major decline is on the horizon. The 13% level was reached at the end of 2021. See page 6.

Conversely, whenever the 10-year compound annual growth rate approaches or falls below zero, it has been an good signal of an excellent long-term buying opportunity. The growth rate declined to 8.3% as of the end of January, but this is not a level that defines a major buying opportunity. Nevertheless, we do not expect “zero” to materialize for a long while, but we do expect there will be several bull and bear market cycles before the growth rate ever approaches zero.

In sum, we would not anticipate an equity rally will sustain an advance bettering the SPX high of 4796.56 made on January 3, 2022 for several years.

Fed and Economics

The preliminary estimate for fourth quarter GDP was 2.9% which was much better than the consensus view and it followed the 3.2% growth rate generated in the third quarter. Fixed residential investment declined 9.2% in the quarter and it is highly unusual for residential investment to decline this much without the overall economy being in a recession. We are not sure if this is good or bad news, but since we expect the Fed to raise rates at least two more times this year, housing will likely drag economic activity lower in coming months. See page 7.

In December, personal income rose 4.7% YOY, disposable personal income rose 3.2% YOY, yet real personal disposable income fell 1.7% YOY. Still, this was an improvement from July 2022 when real personal disposable income fell 5% YOY, and purchasing power was seriously eroding. However, inflation is taking a toll on consumption, which fell 0.2% in December after falling 0.1% in November. And though the pace of PCE has been decelerating in recent months, it was still rising 7.3% YOY in November and December. The question is how strong or weak will PCE be in 2023? See page 8.

There were clear signs that inflation was decelerating in December. The CPI fell from 7.1% YOY to 6.4% and core CPI declined from 6.0% YOY to 5.7%. Inputs to the CPI are also slowing. PPI for finished goods eased from 10.7% YOY to 9.0%, core PPI was modestly lower from 8.0% to 7.89%, and final demand PPI fell from 7.3% YOY to 6.2%. Equities appear to be celebrating this deceleration in inflation, but remember, these inflation rates remain multiples higher than the Fed’s target of 2% inflation. See page 9. The Federal Reserve’s preferred measure for inflation is the PCE deflator and that eased from 5.5% YOY to 5% YOY in December. Even so, this means the PCE deflator remains 70 basis points above the current fed funds rate. In short, there is plenty of incentive for the Fed to increase interest rates 25 basis points at this week’s meeting and another 25 basis points at the next meeting that ends on March 22. See page 10. We expect the Fed’s statement will be hawkish this week, as it should be. Inflation is not as easy to reverse as many investors appear to believe, and though the current rally could have further upside, we would remain focused on maintaining a portfolio tilted toward value.

Gail Dudack

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