Into Every Life a Little Rain Must Fall

DJIA:  34,122

Into every life a little rain must fall.  In the stock market it’s called a correction, in this case a 2% drop in the S&P.  They will tell you it’s because of this, or that, but basically stocks have been stretched, along with investor enthusiasm.  Investor’s intelligence recently showed a move from 0% to 30% in the Bull-Bear spread, a move that typically results in a couple week setback, but little more.  Together with a recent one-year high in the S&P’s favorable implications, the A/D index of S&P components reached a new high as well.  Contrary to what many believe, the average stock tends to drag along the stock averages, both up and down.  Meanwhile, we are now in the seasonally interesting period around the July 4 holiday, with both good and bad implications.  Fortunately, the bad ended with the close June 28, and saw A/D’s days negative 6 of 8 days prior to that.  The favorable period this year extends to the close on July 7.  Historically the market is up some 70% of the time with an average gain around 2.4%, according to

Last time we mentioned the 21-day weighted moving average in reference to GE (108).  Most of Tech and other extended names, like Tesla (258), Netflix (428), Nvidia (408), XLK (171), and so on, have held their 21-day.  If they can hold even this “trading” moving average amidst the weakness in these stretched and volatile stocks, it seems surprisingly positive.  Tech has borne the brunt of the recent weakness, while Econ-sensitive stocks have come through pretty much unscathed, and look promising, PAVE (31) or components like PH (387), ETN (199), FAST (59), PWR (195) and the like.

Frank D. Gretz

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US Strategy Weekly: FOMO

According to Morningstar, US exchange traded funds saw a massive $40 billion weekly inflow for the week ending June 14, 2023. This was the sixth largest weekly amount on record and the flows, particularly into equity ETFs, appear to represent a significant shift in investor sentiment.

Meanwhile, according to the Wall Street Journal, bullish bets on artificial intelligence have been booming this month with more than 1.3 million call contracts on chip makers Nvidia Corp. (NVDA – $418.76), Intel Corp. (INTC – $34.10), and Advanced Micro Devices, Inc. (AMD – $110.39), changing hands on an average day. This burst of activity puts June on track for setting a record that would surpass the trading peak seen in November 2021. Keep in mind that November 2021 is quite memorable since the Nasdaq Composite index reached its all-time high of 16,057.44 on November 19, 2021.

And lastly, another example of extreme volume and extreme prices was seen in CBOE Global Markets data, where there has been record activity linked to S&P 500 index options, with one-day trading in calls surging and pushing up the prices of call options to extreme levels.

Couple this excitement with the $1.44 trillion sitting in retail money market funds (as of June 5), and one can see there is plenty of dry tinder on hand to move prices even higher. Market commentators on CNBC are suggesting it is “FOMO” – the fear of missing out – that is driving the surge in AI related stocks, some of which, like Nvidia have tripled in price in the last six months.

As I listen to analysts on CNBC talk about how artificial intelligence and ChatGPT will change technology as we know it, inspire trillions of dollars of investment and innovation, and disrupt companies that do not adapt, I cannot help but remember the excitement seen in similar times, like the Nifty Fifty era or the rally that led to the dot-com bubble of 2000. There is no doubt that there will be money invested and to be made in artificial intelligence; however, picking the right stocks at the right time will be crucial. Right now, it seems like patience and caution should be advised in view of the three-fold move seen in one of the best-positioned AI-related stocks – Nvidia.


From a technical perspective, there are other signs of caution. The AAII sentiment survey has had three consecutive weeks of above average bullishness coupled with three weeks of below average bearishness. The last time this combination appeared, it lasted five weeks in October-November of 2021. This is another worrisome parallel to the November 2021 top in the Nasdaq Composite index. These parallels to the Nasdaq Composite are important since it is only a small number of technology stocks that are currently leading the June advance. News headlines are focusing on the 14% year-to-date gain in the S&P 500 index, but the Nasdaq Composite index has gained 29.5% to date, or more than double the S&P’s gain. Meanwhile, the Russell 2000 index has recorded a 5% year-to-date gain and the Dow Jones Industrial Average is up a mere 2.4%. It has not been a broad-based advance. However, if there is downside risk in the equity market today, we believe it is also concentrated in the Nasdaq stocks.

The 10-day new high and 10-day new low indicator is bullish averaging 193 new highs and 52 new lows. But our 25-day up/down volume oscillator remains neutral and reveals a lack of convincing volume in advancing stocks. More importantly, NYSE volume was below the 10-day average for many days during the early June advance and the highest volume days in the last four weeks have taken place on May 31, 2023 when the DJIA lost 134 points, June 16 when the DJIA lost 109 points and on June 23, when the DJIA lost 219 points. These high volume down days suggest distribution, not accumulation, of equities. See page 12 and 13.

Last week’s decline in the indices is barely perceptible in the charts of the SPX and IXIC, just like the June rally is not significant in the charts of the DJIA and RUT. The unweighted S&P 500 ETF is similar to the RUT and has been rangebound. See page 11. The Russelll 2000 index remains our main focus and it suggests the market remains in a long-term trading range.


If we deconstruct the drivers of the 2023 equity market, we find that gains are due to a combination of earnings expectations and multiple expansion. A chart of IBES Refinitiv and S&P Dow Jones quarterly earnings expectations for the next seven quarters shows that analysts are anticipating solid straight-line EPS growth through to the end of 2024. See page 8. Unfortunately, PE multiples are currently above the standard deviation range, a sign that stocks are not cheap. And ironically, the 12-month forward PE is higher than the 12-month trailing PE, due to the deceleration in earnings growth seen in the first quarter. That is rare, and it is a pattern that often appears before an earnings decline. Moreover, if we look at the historic relationship between nominal GDP and S&P operating earnings, we find that earnings are, and have been, well above trend since early 2021. These outsized earnings gains could be due to margin improvements or post-pandemic stimulus; however, history suggests that this excess-earnings trend is not sustainable over time. See page 9. In sum, EPS expectations are robust, PE multiples are high, and EPS are rising faster than the underlying economy. It is a treacherous combination.


May’s inflation data produced good news, particularly headline CPI which fell 0.9% to 4% YOY. Yet, prices for food, housing, recreation, and services continue to rise faster than headline CPI. What helped May’s inflation data was a decline of nearly 12% year-over-year in energy prices. Still, inflation trends are generally decelerating, even for owners’ equivalent rent. See page 3. Although most of the deceleration in inflation is due to the dramatic decline in the price of crude oil — which was the initial catalyst for surging inflation in 2021 — the residual problem is now service sector inflation. Service inflation is driven by wage inflation, not energy prices. Unfortunately, the tightness in the labor market may make it difficult to reverse this trend quickly. See page 4.

Retail sales rose 1.6% YOY in May led by restaurants, drug stores, and nonstore retailers. But based on 1982 dollars, total retail and food services sales fell 2.4% YOY, the sixth negative month in the last seven. Typically, when real retail sales have been negative for more than a month or two it has been a sign of an economic recession. It might be different this time, but other data also suggest a recession is on the horizon.

The Conference Board leading economic indicators index declined again in May marking 14 straight months of declines. This is the first time the LEI has been down for 12 consecutive months or more without an economic recession being in place. In addition, the inversion in the yield curve is the greatest of any seen in over 42 years, and it too has historically predicted both economic recessions and bear markets. In our view, the missing ingredient for an all-out recession is negative year-over-year growth in jobs. A healthy post-pandemic labor market is sustaining the US economy. See page 5.

Consumer confidence surprised favorably in June. The Conference Board Consumer Confidence Index gained from an upwardly revised 102.5 in May to 109.7 in June — its highest level since January 2022. The outlook for business and the labor market improved in June. The University of Michigan survey was up from its May low, but it remains below January’s level and is stuck at a recessionary level. Similarly, May housing data included tentative signs that the decline in the residential housing sector could be bottoming. Nonetheless, assuming interest rates will move higher in the months ahead, it could be a tentative bottoming process, at best. We remain cautious.

Gail Dudack

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Follow the trend … But that’s following the herd

DJIA:  33,946

Follow the trend … but that’s following the herd.  The trend is pretty clear.  The problem is it’s so clear most are on to it.  They say the crowd is wrong at extremes but right in between.  This may be one of those extremes, if only temporarily.  When it comes to gauging settlement, we typically prefer to look at investor action rather than investor talk.  Put-Call Ratios relate to the former, and they’re back to levels of last March.  When it comes to indicators that use investor surveys, Investors Intelligence has been around forever, and measures the opinion of market letter writers – a drop dead smart group.  Here the spread between bulls and bears has moved from 0% to 30%, a change which typically results in a couple weeks of stall or pullback.  Subsequently, however, the outcome is surprisingly positive, with the market almost always higher a year later.

Meanwhile, while pretty clearly up, the S&P has achieved a milestone of sorts.  It has moved from a one-year low to a one-year high.  This has happened some 25 times since 1948, according to, with only one loss in the six and 12-month period.  Of course, up doesn’t mean straight up, but there were only two drawdowns of 10%.  You might argue this time is different given what most consider a narrow market.  Indeed, fewer than 5% of the S&P stocks are at one-year highs.  Historically this did not significantly change the outcome.  So we can add this to other aspects of the background that have similarly suggested favorable outcomes.  The first quarter, for example, held the December lows, leading to a higher prices April – December some 90% of the time.  And we have seen back-to-back up quarters which, according to Tom Lee of Fundstrat, never happens in bear markets.

Despite what many consider the market’s limited participation, the A/D index for the S&P has reached an all-time high.  Note this is for the S&P components, not all NYSE stocks, which is what we typically reference.  It’s not unusual to see a discrepancy in these numbers, it’s again about progress not perfection.  The NYSE numbers show no important divergence, at least with the DJ, against which we typically measure.  The S&P A/D Index itself has a credible record, leading to an annualized return in the S&P of almost 19% since 1928, according to  Interestingly, too, of the 23 occurrences there were only three drawdowns of 10% at any point in the next six months.   Contrary to what might seem logical, the average stock tends to drag along the stock averages, both up and down.

Watching the after-hours trades Tuesday night, we couldn’t help but be struck by the juxtaposition of Tesla (265) going by up some 17 points as Cramer stood on the floor of a Ford assembly plant.  To be fair, while no Tesla, both Ford (14) and GM (37) have more than respectable charts, and Tesla has come in a bit since then.  These almost sacred stocks like Tesla, the “Magnificent Seven” or whatever, have been pretty much impervious to market weakness, at least so far.  We hesitate to say corrections here might be healthy, since we never understood why losing money is healthy.  But we know what they mean, and a respite of sorts would do some good.  And a little weakness in the sacred would put a little fear in things, fear creates selling and selling creates a low.  While we consider this a minor selloff, it could take another week or so to be resolved.

The Energy sector is what you might call lurking.  They’re probably not quite ready for prime time, but they’re getting there.  A stock like Vista Energy (24) did break out the other day, but failed to follow through and is, in any case, not exactly an Energy bellwether.  Stocks like Baker Hughes (30) and Halliburton (31) are promising, but still not there.  Meanwhile, NatGas seems particularly interesting, but here the seasonal pattern is unfavorable until almost the end of July.  During this time NatGas is up only some 15% of the time.  Still, seasonals are one thing but not the only thing.  We would pay attention to a breakout in something like UNG (7).  After a little respite, we fully expect Tech to continue as leadership, though we certainly wouldn’t forget those economically sensitive names we went through last time.  We would also note the better action in drug wholesalers like McKesson (417), AmerisourceBergen (188), and Cardinal Health (93).

Frank D. Gretz

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Trend isn’t just your Friend … It’s your nearest, dearest, bestest buddy

Trend isn’t just your friend … it’s your nearest, dearest, bestest buddy.  Look at what trend has done for Tesla (256).  When it recently got on one, it stayed on one 13 days through Wednesday, without so much as one down day.  Consider, too, Tesla isn’t exactly known for a lack of volatility.  Sure the market’s new dynamics has played a role, but not even Nvidia (427) can match Tesla here.  There is, however, another and more mundane stock that is perhaps our favorite example of a consistent uptrend.  Those of us who trade, and a measure favored by IBD, know the weighted 21-day moving average.  The weighting here simply means day 21 counts for 21 times as much as day one.  It is as they say, a very fast-moving average, one which very closely hugs the price action.  Since the start of the year, GE has gone from 65 to 105 without falling below its 21-day weighted moving average.

Meanwhile, the backdrop seems to be filling in the bull market blanks.  Forever it seems it has been “don’t fight the Fed.”  Now if not over, the fight seems close to over, and the Fed won to look at recent CPI and PPI numbers.  Of course, only the Fed would remain data dependent while the data they depend on is old news.  You would think they’ve never heard of the lagged effects of monetary policy but hey, nobody’s perfect.  So that just leaves the looming recession standing in the way here.  And while well-advertised, it doesn’t mean it won’t happen.  We just think there will be no significant downturn, and we say that after consulting with the charts of Grainger (744), Cintas (492), Ingersoll Rand (65), Lincoln Electric (196), Eaton (197), and Parker Hannifin (374) – the latter was used by Greenspan as an economic indicator.  These economically sensitive stocks are at or are near all-time highs.  We doubt this would be the case if we were facing a severe downturn.

The bear market was itself unconventional, perhaps helping to explain why many are uncomfortable with this new uptrend/bull market.  When it comes to the bear market, even its low seems misunderstood.  Most call October the low, true enough if you’re talking about the market averages.  When it comes to the market in terms of the average stock, the low was last June.  Last June was a washout low, October was what they call a secondary low, a low with less selling pressure.  In turn, that has left the recovery a bit disjointed, and complicated by ongoing rotation.  And then, of course, there was the setback of the banking crisis.  The NAZ/Tech breakout in mid-May and the S&P breakout a few weeks later were the game changers.  You might argue this is when the real uptrend/bull market began. Even now, however, we still have not completely come out of what has been three or four months of base building.  Stocks above the 200-day, for example, are still only just about 50%, well below the 70% level of February.

The VIX (14), or Volatility Index is always a bit controversial, often misunderstood, and taken by many to be pretty much useless.  The latter, in this case, often have a point.  When it comes to market weakness, volatility as measured by the VIX rises out of fear, fear creates selling, and selling eventually creates a market low.  However, there is no magic number to the rise needed for such a low, rather it’s a peak and subsequent decline in the VIX that signals the panic/selling is out of the way.  A low VIX, in turn, seems often to stay low without consequence.  Indeed, the VIX currently is at a two-year low as the S&P makes higher highs.  Contrary to popular thinking, multiyear lows in the VIX tend to occur in bull markets, not in bear markets.  Except for August 2000, every two- year low in the VIX occurred in a bull market, suggesting that at the very least the VIX is not a worry.

They didn’t see inflation coming, what makes anyone think they’ll see it going. The Fed does seem determined however, probably out of fear of being wrong twice – it’s called human nature.  Fortunately, the market sees things differently.  Even the Fed induced market bashing Wednesday saw 1700 stocks advance, not bad for any day.  And Thursday’s better than 3-to-1 up day wasn’t exactly the “weak rally” about which we forever worry.  The numbers, of course, speak to a broadening market.  Note the breakout in the Russell despite its 17% weighting in Regional Banks.  One group that would further help here is Energy, which had a good day Thursday – especially Nat Gas.   But most stocks are at least lifting, and why not.  After all, they stopped going down a year ago and since have just been base building.  We don’t like to sound more bullish on the way up, but in this case things have become more bullish.

Frank D. Gretz

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US Strategy Weekly: An Old Wall Street Adage

A Hostile Pause

The Federal Reserve is likely to pause at this week’s FOMC monetary meeting for a number of reasons, but none greater than the fact that this is precisely what the market has discounted and is expecting on June 14. To date, the Fed has been successful in molding sentiment for a rate hike well in advance of each meeting and therefore it has not shocked investors with its actions. This is done quite adeptly through presentations and speeches made by various Board Governors in the weeks preceding each FOMC meeting. However, while sentiment is currently looking for a pause, we do not think Chairman Powell is convinced that rate hikes are over. We believe he is being honest when he says that future policy will be driven by future data.

Right now, it is difficult to predict how weak or how strong future data and the economy will be in the second half of the year. As we pointed out last week, there were a number of weaknesses in May’s jobs report that were hidden by a strong headline number. Plus, no one can predict what will happen in October when the moratorium on student loans ends and 40 million borrowers will begin repayment for the first time in over three years. This will be an unprecedented event. What is certain is that it will dampen consumer spending.

Yet as the FOMC meets this week, a major discussion is likely to center on the impact of the debt ceiling resolution on the second half of this year. How the debt markets will respond to what is expected to be the issuance of more than $1 trillion in Treasury bills will be another unknown. This massive debt issuance is a double-edged sword since the increase in supply is expected to result in rates moving higher. And with so much of America’s debt on the short end of the curve, interest payments will also rise, increasing America’s overall debt load. This circular problem of higher rates and more debt issuance may not become a problem in the near term but barring a change in the trend of US debt and US interest rates, it will become a significant problem in the intermediate-to-long-term.

Nevertheless, investors have been celebrating the expectation that the Fed will pause in June and may or may not raise rates again in July. There is a growing consensus that a July rate hike is one and done, or that rate hikes are already done. But keep in mind that this has been what has been fueling the June rally. Recent equity gains are due to a shift in sentiment and not a result of good earnings. Yes, the first quarter’s earnings reports did generally beat expectations, but only because those expectations were already beaten down dramatically. What really matters is whether earnings are growing on a year-over-year basis. According to Refinitiv’s “This Week in Earnings” report, the first quarter earnings results are expected to show a rise of 0.03% on a year-over-year basis, and if the energy sector is excluded, earnings are expected to fall 1.7% YOY. According to S&P Dow Jones consensus data, which uses GAAP accounting, first quarter earnings are expected to rise 6% year-over-year, but from a much lower 2022 base. S&P Dow Jones data shows S&P 500 earnings per share fell 5.4% YOY in calendar 2022; whereas, Refinitiv had earnings rising 4.8% YOY in calendar 2022.

Equity prices have not been rising due to expectations of a stronger economy. According to data from the Mortgage Bankers Association, housing has become unaffordable for most Americans. In April the industry group’s Purchase Applications Payment Index rose to a record high of 172.3. Similarly, a recent report from the National Association of Realtors and states that over 75% of homes on the market are too expensive for middle-class buyers. In sum, a combination of inflation and rising interest rates is having a very negative impact on most households.

There has been some good news recently. The Fed’s balance sheet is contracting again following the liquidity boost in March done to offset the banking crisis. Although reserves are still $50 billion above the low level seen in early March, there is a sense that the banking crisis has eased. Meanwhile, a key liquidity benchmark – the 6-month rate of change in total reserves at the Fed – continues to be negative, indicating that the Fed is generally draining reserves from the system. This could become meaningful in coming months. While an increase in the Fed’s reserves tends to coincide with bull markets, the draining of reserves has been less predictive for the equity market; however, it tends to coincide with flat trends. See page 3.

Money supply (M2) continues to contract at a record pace as bank deposits and other liquid deposits leave the banking system in search of higher-yielding substitutes. This is not surprising, but it does hinder banks that need to borrow on the short end of the interest rate curve and loan at the higher end. It points to the fact that credit will be tighter in the months ahead. See page 4. And since the Fed has raised the fed funds rate nine times in the last twelve months, higher interest rates also impact borrowers. It is notable that the real fed funds rate is now positive for the first time since October 2019. See page 5.

If you wonder why there is a big debate among economists about whether a recession is at hand, or not, the charts on page 6 may help. It might be different this time, but history suggests a recession is on the horizon when we look at historical parallels. The current inversion in the yield curve is the greatest seen in over 42 years, and inversions have historically preceded economic recessions. Economic recessions produce bear markets in equities. The inversion of the yield curve may come early, but an inversion of this depth and length has predicted a recession in every case since 1954. We are of the view that history is a good guideline for defining risks in the equity market despite the fact that market sentiment is now tilting toward a mild recession or no recession. The one indicator that does not (yet) point to a recession is the year-over-year change in employment. That remains positive.

The acceptance of the current advance in stocks has been swift and dramatic and this is worrisome to us. Last week’s AAII sentiment survey resulted in a 15.4% surge in bullishness, now at 44.5%, and a 12.5% fall in bearishness, now at 24.3%. Investor bearishness is currently at its lowest level since November 11, 2021. Bullishness is now above average for the first time since February 2023 and at its highest level since November 11, 2021. Note that November 11, 2021 was less than two months prior to the major top in equities seen in January 2022. The Bull/Bear 8-week Spread remains in positive territory, but barely. See page 11.

Several technical indicators have improved this week including the 10-day averages of new highs, now at 172, and new lows, now at 60. This combination has turned positive with new highs above the 100 benchmark. But our 25-day up down volume oscillator remains neutral at 1.26 and is actually down from last week’s high. More importantly, the NYSE volume has been below the 10-day average for the last nine consecutive trading sessions and has not been impressive. The last high-volume day took place on May 31, 2023 when the DJIA lost 134 points. In sum, we would not chase this rally, particularly the large cap technology stocks that have been in the lead. If it is true that the real catalyst for the advance is the expectation that the Fed will pause in June, the wisest thing may be to follow the Wall Street adage “sell on the news.”

Gail Dudack

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Turn your back… and it’s a new bull market!?  

DJIA:  33,833

Turn your back… and it’s a new bull market!?  So they say, they being those who believe a 20% rally in the S&P makes it so. Fine with us, though it doesn’t quite feel like a new bull market.  To feel it, you probably have to be in what someone aptly called the Magnificent Seven, and probably little else. Even if you were in uptrends like McDonald’s (286) or Microsoft (325), they never seem to go together. It’s like Superman, why is it you never see Superman and Clark Kent together? And who amongst us is without sin, that is, a few clunkers.  So the S&P has been tough to match, much like the 80s when few owned enough Microsoft to keep up. Apple (181) these days is a 7% position in the S&P, so to speak, while most funds can’t hold a 7% position in anything.  Whatever you choose to call this market, Friday’s rally says they want to go higher.

Last Friday’s was a surprisingly good rally, and in ways that were more subtle than most realize. The Dow, for example, rose 700 points, both impressive and not very subtle. Consider, though, the Dow has lagged the NAZ and S&P, making its rally a bit more impressive. Similarly, Friday’s 5-to-1 A/D numbers are not unheard of, but they typically come along after a washout sort of selloff.  There was more concern than fear about the debt ceiling, and certainly no real weakness. The QCHA is a number from the old Quotron system, which measures how much stocks are up, not just whether they’re up like the A/Ds. Friday was the best day since January, meaning stocks were not just 5-to-1 up, they were up a lot.  A number of years ago we used that number in a piece and got a call from Barron’s asking where they could find it.  We both had a good laugh when we said – Barron’s. 

Not only were the Friday moves in some individual stocks dramatic, they also seemed technically important.  A 17-point move in Caterpillar (234), for example, is an outsized move for that stock.  More importantly, it also moved the stock above its 50-day moving average for the first time since mid-March.  Similarly, without wanting to be demeaning of our four-legged friends, Dupont (70) has been among them.  Here, too, its five- point rally on Friday lifted the stock above its 50-day.  Then there are the Regional Banks, a group we had begun to think of as investment shorts, especially in light of the Treasury’s required financing.  The Regional Bank Index (KRE-44) on Friday also moved above its 50-day.  Meanwhile, there were a myriad of Econ-sensitive stocks, already with decent patterns, that performed well – names like Cintas (483), Eaton (188), Fastenal (54), and Parker Hannifin (356).  And who knew AI was so dependent on welding – to look at Lincoln Electric (191), you might think so.

What has been a narrow market has not gone unnoticed.  And things noticed usually don’t matter, or at least they’re not the market’s undoing.  Now things seem to have gone a step further, where some are arguing narrow markets don’t matter.  While we have heard, but not read the arguments here, we’re sure they have their data.  Then, too, there’s your data, there’s my data, and there’s the undisputed data.  Unfortunately, there’s no undisputed data here, the real issue may lie in time frames.  Back in 2018 the Dow moved to successive new highs in three days, while the A/Ds were negative each of those days.  The market subsequently abruptly fell 20% into the end of December.  In 1987 the A/D Index peaked in March, and subsequently showed a pattern of negative divergences against the Averages.  While the latter continued to move higher, it didn’t matter until October – then came the Crash.  Divergences matter, sometimes not until they matter.

While we haven’t exactly embraced the Cathie Wood/ARK concept, there are a couple of the ETFs that cover some stocks we like. The ARK Autonomous Technology ETF (ARKQ-53) has a 15% position in Tesla (235), along with Nvidia (385) as one of its top 10 holdings.  When it comes to stocks like NVDA, our rule of thumb is the first time you think it’s over, you’re wrong, and so too the second time.  Typically, there’s no third time. Momentum like this doesn’t go away easily or quickly.  Not to dismiss the market’s seeming broadening, Tech is leadership, but as Wednesday made clear, there will be setbacks.  Meanwhile, stocks above the 200-day have improved to 51%, but here it’s progress not perfection.  And don’t forget those A/Ds, it’s not just the Averages that will keep this going, you have to have the average stock as well.

Frank D. Gretz

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US Strategy Weekly: It’s Not What It Seems

Regional Banks

Last week’s passage of a bi-partisan debt ceiling bill extended the worrisome debt ceiling debate to January 2025. This bill resolved a major crisis that could have triggered a default on US obligations and crushed the US dollar and economy. However, the aftermath of this bill could result in different unintended circumstances. And while some investors may be celebrating these consequences, we believe the short-term positives may not outweigh the longer-term problems.

The balance in the Treasury General Account dropped from $140 billion in mid-May to under $23.4 billion last week and the lifting of the debt ceiling means the Treasury can and must refill its coffers in the coming months. Analysts at Deutsche Bank have estimated that a whopping $1.3 trillion in Treasury bills will be issued over the remainder of 2023, bringing total issuance for the full year to about $1.6 trillion. This massive issuance of Treasury bills will almost certainly drain liquidity from the financial system and could also steepen the yield curve.

The problem with this is that a further rise in short-term interest rates and a further steepening in the yield curve will make the environment even more difficult for the banking system and for the regional banks in particular. Banks borrow on the short end of the yield curve and lend on the long end and a steep yield curve is not a profitable situation. Regional banks are already suffering from a serious exodus of deposits as account holders seek higher-yielding investments found in the Treasury market and/or money market funds. And as deposits continue to leave the financial sector, credit conditions will continue to tighten, and this will slow economic activity.

Adding to the pressure on the banking sector is the fact that regulators are currently planning to increase capital requirements for all banks with $100 billion in assets or more (down from $250 billion in assets) and this could mandate increases in capital cushions for some banks by as much as 20%. Again, this would add another burden on regional banks.

Last, but far from least is the potential for a crisis in commercial real estate and the ramifications on the commercial real estate debt market. According to the Wall Street Journal, in the next three years an estimated $1.5 trillion in commercial mortgage loans will come due. Data provider Trepp indicates that interest-only loans as a percentage of newly issued commercial mortgage-backed securities have represented 65% or more over the last ten years but this increased to 88% in 2021. And while borrowers typically pay off these mortgages by selling real estate or getting a new loan, falling real estate prices, and rising interest rates make neither of these options attractive in the current environment.

Given all these pressures on the real estate and financial markets, we find it curious that regional bank stocks have rallied in recent trading sessions. However, it may be that investors have viewed this from a short-term perspective and have concluded that the Federal Reserve is unlikely to raise interest rates next week. Given the fact that the Treasury market will already be dealing with a significant increase in supply in the month of June and is faced with an unknown amount of demand, this may prove to be true. In fact, it is questionable whether the Fed can continue with its quantitative tightening policy in the face of record debt issuance. Therefore, we are less convinced that the Fed will raise rates in June. But while the Fed may choose to pause next week, this is not great news, and it does not make us bullish. 

Labor Markets

The BLS establishment survey indicated an increase of 339,000 jobs in the month of May, which was stronger than expected. However, the accompanying household survey suggested that employment fell by 310,000 jobs and that unemployment grew by 440,000. This discrepancy explains the increase in the unemployment rate from 3.4% to 3.7% for the month, but it also raises questions about the real strength of the job market. Job trends are important since one of the best leading indicators of a pending recession is a year-over-year decline in jobs. From this perspective, neither BLS survey suggests the economy is on the verge of a recession. See page 5. And the household survey showed other cracks in the data. Permanent job losers as a percentage of all unemployed was 26% in May, up from 21% in October. Of job losers and those completing temporary work, 36% were permanently laid off in May. The number of workers no longer counted in the labor force, but who indicated they want a job, increased from 5% to 6%; while discouraged workers increased 93,000 in the last 2 months to 396,000 in May. See page 6. Overall, the headline 339,000 job increase with upward adjustments to previous months was just not what it seemed. There were signs of weakness beneath the surface.

The Stock Market

Tesla Inc. (TSLA – $221.31), Alphabet Inc. C (GOOG – $127.91), (AMZN – $126.61), Apple Inc. (AAPL – $179.21), Meta Platforms, Inc. (META -$271.12), Microsoft Corp. (MSFT – $333.68), Netflix Inc. (NFLX – 399.29) and Nvidia Corp. (NVDA – $386.54) , represented about 22% of the S&P 500’s market capitalization at the start of the year, and now account for more than 30%. These stocks have been investor favorites this year which helps to explain why the equally weighted version of the S&P 500 (.WEGSPC – $5842.49) is up just 1.1% this year, the DJIA is up 1.3%, and the Russell 2000 index is up 5%, while the SPX is up 11.6% and the Nasdaq Composite has gained nearly 27% YTD. The recent rally clearly generated breakouts in the SPX and the Nasdaq Composite but is not visible in either the DJIA or the Russell 2000. See page 11. And despite the drama of a 701-point gain in the DJIA on June 2, 2023, there was no meaningful change in our 25-day volume oscillator or the NYSE cumulative advance/decline line in recent days. Moreover, the 701-point move materialized with NYSE volume that was below the 10-day average and volume continues to trend below its 10-day average. See pages 12-13. These are not impressive breadth statistics. We remember the Nifty Fifty and Dot-com eras, so we know narrow markets can be sustained longer than many expect. But we are not chasing this rally and believe the broad market will remain in a wide trading best seen in the Russell 2000 between 1650 and 2000.

S&P Earnings As the first quarter earnings season ends, the S&P Dow Jones consensus estimates for 2023 and 2024 were $218.69 and $244.70, up $0.77, and $1.03 for the week, respectively. Refinitiv IBES earnings estimates for 2023 and 2024 were $220.89 and $246.70, up $1.54, and $1.63, respectively. But note that last week’s big increases effectively erased the declines seen in estimates over the prior three weeks. We did not see any major earnings release to account for this big change and therefore believe it is due primarily to positive forward guidance. However, it is also important to note that S&P data shows that 18.4% of companies reporting first quarter earnings had a decrease of 4% or more in their shares outstanding. This decline in shares outstanding boosts earnings per share but does not represent a significant change in overall earnings growth. In sum, earnings are not all that it seems. See page 9.

Gail Dudack

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Party like it’s 1999!  That is to say, party like you own Tech, and little else

DJIA:  33,061

Party like it’s 1999! That is to say, party like you own Tech, and little else. Back then you could put dot-com behind your name and it made it worth another 20%. The same is true now if you’re anything AI-ish. The latter is the new, New Economy.  Meanwhile, the Old Economy stocks are pretty much everything else. Hence, it’s an S&P Index hovering around its highs with fewer than 40% of stocks in uptrends, that is, above their 200-day.  This is anything but a healthy backdrop, technically speaking. While this will last until it doesn’t – you can’t underestimate momentum. The Semis had their best day ever last Thursday, gaining some 11%. When they have gained 5% or more in a day, they’re higher a month later more than 70% of the time, according to Back in 2000, it took a peak in the dot-coms to get the rest of the market going again, by then the rest had become sold out. On the plus side, with better than 3-to-1 A/Ds, Thursday was a surprisingly good day.

Speaking of Tech, it wasn’t a pretty picture after hours for those reporting on Wednesday. We don’t like to see downside gaps, but we find their significance less when they don’t change an overall uptrend. You might want to look to Snowflake (167) as a guide here.

Frank Gretz

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