Two Months … But Who’s Counting

DJIA:  35,282

Two months … but who’s counting.  The market hasn’t suffered a 1% down day in two months. That’s quite a streak though by no means the longest.  It’s the kind of streak that doesn’t happen in bear markets.  Still, when the streak ends you have to wonder if the abyss awaits.  Despite what you might think or fear, history suggests otherwise.  It’s that momentum thing again – big uptrends don’t turn on a dime.  At play here, too, is what they call the market’s broadening.  And it’s not just semantics, it is broadening rather than rotation – we’ve expanded without leaving a lot behind.  The improvement in Staples and Financials are the prime examples here, both broad areas.  It’s a tough call to be negative on Tech, not one we are brave enough to make, or believe should be made.  That said, Tech stocks have come a long way and now there are opportunities elsewhere.

To make clear our thinking on Tech, there’s momentum here that won’t easily go away.  We’re thinking of a stall more than real weakness.  More than 90% of Tech shares are above their 50 and 200-day averages, having cycled from less than 7%.  This kind of change has produced good returns over the next six and 12 months for both Tech and the S&P, according to  The recent action here has become a bit more ragged, including Wednesday’s surprising weakness in Microsoft (331).  Meanwhile, while most may not realize it, stocks like Walmart (159) and Costco (562) are in their own long-term uptrends and arguably are acting better than most of Tech recently.  These are among the top 10 holdings in the Staples ETF (XLP-75), together with Coke (62) and Pepsi (189) which also are acting well and similarly have long-term uptrends.  As we suggested above, a problem for Tech might be it’s no longer Tech and Tech only acting well, you now have options.

So you say you always believed in the Meta-verse, or was it Facebook?  Left for dead late last year, Meta Platforms (312) as it’s now known, has tripled.  If Meta was on the giveth side, Microsoft was a bit on the taketh this week, but in the case of the latter, you have to wonder for how long.  The stock is dabbling with its 50-day, as it did a couple of weeks ago, and again back in April.  Were it to break, which seems unlikely, it would be a change of some concern.  Meanwhile, Google (129) had its own upside gap – guess FANG isn’t going away this week.  On the other side of Tech, both Costco and Walmart are bumping up against all-time highs, together with the likes of Cintas (505), Grainger (725) and Parker Hannifin (397) – strange bedfellows you might say.  And these days there’s the much improved commodity complex – Steel, Copper, and of course, Oil.  The China news may have helped, but these have been improving for some time.

Volume is important, both for the overall market and for individual stocks.  For the latter volume often precedes price, while a rally without volume is suspect.  Stock volume is pretty straightforward, what you see on the screen usually will do.  It’s a different story when it comes to the overall market where one might ask whose volume or what volume?  We use SPY volume which seems a reasonably straightforward and consistent gauge.  Most important is what side is volume on, so to speak.  We look at an A/D Index calculated only on those days when volume is higher than the prior day.  In theory volume should rise on up days and fall on down days, and over the years this Index has been helpful.   This measure turned decisively higher at the end of May.  Meanwhile, have you noticed stocks rarely split anymore?  If every $200+ stock were to split, think what that would do for volume overall.

While the Fed meeting was a snooze, we are always interested in what Powell has to say.  In this case he repeated numerous times that any further raises in rates will depend on incoming data.  We find it fascinating that even we know monetary policy acts with a considerable lag, yet policy depends on the whimsy of some number du jour?  Still the market hangs on this stuff. Fortunately Fed speak doesn’t usually matter for more than a day, and “don’t fight the Fed” has been about as useful as “sell in May.”  The market tells the story and the average stock tells the market story.  Talk has centered on the Dow’s winning streak going into Thursday, but the streak in the A/D numbers has been just as good.  Tops occur when markets lose participation as the money runs out – little sign of that so far.  Despite the performance by Meta, many stocks reversed early on Thursday, including Microsoft.  With Thursday the market may be in need of a little more correction.

Frank D. Gretz

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Contrary to many predictions at the beginning of the year, stocks have advanced nicely for the first half of 2023. While gains in the second quarter were still concentrated in large technology companies, market breadth broadened. On an equally weighted basis, the S&P 500 total return was 7% for the first half of the year.

Financial markets react not only to the level of economic data, but also to the direction and rate of change—and a lot has improved in the U.S. this year. To date, the percentage of people employed increased by 1% to an all-time high of 156 million, while unemployment hovers near the multi-decade low of 3.5%. With inflation falling, real disposable income increased 2.5% through May. Contributing to the current robust employment situation are many areas of the economy that are thriving, including fossil fuel production, new homes under construction, reshoring of manufacturing, and the beneficiaries of the $280B CHIPS Act and the $437B Inflation  Reduction Act.

There are risks this current economic strength could diminish. The U.S. Bureau of Labor Statistics reported 209,000 jobs were created in June, which fell short of estimates. More importantly, the rate of growth in private sector job creation continues to slow, reaching 159,000 in June. This figure has consistently slowed for the past 12 months. The U.S. labor market does not appear to have rolled over enough to remove concerns about wage inflation yet, and the Federal Reserve has forecast additional interest rate increases.  Price inflation likely peaked in mid-2022, however core inflation was still 4.8% on a year-over-year basis in June.

For these and other reasons, aggregate earnings expectations for both fiscal year 2023 and 2024 have been revised significantly lower since early 2022. The U.S. Treasury yield curve remains inverted, and the Conference Board’s Leading Economic Index has been in decline for 14 consecutive months, all while interest rates have been rising.

We believe the stock market is trading at one-year highs based upon the assumptions that there will only be a mild economic slowdown, a consistent drop in inflation, and the Fed will not hike rates more than expected. To extend the gains meaningfully from here, however, we think we will have to see interest rates falling, economic growth re-accelerating, or an increase in S&P 500 earnings estimates.  As to earnings and interest rates—both continue to matter.

July 2023


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US Strategy Weekly: The Elusive Pivot

The Dow Jones Industrial Average

We expected the last few trading days to be a pivotal time for the stock market, particularly since the DJIA and Russell 2000 indices were both so close to breaking above important resistance levels. Plus, our 25-day overbought/oversold volume oscillator was at the brink of possibly confirming the current advance with a lengthy overbought reading. However, some, but not all of this came to pass.

The Dow Jones Industrial Average did break above the 34,500 level on July 18th, but mostly thanks to a 14-point gain in Microsoft Corp. (MSFT – $350.98). Microsoft, up nearly 50% year-to-date with a market capitalization of $2.6 trillion, added over 90 points to the DJIA on July 18 and this boosted the DJIA to its highest level since February 2022. The catalyst for Microsoft’s hefty move was a free online event called Microsoft Inspire where Satya Nadella told corporations they could “learn how to accelerate AI transformation, drive customer success, and fuel business growth” with a future product called Microsoft 365 Copilot.

This week the company reported fiscal fourth quarter earnings which beat expectations with an 8% increase in revenues and net income of $2.69 per share, up from $2.23 a year earlier. But according to Yahoo Finance, the stock is currently trading at a trailing 12-month PE ratio of 38 times, which is rich even if Microsoft 365 Copilot proves to be successful. Technology analysts estimate Microsoft 365 Copilot product could add 10% to future revenues (although not before 2024) and this would be helpful since only revenues grew 7% in the last fiscal year. However, even 10% growth could be a hurdle since companies like, Inc. (AMZN – $129.13) and Alphabet Inc. (GOOG – $122.79) are competing for the same customers in the gen AI space. Competition usually lowers margins. Again, Big Tech has been core to the 2023 advance and earnings expectations are high.

The Russell 2000 Index

The Russell 2000 index did not move above the 2000 resistance, nor did the Invesco S&P 500 Equal Weight ETF (RSP – $154.65). Both are hovering at the top of the trading ranges that have contained both charts for the last 15 months. See page 9. It is still pivotal for these two indices. It is a week that could be market moving since it includes many earnings reports, an FOMC meeting, the advance report on second quarter GDP, and June’s personal consumption expenditure index. But for now, these indices continue to be in a long-term trading range.

The 25-day overbought/oversold volume oscillator

Our 25-day overbought/oversold volume oscillator is at a 2.53 reading this week and in the neutral range after recording a number of overbought readings on July 3, July 7, July 12, July 13, July 18, and July 19. See page 10. These were the first overbought readings since the one-day overbought readings recorded on April 28, April 24, and April 18. However, none of these overbought readings lasted the minimum of five consecutive days required to confirm the advance in the averages. Sustainable rallies are characterized by significant volume in advancing stocks which is denoted by a lengthy overbought reading. Impressive advances will include at least one extremely overbought day. This has not appeared to date. However, these technical requirements are required at a new market high and so far, none of the major indices have recorded new all-time highs. All in all, it is not that surprising that our indicators are mixed.


We expect the Federal Reserve will raise interest rates 25 basis points at this week’s meeting and remain “data dependent” about policy choices in future meetings. Fed Chairman Jerome Powell is apt to keep his comments somewhat hawkish about expectations for the September meeting, since any indication of a pause in monetary policy would inspire speculation and there are already signs of bubbling speculation in the stock market. Moreover, with the midpoint of the fed funds rate at 5.13% and inflation at 3%, it leaves the real fed funds rate at 213 basis points. Historically, a fed tightening cycle will generate a real fed funds rate of 400 basis points and we believe Powell’s goal is a minimum of 300 basis points. This 300-400 basis points can materialize through a combination of rising interest rates and falling inflation. This explains why the next few CPI and PCE deflator reports will be very important for the Fed and for the stock market. In our view, the Fed will likely raise interest rates again in September. At present, the consensus is not expecting a September rate hike which means it could be a negative shock. Therefore, we would not be surprised if Fed board members publicly discussed the possibility of another rate hike in the weeks ahead.

A Mixed Economy

The relationships between quantitative tightening, contracting money supply, and stock price movement have not been consistent in recent decades. But it is clear that the Fed’s liquidity boost in March done to offset the regional banking crisis is now over and their quantitative tightening program is back on trend. As a consequence, money supply measures, in particular M1 and M2, are now declining at a remarkable pace. See page 3.

Money supply is commonly defined as a group of safe assets that households and businesses can use to make payments or to hold as short-term investments. For example, US currency and balances held in checking accounts and savings accounts are included in many measures of the money supply. In past decades, money supply provided important information about the near-term course of the economy, equity prices, and inflation in the long run. We expect M2 to be less predictive today, but with the 6-month rate of change in money supply now contracting at a historic 3% YOY it could be a sign of slowing economic activity ahead.

The Conference Board’s leading economic indicator fell in June for the 15th consecutive month. As seen on page 4, this has been a reliable recessionary signal over the last 25 years. This indicator also suggests a recession is directly ahead.

Existing home sales were 4.16 million units in June, down 19% YOY. The median home price rose to $416,000, up 3.6% for the month but down 1.2% for the year. The recent rise in existing home prices is a result of near-record-low inventory. Not surprisingly, the National Association of Home Builders survey was at the best levels seen since June 2022, although traffic of potential buyers still remains in recessionary territory. Residential real estate appears to be recovering, but the potential for higher interest rates continues to be a risk. See page 5. The Conference Board confidence index rose to 117.0, its highest level since July 2021. Gains were driven by an improvement in consumers’ outlook for income, business, and job market conditions. The University of Michigan sentiment index jumped to 72.6 in July, up 41% YOY and its highest level since September 2021, yet the index still remains in recessionary territory. A rising stock market and stable gas prices helped boost the index in July. See page 6. In sum, consumer sentiment is improving but the stock market appears to be pivotal to this view. Unfortunately, equity prices have had a big advance without a big uptick in earnings. The second quarter earnings season has the potential to be important for investor sentiment and we remain somewhat cautious and would not chase current leaders but focus on companies with solid and predictable earnings streams.

Gail Dudack

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Who Needs Nvidia… When You’ve Got Good Old Microsoft 

DJIA:  35,225

Who needs Nvidia (455) … when you’ve got good old Microsoft (347).  On Tuesday MSFT showed NVDA how AI is done, and in the process moved to an all-time high.   The move came after the company announced pricing for its new AI subscription service – making money from AI, what a novel idea.  It’s not so much that this market is resilient, it’s more that it’s inventive.  While everyone worries about good stuff like earnings and rates, along comes AI to take everyone’s mind off of that.   Earnings so far haven’t been as bad as predicted, and the look of those Econ-sensitive stocks is reassuring.  New to the positive side is the recent hit to the dollar, typically good for the NAZ and the Russell.  The real positive, however, remains the technical background.  The stock market and the economy are two different things.  The stock market is sometimes hallucinatory, but it’s usually anticipatory.  What’s important here is what most stocks are doing, and for now most days they go higher.

Suddenly everyone has noticed the market is broadening.  Then, too, you have to ask relative to when?   We see this as pretty much a function of the impressive move in the energy complex –mindful that there are many stocks here – and the stabilization in the banks – again, many stocks here.  Getting back to time frames, to look at the Russell (1966) or the Equal Weight S&P (154), while much better, they’re only back to their February peaks.  Mind you we’re not complaining, for now we’ll take progress over perfection as we have become fond of saying in this market.  More important in many ways is the number of stocks above their 200-day, a good proxy for stocks not just going up, but going up enough to be in uptrends.  There was a rather dramatic jump last week to 63% versus only 50% the prior week.  It also remains below its February peak, but there’s that progress thing again.  Another important aspect of these numbers – 70% historically has said bull market.

Gold it seems has little to do with anything.  It certainly hasn’t proven an inflation hedge, or a hedge of any sort against the war in Ukraine – what did those oligarchs do with all their money?  Where there is some rhyme or reason is the correlation between the dollar and Gold, among other things.  And, indeed, the dollar has turned weak– recently dropping 3% in just five days to its lowest level of the year.  Weakness here typically begets even more weakness.  Pretty much tick for tick with the dollar, Gold shares have improved with most now above their 50-day averages.  This would include the ETFs, GDX (31) and GDXJ (38).  Gold also has seasonality going for it.  Between early July and early October gold is up some 63% of the time, with the average gain outstripping the average loss, according to

Gold may be in its own world, but that is not to say other commodities haven’t come to life as well.  We’re thinking here of the basics like Copper (COPX-40) and Steel (SLX-67), XME (52) is illustrative as well.  This seems another indication economies are not in such bad shape.  Of course, we contend that shows up foremost in stocks that would seem sensitive here.  You know most of them by now, but the PAVE ETF (32) covers them pretty well.  To look at Lincoln Electric (210), who knew AI entailed that much welding?  To judge by the ETF, PHO (58), one of the best acting commodities is water.  And Bitcoin has excelled of late, helped by the seal of approval from your good friends at Blackrock.   If overcoming adversity tells a story, so far so good for Bitcoin.

Have you noticed the reluctance on the part of most to call this a bull market?  That’s possibly explained by the inverted yield curve, the hawkish Fed and earnings worries.  There’s the fear some other shoe is about to drop.  Meanwhile, it certainly acts like a bull market, though one which has evolved in an unusual way.  Most would tell you the low was last October, and true enough for the averages.  For most stocks, however, the low was last May-June.  At a typical bear market most stocks make their lows together, not so this time.  Consequently, the uptrend has evolved differently.  And then there was the banking mishap in March, which also served to confuse things.  They say bull markets climb a wall of worry.  And they say bull markets don’t give you a good chance to buy.  That sounds a lot like this market, though Thursday did remind you even bull markets have their corrections.

Frank D. Gretz

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US Strategy Weekly: Do Earnings Matter?

Inflation Changes Everything

There was a perfect storm of good news this week. It started on July 12 with the release of June’s CPI data. Headline inflation tumbled from 4% to 3% in June and core CPI fell from 5.3% to 4.8%. Both were better than expected. And though many subcategories of CPI showed price gains greater than 3% YOY, most trends appeared to be decelerating. The transportation sector showed prices falling 5.1% YOY and motor fuel fell 27% YOY. One surprise in June was that all items less food rose only 2.5% YOY, down from 3.6% in May. What most impressed us was that for the first time since March 2021, June’s inflation of 3% fell below the average long-term inflation rate of 3.5%. This was a significant hurdle in our view and a sign that the Fed’s target of 2% inflation is possible. See page 3.

The PPI was also released last week. It showed finished goods prices declining 3.1% YOY, although finished goods excluding fuel and energy rose 4.3% YOY. But in general, PPI data indicated that commodity prices are no longer driving inflation. Service sector inflation remains an issue, but less so in June. Service sector CPI, although still high at 5.7% YOY, was down from 6.3%. What could be encouraging for service sector inflation was the deceleration in wage growth inflation from 5.6% YOY in January to 3.8% in June. Also decelerating was owners’ equivalent rent which eased from 8.1% in May to 7.8% in June. In sum, there was good news in most CPI categories, and this cannot be underestimated in terms of Fed policy, household purchasing power, and its impact on PE multiples. See page 4.

The New Student Loan Forgiveness Plan

Good news continued with the Biden Administration’s new proposal on July 14 to replace a loan forgiveness plan that was recently struck down by the Supreme Court. This new complex repayment plan — called the SAVE plan or Saving on a Valuable Education plan — is expected to save borrowers thousands of dollars by keeping their monthly payments small – often as small as $0 — while preventing interest from exploding on balances that they owed. According to the Department of Education, borrowers would now pay back just $6,121 for every $10,000 borrowed. A DOE fact sheet states that borrowers who earn less than $32,805 a year ($67,500 for a family of four) will not have to make any payments and more than 800,000 borrowers could have their remaining loan balances erased. This latter point would be the equivalent of $39 billion in debt forgiveness.

Law experts believe this complex and multifaceted plan is likely to survive since it is a revision of an existing income-driven repayment plan (IDR) called Revised Pay As You Earn (REPAYE). The estimated cost to taxpayers for this plan ranges from $138 billion (DOE), to $230 billion (CBO), and to $361 billion (Penn Wharton Budget Model), depending upon the source. Yet regardless of the cost, the new SAVE plan is clearly another fiscal stimulus program. And to a large extent, it reverses the risk that faced many households on October 1 when the student debt moratorium was scheduled to end. As we had noted, the end of the student debt moratorium would have meant 44 million Americans would restart monthly debt payments averaging between $210 to $320 and this would have been a big negative for the economy at the end of the year. The Biden Administration has erased this risk.

Merger Mania

On July 18, a US court ruled that Microsoft Corp.’s (MSFT – $359.49) $69 billion takeover of Activision Blizzard Inc. (ATVI – $92.74) could proceed despite objections from the Federal Trade Commission. MSFT rose 13.76 points for the day, giving the Dow Jones Industrial Average a big boost. But it also was an important milestone for the merger-arbitrage sector of the financial industry which has been going through a rough patch. There are several mergers lined up in the technology industry that could now start moving through the pipeline. This lifted stock prices and Wall Street’s confidence. Another catalyst for MSFT was its announcement of Microsoft 365 Copilot, which is a major bet on the value of AI to Microsoft corporate clients. The stock responded favorably and its market capitalization of $2.71 trillion is now second only to Apple Inc. (AAPL – $193.73) which is valued at more than $3 trillion.

Global news was also good for inflation, for example, Canada’s inflation rate fell to 2.8% in June. And global growth is slowing. Argentina’s GDP fell 5.5% YOY in May, and some forecasters expect China’s economic growth slow to 3%. In the US, retail sales for June rose only 1.5% YOY which means that after inflation, retail sales fell 1.5%. This was the seventh month in the last eight months in which sales were negative on a year-over-year basis. See page 5. Historically, negative real retail sales are associated with declining nominal GDP and a recession. Inverted yield curves and monetary tightening are also recessionary. But the offset to these items may be that job growth remains resilient, and this may be the most important indicator of all.

Earnings and Valuation are weak

The July 14, 2023 “This Week in Earnings” report from IBES Refinitiv showed a $1.86 decline in 2023 consensus estimates last week. See page 6. It is important to mention this since the stock market has been responding positively to the early second quarter earnings reports, due in large part to the fact that IBES also writes that “80% of the 30 companies that have reported earnings to date have beaten expectations.” Yet IBES also indicates that the 2023 S&P 500 earnings estimate is now $217.28, and below the 2022 earnings number of $218.09, representing a decline in earnings growth for 2023. See pages 6, 8 and 15. The current IBES EPS estimate for next year is $244.74, reflecting a 12.6% increase, but up from an earnings decline in 2023. All in all, this is not the earnings backdrop one would expect when the SPX is up 18.6% year-to-date and the Nasdaq Composite is up 37.1%. It is more in line with the Dow Jones Industrial Average which is up 5.4% year-to-date, or the Russell 2000 index which has gained 12.2%.

According to our valuation model, the equity market has been trading well above the fair value range since the first quarter of 2021, or for the last two years. The last time this happened was early 1997 leading to the peak in March 2000. In short, the market remained extremely overvalued for three years. This is what characterizes a bubble. Our earnings forecasts are well below consensus, but we show the model with both S&P and DRG estimates, and the “overvalued” results are similar. See page 7. In our view, the market is at a turning point. It either continues to soar ahead led by a limited number of stocks, much like a bubble where fundamentals are disavowed, or it consolidates or retreats waiting for earnings power to support higher stock prices.

Technical Help The charts of the indices may help in this time of indecision. The technical patterns of the SPX and IXIC are extended after recent gains and look vulnerable near term. Conversely, the DJIA appears to have just broken out (thanks to MSFT). The RUT continues to trade within its long-term trading range between 1650 and 2000, but is closing in on the 2000 level. The answer to whether the equity market is going to make a dramatic run up to new highs or take a pause, may be found in the near-term action of the Russell 2000 index. A clear breakout in the RUT well above the 2000 resistance level would be a big catalyst for further equity gains. Either way, we would not chase the recent market leaders but would look for stocks with solid earnings growth and reasonable multiples.

Gail Dudack

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It is Said the Prophet Enters Every Undertaking With Fear and Trepidation

DJIA:  34,395

It is said the prophet enters every undertaking with fear and trepidation … and so is always successful.  The market, however, seems not to worry while the rest of us do.  Seems a propitious backdrop.  The CPI threw the market a bone on Wednesday, but more often than not news has been more against it than for it.  Then, too, we would be the first to say markets make the news.  Bless their heart, the Fed is nothing if not persistent in it’s hammering.  Yet, the uptrend has been amazingly persistent, not just in terms of the market averages, but the average stock as well.  We had expressed some concern about Regional Banks and by extension Commercial Real Estate.  For now the stocks have so far overcome even that fear.  Granted stocks are not cheap, when are they ever in any uptrend like this?  When the trend changes that’s when not cheap matters. 

The market often defies simple logic, in this case by ignoring gravity of sorts.  The market seems at peace with the world, or at least resigned to whatever discomfort it sees.  It’s easy to be concerned with rates and earnings, but why if the market itself is not.  If you define a pullback by a decline from a 20-day high, there have been no pullbacks larger than 5% or even 3% since March.  The current streak of some 70 days since the last 3% pullback ranks in the top 7% of all streaks since 1928, according to  While the mere recognition of this may cause you some concern, history seems to suggest otherwise.  A distinction has to be made between markets that are trading at a multiyear high, versus a one-year high.  In the case of the former, extreme confidence seems to set in, resulting in poor returns.  However, that doesn’t seem to happen when stocks are trading at a one-year high as the S&P then has a history of continuing to rise.

The real news in the last week hasn’t been AI, it’s been OI-H (326) – that is, Oil.  Many of these stocks have been improving for some time, but last Friday they didn’t just break out they blew out.  A distinction needs to be made here between Oil and Oil Service/Drillers.  It’s the Schlumbergers (57) more than the Exxons (105) that had the big moves. Here again, more evidence of broadening participation.  Meanwhile, what’s wrong with those econ-sensitive stocks?  How can they be bumping up against their highs when there’s a looming recession?  It would seem the answer might be what recession?  Parker Hannifin (399) and Fastenal (57) are but two of the many.  FAST makes nuts and bolts – very techy, techy.  PAVE (32) is an ETF that covers several of these names.

Meanwhile, they’re really killing Tech.  It must have been about four or five weeks since stocks like Nvidia (460) and Adobe (517) made new highs – what a drubbing!  We mention these two names because to look at the charts you wouldn’t know one from the other.  The weekly charts show a spike-like move higher a few weeks ago, followed by a four-week consolidation.  You might want to write this down – stocks don’t go straight up.  Rather, this is about as good as it gets – a spike up and a high-level consolidation.  Another way to think of stocks like this is the good stocks, like good markets don’t give you a good chance to buy.  Hence their shallow corrections. Conceptually speaking, when it comes to stocks like these the first time you think they’re done, you’re wrong.  The second time you think they’re done, you’re wrong again.  By the third time you don’t even think it, let alone say it out loud.

Back in the last bull market we used to say most days most stocks go up, and it seems so now.  We understand the narrow market argument, we just don’t think it’s the negative many try to make it.  To some extent the market can always be considered narrow – there’s the leadership stocks, and the rest.  Granted things are a bit extreme this time but there’s an important mitigating factor.  The rest of the market is at least going up – look at the A/D numbers.  It would be a different story if were Tech and only Tech, and the rest were going down.  That’s simply not the case.  The breakout in Oil Service stocks is an important change, which obviously suggests participation is broadening.  In terms of performance the market has been narrow, in terms of participation it has not.

Frank D. Gretz

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US Strategy Weekly: An Optimistic Consensus

The Consensus View

Stock markets may have their foundations built on fundamentals, but the short and intermediate-term moves are, more often than not, driven less by fundamentals and more by expectations and sentiment. And in our view, the expectations for the second half of this year are now a consensus that includes the following: 1.) the Federal Reserve will raise rates one or two more times and then pause; 2.) headline inflation will continue to decelerate to the 3.5% level or lower by year end; 3.) a recession is possible but the economy may instead suffer a rolling recession over the next twelve months; 4.) the housing sector is showing green shoots; 5.) interest rates are at, or close, to peaking all along the curve; and last, but far from least, 6.) earnings growth will rebound over the next four to six quarters.

The Media Plays a Role

However, we have noticed that the media is also playing a role in boosting investor sentiment. The National Federation of Independent Business (NFIB) released its Optimism Index for June this week. Reuters ran the story with the headline “Small business confidence reaches 7-month high in June, NFIB says.”  That is not what we read on the NFIB website. The NFIB’s headline was “Small Businesses Raising Prices Falls to Lowest Level Since March 2021.” And the NFIB’s opening text was “Small business optimism increased 1.6 points in June to 91.0; however, it is the 18th consecutive month below the 49-year average of 98. Halfway through the year, small business owners remain very pessimistic about future business conditions and their sales prospects.” We were stunned at how different the Reuters story was from that of the NFIB. Reuters was clearly editorializing and not reporting. On page 7, we show charts of the NFIB’s survey, and you can judge for yourself which headline is more appropriate for the June report.

Too Optimistic Too Quickly

Perhaps the “optimism” we are reading in the financial press stems from the fact that the residential real estate market may, at last, be finding some sunlight. A recent Bloomberg headline states: “Homebuilding Set to Boost US Economy After Two-Year Contraction.” The NAHB housing index ticked up to 55 in June from 50 in May and it was the first time this index rose above the 50 benchmark in nearly a year. Condo sales rose in May, but single-family sales declined. A dwindling supply of single-family homes partly explains the housing market’s buoyancy. But to the extent that a lack of supply of single-family homes is due to the fact that homeowners are locked into their homes as a result of higher interest rates and higher home prices, this may not be a good thing. Right now, remodeling is cheaper than buying a new home for many households. Plus, recent consumer credit data shows that nonrevolving credit fell at an annualized rate of 0.4% in May. Revolving credit increased at an annualized rate of 8.5%, but this was down from 14.2% in April. In other words, a combination of tighter lending standards and higher interest rates are triggering a slowdown in consumer credit. This may make housing less affordable and as a result, the housing market bounce may be short-lived. Last, but far from least, one should not forget that the moratorium on student loans will end in October!

Investor Sentiment Warning

Nevertheless, optimism is spreading. Last week’s AAII sentiment readings produced a 4.5% rise in bullishness to 46.4% and a 3.0% decline in bearishness to 24.5%. This was the highest bullish reading in the AAII survey in 2023 and it was the highest since the 48% reading on November 11, 2021. In addition, bullish sentiment was above average for the fifth consecutive week, matching the streak last seen in October and November 2021. Unfortunately, in this case, sentiment is a contrary indicator. It is important to point out that current readings are similar to those seen in November 2021 and in this latter case, they appeared a month or two ahead of the January 2022 peak in equity prices. See page 13.

Inflation and Earnings

June inflation data will be released this week and many economists are looking for good news. Moody’s Analytics has inflation falling to 2.8% in the second half. That would be excellent news, but it may also be optimistic. The good news is that many areas of the CPI are seeing prices declining on a year-over-year basis, particularly since crude oil prices are currently down 33% YOY. Most energy-related and transportation-related areas of the CPI are seeing declining prices, and so are used cars, personal computers, and nondurables. On the other hand, the service sector showed prices rising 6.3% YOY in May.

The service sector is labor intensive and therefore, the Fed is also focusing on both service sector inflation and wage inflation in forming its monetary policy. Average hourly earnings rose 4.7% YOY in June, which is down nicely from the March 2022 level of 7% YOY; yet from the Fed’s perspective, this is still more than double its target of 2% inflation. Moreover, it means wages grew 70 basis points above May’s inflation rate which could create demand pull inflation. See page 5.

Average weekly earnings rose 3.8% YOY in June, quite a bit less than the average hourly earnings gain of 4.7% YOY, because hours worked dipped from a year ago. But after adjusting for inflation, real weekly earnings in dollar terms, have been declining since January 2021. Only recently have wages been growing faster than inflation. Again, what is good for consumers (real purchasing power) will be bad for employers (higher cost of labor) and this balance will impact consumption and margins in the second half of the year. Economists will be watching June inflation numbers to see how this impacts real earnings. See page 6.

Beating inflation is important. As we have pointed out, inflation erodes the purchasing power of consumers, it pressures corporate margins, and typically lowers PE multiples. Based upon the IBES Refinitiv earnings estimate of $219.14 for the S&P 500, equities remain overvalued at the current PE of 20 times. We define the market as being overvalued if the sum of the PE and inflation exceeds the top of the standard deviation range, or 23.8. The current PE of 20 and inflation of 4% puts the market above the standard deviation line of 23.8. See page 9. It also makes earnings season important. In terms of the second quarter earnings season, investors appear to have discounted a lot of good news in advance. One example of this is the rally seen in financial stocks this week, just ahead of their earnings releases later this week. Meanwhile, less heralded is the fact that consensus estimates continue to fall. The S&P Dow Jones consensus estimates for 2023 and 2024 are $216.59 and $242.80, down $0.29, and $0.26, respectively this week. Refinitiv IBES estimates for 2023 and 2024 are $219.14 and $244.88, down $0.38, and $0.58, respectively. S&P Global data shows that 18.4% of companies reporting first quarter earnings had a decrease of 4% or more in shares outstanding, which effectively boosted earnings per share, but not overall earnings growth. This pattern of lowering shares outstanding is not quality earnings. In general, this is a stock picker’s market. There are good companies to buy, but we see a pattern of bullish optimism that needs second quarter earnings to be outstanding. If they are not, the recent rally is in peril in our view.

Gail Dudack

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What Gets Downgraded Most Days, Goes Up Most Days

DJIA:  33,922

What gets downgraded most days, goes up most days … and is not Ford (15) or GM (39)?  It’s that other car, battery, AI, autonomous driving, etc. company.  Talk about the fickle finger of Funnymental analysis, with its holy grail of value, Tesla (277) is overvalued and Nvidia (421) is not?  As we have suggested many times, stocks and markets sell at fair value twice – once on the way higher, and once on the way lower.  The trick is to figure out whether they’re on their way to becoming more overvalued or more undervalued.  The figuring out is called following the trend.  We trade so we use the weighted 21-day we’ve referred to recently.  For those of you who don’t mind waiting for instant coffee, the 50-day is probably best.  While for the moment we’re praising Tesla, we’re fully aware the stock did sell for 400 back in late 2021.  That’s why discipline is often more valuable than thinking.     

Does the market make the news, or does the news make the market.  Technicians, of course, hold it’s the former.  In good markets, there is no bad news.  When the news is bad, in good markets it’s construed as good, or just simply ignored.  This market has been a good example as it continues to ignore the Fed’s berating, at least until Thursday.  The real point is that it’s not the news per se, it’s how the market reacts to the news.  When it comes to individual stocks, we don’t really care about earnings, but we do care how stocks react to those earnings.  An interesting example recently was FedEx (248) back on June 20, when the company apparently disappointed.  The stock did react temporarily, only to quickly move back to its high and break out.  Because of its Rorschach test like long-term pattern, the stock has never been one of our favorites.  That said, the pattern we just described, the fakeout move to the downside and subsequent breakout, is pretty much money in the bank.

Sell in May and go away?  That worked fine provided you were back June 1 when the S&P broke out.  Seasonal tendencies are but one of the things to consider in analyzing markets, certainly not the most important.  Most important, of course, is basic supply and demand – the trend.  Like many aspects of market analysis often there’s a message when markets don’t follow the probabilities, sell in May being a perfect example.  We’re also intrigued by the seasonal probabilities of natural gas, which from now until almost the end of July show only a 15% chance of advancing.  The average loss during this period is more than twice the gain.  Nonetheless, the ETF here, UNG (7) is basing and would break out above 8.  It also seems encouraging that a couple of related stocks like Southwestern Energy (6) and Comstock Resources (11) are acting better.         

So, where’s the worry?   Sticking with the technical stuff, we’re a bit surprised by the lag in stocks above their 200-day, a measure of trend as well as direction.  The numbers here will vary depending on the database – all NYSE stocks versus S&P components showing 53% to about 63%.  The real issue here, however, is these numbers are well below the 74% of last February.  Given the improvement in the S&P Equal Weight and the Russell 2000, the divergence seems surprising.  Of course, it likely lies in the poor behavior in banking shares back in March.  Throw in Energy, and you have a lot of issues below their February levels.  We hesitate to make excuses for the numbers, but we will at least as long as the A/D Index continues to show improvement.  In other words, for now we’ll take progress over perfection.

The key to a healthy market is participation.  During the recent 2% setback A/Ds were negative for five consecutive days.  Weakness happens, weakness doesn’t kill uptrends.  What kills uptrends, at least eventually, is weak rallies.  Since that little setback, A/Ds turned positive for six consecutive days through Tuesday.  It didn’t necessarily have to be that way; those numbers could’ve turned flat or at least mixed – it could’ve been a weak rally.  We will see a weak rally eventually and it will be a warning, but sufficient unto the day is the evil thereof.  We can see the numbers actually getting better along with stocks above their 200-day with a little more improvement from the banks and energy.  Thursday’s weakness was nasty but again, weakness happens, it’s the recovery that will be important.  Meanwhile, the Bitcoin stocks have had a good week as have some names in Quantum Computing.

Frank D. Gretz

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US Strategy Weekly: Half Time

At the end of the first half of the year, the S&P 500 closed strong with a gain of nearly 16%, which was the best six-month performance for this index in forty years! Yet the S&P 500 was not the best-performing index year-to-date. The Nasdaq Composite gained twice as much with a 32% rise. Conversely, the DJIA only advanced 3.8%, or less than a fourth of the SPX’s gain. In short, large capitalization technology stocks were at the core of the performance in the first half, while the Russell 2000 index rose 7.2% and the Invesco S&P 500 equal weight ETF (RSP – $150.01) rose less than 6%.

Still, it was a better performance than most forecasters expected, including us. And earnings also surprised. But as we pointed out recently, S&P data shows that 71.4% of companies that reported first quarter earnings had a decrease in shares outstanding from a year earlier and 18.5% reported a decrease of 4% or more in outstanding shares. This effectively boosted earnings per share, even without any overall earnings growth. Nevertheless, given the first quarter’s results, our 2023 estimate of $180 is far too bearish and we are raising our forecast to $200 and simultaneously raising our 2024 estimate from $201 to $220. See pages 5 and 12.

However, even if we use the 2023 S&P EPS estimate of $219.52, equities remain rich with a PE of 20.3 times. This is well above the long-term average PE of 15.9 times. History shows that whenever the sum of the S&P’s PE and the rate of inflation is above 23.8, or one standard deviation above normal, the market is overvalued. At present the 12-month forward PE of 20.3 times and inflation of 4% equals 24.3 and is above the normal range. The S&P trailing PE is 21.5 plus inflation, equals 25.5 and is also above the normal range. Even when the 12-month forward PE of 19.5 times is added to the inflation rate of 4% the sum is 23.5 and just at the standard deviation line. In other words, the equity market is richly valued and is therefore at risk of earnings disappointments or any negative news.  

Student Loan Moratorium

At the end of June 2023, the Supreme Court blocked President Biden’s bid to provide $430 billion of student loan forgiveness to borrowers. This was not a surprising development since the Constitution states that the “power of the purse” resides in Congress, not the Executive branch of government. And even with a string of new proposals to circumvent the Supreme Court ruling, it is very likely that the three-year moratorium of debt payment for student borrowers will come to an end in October.

A Federal Reserve Board study estimated that most student borrowers improved their credit profiles during the moratorium and savings balances increased by $80 billion dollars. However, 44 million Americans will have to start paying back student loans in less than three months, with payments ranging from $210 to $320 per month. This will be a burden for many households and most economists expect that the resumption of student loan payments will generate a loss of roughly $70 billion in annual personal spending. While $70 billion may be a small number relative to nominal GDP of $26.5 trillion, it will be a major headwind for retail sales and some consumer-driven companies.

According to the Federal Reserve Bank of NY, total household debt increased $148 billion to $17.05 trillion in the first quarter of 2023. Mortgage balances climbed by $121 billion and were $12.04 trillion at the end of March. Auto loan and student loan balances also increased to $1.56 trillion and $1.60 trillion, respectively.

Credit card balances were $986 billion at the end of the quarter and flat on a quarter-over-quarter basis. However, while credit card balances did not increase much in the last three reported months, they grew 17% YOY. This was the largest increase in the 20-year history of the Fed’s data. And the fact that credit card debt did not increase in the first quarter of 2023 suggests that many consumers may have reached or may be reaching their credit limits. If true, this could be a concern for the economy, particularly since many of these same borrowers will soon need to restart paying their student loans. In sum, the start of the fourth quarter could bring about some surprising weakness in consumer spending.

We looked further into the Fed’s data to see how important student loans are to households and the economy in general. At $1.6 trillion, student loans are the second largest category of household debt and even though student loan borrowing grew the least of all debt categories in the last four quarters, it represents 9.4% of total household borrowing. However, sluggish growth and low default rates may be due to the moratorium, and we expect delinquencies and defaults will surge once the moratorium ends in October. Moreover, according to NY Fed data, student debt is not just concentrated in the 20-year-old to 30-year-old segment of the population; in fact, it is spread across all age categories and 23% of student loan debt is held by those 50 years of age or older. Keep in mind that at the same time debt payments will begin, the Fed is expected to be increasing interest rates. All in all, this will make the fourth quarter a very interesting time for the economy and the stock market.

Technicals: good and bad

The good news is that our 25-day up/down volume oscillator is at 3.78 reading as of July 3, 2023 which is the first overbought reading since April 28. It is important to see if this indicator can remain in overbought territory for a minimum of five consecutive trading days to confirm the recent advance. There have been other one-day overbought readings on April 8 and April 24; however, none of these one-day readings were sustained and none confirmed rallies in the averages. In general, this pattern reveals a lack of convincing volume in advancing stocks and the oscillator remains in neutral territory.

More importantly, NYSE volume was below the 10-day average for many days during the advance; conversely, 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 7.

Last week’s AAII readings saw a 1.0% decline in bullishness to 41.9% and a 0.3% decline in bearishness to 27.5%. But it was also the fourth consecutive week of above average bullishness and below average bearishness. The last time this same combination was seen was October-November of 2021 when it persisted for five consecutive weeks. The market made a significant peak in January 2022. The technical patterns in the S&P 500 and the Nasdaq Composite index are bullish and explain why many strategists have now shifted to a more favorable outlook for 2023. But the DJIA is yet to break out and while it has a potentially positive pattern, it is currently ambiguous. We have put the Russell 2000 index and equal weight SPX ETF side by side on page 6 to show how similar these charts are for 2022 and 2023. Both have been in a trading range for over 12-months, and we believe this is a more accurate depiction of the equity market’s performance this year.

Gail Dudack

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FOMO: Fear of Missing Out

The increases seen in equity indices in the first six months of 2023 exceeded most forecasters’ projections and the first half ended with a gain of nearly 16% in the S&P 500 index. This was the best six-month performance in this index since 1983; however, the action of the S&P 500 index was not the experience of all equity investors. The tech-centric Nasdaq Composite index rose nearly 32%, or over twice the performance of the S&P 500. Conversely, the Dow Jones Industrial Average advanced a mere 3.8%, or less than one-fourth the performance of the S&P 500. The broader-based small capitalization index, the Russell 2000, rose 7.2%, and the Invesco S&P 500 equal weight ETF (RSP – $149.64) gained less than 6% year-to-date.

The disparity among the performances of the indices is best explained by the fact that the returns in the Nasdaq Composite and S&P 500 indices were due to gains in a relatively small group of large capitalization technology stocks, primarily those companies with exposure to generative artificial intelligence. It was a classic display of “FOMO: fear of missing out” that drove the momentum of AI-related stocks. As an example, Nvidia Corp. (NVDA – $423.02), which designs the chips and software used to power generative AI systems, soared nearly 190% in the first half of the year and Microsoft (MSFT – $340.54), which recently partnered with OpenAI, a company that debuted its ChatGPT generative AI-powered chatbot in November 2022, gained 42% year-to-date.

According to S&P Global Intelligence, in the first six months of the year, the top 10 performing companies in the index accounted for 37.4% of the total gains in the S&P 500 and several of these stocks hit major milestones at the end of the second quarter. Apple (AAPL – $193.97) breached the $3 trillion market capitalization mark and Microsoft was next in line with a market capitalization exceeding $2.5 trillion at the end of June.

What was most surprising was the market’s positive performance in spite of significant hurdles, in particular, the aggressive interest rate increases done by the Federal Reserve Bank and a series of US regional bank failures. Typically, either of these two scenarios would have triggered a decline in equity prices. However, in the month of June there were a number of developments that boosted investor optimism. The Federal Reserve Bank decided to pause its series of interest rate increases on June 14. CPI and PPI data for May showed inflation pressures were decelerating in most sectors of the economy. May housing statistics hinted at a possible turnaround in the residential housing recession. And finally, the last revision of first-quarter GDP growth showed economic activity increased at a 2% annualized rate, up from an earlier estimate of 1.3%. This latter point may be the good news/bad news story for the second half of the year since a strong 2% number gives the Federal Reserve more leeway to increase the fed funds rate in the months ahead without fear of pushing the economy into a recession.

Recession or no Recession?

Those looking for a recession in 2023 have been stymied to date, but according to historical precedents, there have been a number of reasons to expect a recession is on the horizon. First and foremost, the inversion of the government yield curve has been near historic levels and exceeded only by the inversions seen in January 1981 and September 1973. In both 1981 and 1973, a deeply inverted yield curve predicted severe recessions ahead. Economists have focused on the yield curve as a warning shot because in the last 70 years an inverted yield curve preceded each of the 9 recessions defined by the NBER.

Another economic caution signal is the Conference Board Leading Economic Index (LEI). This index is a composite of 10 variables that typically foresees turning points in the business cycle by about seven months. Over the last 60 years, a sustained decline in the LEI has preceded all but two US recessions. False signals in the LEI are rare, although a decline for several months in October 2019 did not result in a recession. Nevertheless, the LEI has been declining for 14 consecutive months and this is the first decline of this length without an economic slowdown.

Monthly retail sales are an important indicator of economic activity since roughly 70% of US GDP is driven by personal consumption expenditures. When monthly retail sales are adjusted for inflation, it is easy to see if real sales are increasing or decreasing. Typically, if real retail sales are declining for more than three months it is either a symptom of a recession already in place or of one about to appear. As of May, real retail sales have been negative for six of the last seven months, yet GDP for the second quarter was revised upward to 2%. In short, a series of economic indicators have been waving warning flags of a recession and supporting a cautious view. Nonetheless, the economy has been resilient.

However, our favorite indicator for predicting a recession may hold the key to economic strength or weakness. Year-over-year changes in total employment have accurately predicted recessions in each of the last seven economic cycles. When the total number of people employed in the US turns negative on a year-over-year basis, it is a precursor of a recession. When this deceleration or decline in job growth reverses, it signals the end of a recession and the start of an economic recovery. By this simple measure, the US economy appears to be in fine shape because as of the end of May job growth was 2.7% YOY and well above the long-term average of 1.7%. The strength in the job market supports those economists who believe the Federal Reserve may be able to get inflation down to 2% without a major recession. Overall, this mix of indicators is likely suggesting that the second half of 2023 will be a mix of hot and cold sectors and of generally sluggish growth.

Student Loan Forgiveness

Several post-pandemic stimuli will end in the second half of the year, and this could negatively impact the consumer. The biggest of these is the end of student loan forgiveness. At the end of June 2023, the Supreme Court blocked President Biden’s bid to provide $430 billion of student loan forgiveness to borrowers. It was not a surprising development since according to the Constitution, the “power of the purse” resides in Congress, not the Executive branch of government. And though the White House responded with a string of new proposals to circumvent the Supreme Court ruling, it is very likely that a three-year moratorium of debt payment for student borrowers is coming to an end in October.

As a reminder, in March 2020, the CARES Act suspended payments for federally sponsored student loans, or roughly debt totaling $1.4 trillion. The Act also mandated a zero percent interest rate on outstanding balances and suspended collection activities on defaulted student loans. A Federal Reserve Board Study, “Implications of Student Loan COVID-19 Pandemic Relief Measures for Families with Children (May 2023), quoted an analysis which estimated that most student loan borrowers were able to improve their credit profiles during the pandemic and as of the Spring of 2022, grew their savings balances by $80 billion. This was a plus for economic activity. An analysis by Goss, Mangrum, and Scally (2022) estimated that approximately $200 billion in aggregate payments were waived for all borrowers that were eligible.

In other words, $100 billion per year in debt payments were frozen whether or not borrowers were current or in default on their loans, and this provided a substantial boost to consumer spending. However, in October, 44 million Americans will have to start paying back student loans with payments ranging from $210 to $320 per month and this will become a burden for many households. Moreover, many debtors will have had a change in their servicing companies in the last three years and this will add to the confusion in October and what is expected to be an increase in defaults and reductions in credit ratings for many borrowers.

All in all, economists expect that the resumption of student loan payments will generate a loss of roughly $70 billion in personal spending. While $70 billion may be a small number relative to nominal GDP of $26.5 trillion, it will be a major headwind for retail sales and some consumer-driven companies.

offense or defense?

In our view, the reason investors focused on stocks linked to generative artificial intelligence is that earnings growth for the overall market has been negative for three consecutive quarters and the outlook for 2023 corporate earnings remains uncertain. Although it has not received much attention, S&P Global data shows that in 2022 earnings for the S&P 500 declined by 5.4% and expectations for 2023 include an increase of 10% year-over-year. Overall, this does not support a robust bull market.

The June runup in equity prices was driven more by sentiment, and excitement in AI, than by earnings growth and as a result PE multiples have expanded. The S&P 500 index is now trading at 21.6 times earnings, which is 36% above the historical average of 15.9 times. This makes the equity market vulnerable to any unexpected surprises, particularly if the Federal Reserve continues to raise interest rates in the second half of the year.

However, since most of the recent gains have been concentrated in the AI favorite stocks which dominate the Nasdaq Composite index, this is where most of the risk is concentrated. The excitement in AI stocks is reminiscent of the Nifty Fifty era which led to the 1970 peak or the technology bubble of 2000. And the $1.44 trillion sitting in retail money market funds means there is plenty of dry tinder that could move these stock prices even higher. But we would not chase large capitalization stocks at this point. Instead, we would invest for the longer term and focus on companies with the most predictable earnings streams for 2023 and 2024 and where PE ratios are below the S&P 500 level of 21.6 times.

*Stock prices are as of June 30, 2023

Gail Dudack, Chief Strategist

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