Monthly Archives: June 2020

Apples Magic- Are Buybacks Worth Paying Up For?

Apple’s valuations are near their most expensive levels of the last ten years. Now consider that today’s valuation premiums are amidst a much higher risk-free bond yield than during most of the previous ten years.

apple valuations

Apple has a market cap of $2.8 trillion. Assuming its price-to-earnings ratio and margins remain stable, Apple must sell nearly $400 billion of products and services each year to keep its share price stable. To fathom that, consider that every man, woman, and child on planet Earth must spend about $45 on Apple products yearly.

The point of sharing those statistics and the valuation premium is to contextualize whether Apple can grow at the growth rate implied by its investors. Further, if its earnings growth alone doesn’t support a valuation premium to the market’s valuation, can the continued use of stock buybacks support the premium?

Apple’s Track Record

The graph below shows Apple shares have provided its investors with a fantastic 20% annualized growth rate for the last 39 years. That is more than double the 8.7% growth rate for the S&P 500 over the same period.

apple stock price

Its exceptional outperformance versus the market is warranted. Since 1993, Apple’s earnings per share have grown at over 3x the rate of the S&P 500.

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While Apple may have an incredible record of earnings growth and share price appreciation, current investors must avoid the temptation to rest on prior trends. Instead, their focus should be on what may lie ahead.

The following graph shows the running 3-year annualized growth rates for sales, net earnings, and earnings per share. Recent growth rates are much lower than they have been. We truncated the graph to the last ten years to better highlight the more recent trends.

apple sales and earnings trends

Earnings and sales were boosted in 2021 and 2022 by the stimulus-related spending and inflation caused by the massive pandemic-related fiscal stimulus. Many companies, including Apple, saw demand increase and could expand profit margins, as inflation was easy to pass on to customers.

However, Apple’s earnings and sales growth are returning to pre-pandemic levels. To better appreciate what the future may hold, consider the five pre-pandemic years highlighted in blue. During that period, sales grew by 4.2% annually. Net earnings grew by 4.3% and EPS by 10.4%

The Magic of Stock Buybacks

The price of a stock is not meaningful. Apple stock trades for $182 a share. Its market cap is roughly $2.85 trillion. If the company repurchased all but one share, its market cap would be unchanged, but its share price would be $2.85 trillion. 

That simple example highlights how valuable buying back shares can be for investors.

Back to Apple’s recent EPS, net earnings and sales trends. Its EPS grew roughly double that of sales or net earnings. The graph below helps explain how they pulled off such a feat. Once Apple started buying back shares in late 2013, its EPS grew 4-6% more than its actual earnings.

share buybacks and eps less earnings growth apple

The following graph compares Apple’s annual EPS versus its EPS if it had not repurchased shares. The graph starts in 2013 when Apple began to aggressively buy back shares.

apple eps vs eps constant share count
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Why The Premium Versus The Market?

Apple has recently grown its earnings and sales at an approximate 5% growth rate. This is only about 1% higher than the approximate 4% nominal GDP growth from 2017 to 2019. But less than the approximate 9% EPS and sales per share growth of the S&P 500. 

So why are Apple investors willing to pay a premium for subpar growth?

Apple is an incredibly successful and innovative company with a long history of rewarding investors. Investors are willing to pay for the future potential of new products and services with enormous income potential. Such investor goodwill is hard to put a price on.

Passive investment strategies are a second reason. Apple and Microsoft are the two largest stocks by market cap. The increased popularity of passive investment strategies feeds the most extensive market cap stocks disproportionately to smaller companies.

Consider the holdings of XLK, the $52 billion tech sector ETF. Apple and Microsoft make up almost 50% of the ETF. If an investor buys $1,000 of XLK, approximately $500 will go to Apple and Microsoft, and the remaining 62 companies will get the rest.

xlk technology holdings

Finally, and most importantly, are share buybacks. While we can’t quantify what future innovation, goodwill, and passive investment strategies are worth, we can grasp Apple’s ability to continue forward with buybacks.

Future Buyback Funding

The chart below shows Apple has been spending between $60 and $80 billion per year on stock buybacks. Keep that figure in mind as we walk through its sources of cash to continue buying back shares.

apple annual buyback costs

Debt, cash, and earnings are their predominant sources to fund buybacks.

Debt Funded Buybacks

Apple came to market with its first long-term debt offering in 2013, commensurate with its initiation of share buybacks. Apple’s debt peaked eight years later at $109 billion. Using debt to fund share buybacks made sense, with borrowing rates in the very low single digits. However, the calculus has changed, with rates now at 4% and higher.

Cash and Marketable Securities on Apple’s balance sheet are at $61.5 billion, about a year’s worth of buyback potential. While a massive amount of money, it is off its peak of $107 billion.

apple cash and marketable securities

Lastly are earnings. Apple has been earning about $100 billion a year since 2021. Even if they regress to pre-pandemic levels ($50-$60 billion), earnings are enough to continue supporting its buyback program. However, if earnings are employed to buy back shares, it comes at the expense of investments toward innovations and product upgrades. Furthermore, Apple pays about $15 billion yearly in dividends, which also requires funding.

The graph below shows that from 2018 to 2020, Apple spent more on buybacks than it made. It was relying on debt and cash to make up the difference.

buybacks as a percentage of earnings

Over the last two years, buybacks only account for 60% of earnings, allowing cash to grow for future buybacks and investments. Hence, if $100 billion a year in earnings is sustainable, even without growth, $60 to $80 billion a year in buybacks is entirely possible. If earnings retreat to their pre-pandemic level, debt and cash will be required. If interest rates stay at their current levels, debt may not be financially sensible.

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Unlike most “growth” companies, a bet on Apple is a bet on their ability to buy back shares. It appears that Apple can continue to buy back its shares with earnings and cash. Such would maintain their higher-than-market EPS growth with or without above-market earnings growth.

Other than negative earnings growth and high-interest rates, a buyback tax on corporations, as is being proposed, could also reduce or eliminate their buyback program. If such a bill were to pass or Apple cuts back on buybacks for another reason, its premium valuation may wither away.

Shale Oil- Should Investors Fear The Red Queen Effect?

In a recent article, geologist Ted Cross of Novilabs eases investor concerns about the rapid depletion rate of shale oil wells. He claims investor fears are comparable to The “Red Queen Effect,” a concept from Alice in Wonderland: “It takes all the running you can do to keep in the same place.” Investors worry that new shale oil production will decline so quickly that new wells can’t offset the declining production of existing wells. Therefore, total production increases are evermore challenging to achieve. Ted acknowledges the sharp decline in new shale oil wells but notes:

Yes, shale wells decline rapidly early in life, but those declines moderate as they age, settling in somewhere between 5% and 10% per year. As the collective population of shale wells gets older and older, the “base decline” gets lower and lower.

The graph below shows total oil production keeps rising with less production, as a percentage, attributed to new shale oil wells. In 2014, shale oil production hit about four million barrels per day, with almost two-thirds coming from new wells. Ten years later, total production is more than double that rate. However, only 43% is from the output of new wells. He also adds that the rate of decline of older shale oil wells moderates even further. To wit: “The Bakken was able to post impressive growth in 2023 in part because wells in the play from 2022 and prior only declined 33% in aggregate.” The bottom line is that shale oil production declines much quicker than traditional wells, but the rate of decline is less than investors fear.

shale oil well total production and depletion by year drilled

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

The Russell 2000 jumped in yesterday’s trading again, revving up the speculative crowd. As noted on Tuesday, retail investors have been chasing small-cap stocks for a potential “catch-up” trade with the rest of the market. As shown below, the Russell 2000 still trades well below its all-time highs and is lagging the performance of the large-cap index by a significant margin. As shown, the Russell 2000 is now at a critical juncture, a break out of the downtrend could set the index up for a push higher. However, this has also been the point of previous failures over the last year.

Market Trading Update

In yesterday’s commentary, we suggested remaining a bit more cautious as the current speculative push is getting rather long in terms of duration. The S&P 500 index has been positive in 13 of the last 15 weeks, the longest stretch of gains since 1989. While retail investors are turning their attention to the more speculative names in the market, it is worth noting that hedge funds and institutions have started selling positions. As we will discuss on Friday, it is worth noting that “dumb money” is currently very allocated to risk assets. Such is usually a point where forward returns weaken significantly.

Personal Interest Rates Are Rising Rapidly

The graph below shows total personal interest payments as a percentage of total income. In the post-financial crisis era, the effective personal interest rate ranged between 1.50% and 2.00%. It is now following bond yields higher and approaching 2.50%. The rate itself is now higher than most consumers are accustomed to. However, more importantly, note that prior peaks preceded recessions. Given that personal consumption accounts for about two-thirds of GDP, the ability to borrow and borrowing terms are essential to the economy. The graph also explains the lag effect. It has taken two years since the Fed started raising rates for the effective personal rates to near prior peaks.

effective personal interest rate

More On Buffett And Market Excuberrance

Lance Roberts’s latest article, This Is Nuts- An Entire Market Chasing One Stock, discusses the poor breadth of the market and the leadership role that Nvidia plays. Per the article:

In momentum-driven markets, exuberance and greed can take speculative actions to increasingly further extremes. As markets continue to ratchet new all-time highs, the media drives additional hype by producing commentary like the following.

He supports his statement with the following graph. It shows that markets are “exceedingly overbought.” He continues:

The composite index below comprises nine indicators measured using weekly data. That index is now at levels that have denoted short-term market peaks.

technically overbought oversold readings sentiment buffett

Along the same lines, yesterday’s Commentary informed us that Warren Buffett’s Berkshire Hathaway portfolio is sitting on record amounts of cash. He does not see value and is not willing to chase the market. Today, we share another bit of advice from his speech last weekend.

“One fact of financial life should never be forgotten. Wall Street – to use the term in its figurative sense – would like its customers to make money, but what truly causes its denizens’ juices to flow is feverish activity. At such times, whatever foolishness can be marketed will be vigorously marketed – not by everyone but always by someone.”

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The Conference Board Says Smooth Sailing Ahead, But….

As we noted in our current Weekly Newsletter, Conference Board Scraps Its Recession Call, the Conference Board, publisher of the well-followed leading economic indicators (LEI), has rescinded its recession prediction. As we wrote: “According to the Conference Board, the reason for the retraction of the recession call was the improvement in underlying indicators.” While it’s tempting to think we are out of the woods on the economic front, the graph below, courtesy of @gubbmintcheese, warns of a significant divergence between LEI and the S&P 500.

The obvious takeaway from the graph is that the Conference Board’s LEI and S&P 500 are historically well correlated. Such makes a lot of sense. Corporate earnings tend to grow when the economy is doing well; thus, their stock prices rise. While the correlation is strong, there are periods where the S&P 500 leads LEI, such as 2020, 2013, and 2017. There are other times when LEI led the S&P 500, such as the lead-up to the 2008 financial crisis. Who’s leading who is a very important question today. As the graph shows, the divergence between the LEI and the S&P 500 is among the largest since 1995. Is LEI set to turn significantly positive, as the Conference Board must believe, or will the market catch down to LEI?

lei and S&p500

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

The market remains confined to a very defined trading range. With support at the 20-DMA and a clear channel that began in November. The market failed at the top of that range yesterday, and with a slew of economic data out this week, a retest of the 20-DMA is possible. The negative divergence of the MACD and RSI indicators suggests risk to the current market trend. The good news is that we are seeing some rotation in the market from the previous leaders to other sectors of the market on a relative basis. That rotation could sustain this rally a while longer. However, the rally that began in November is getting very long in terms of duration. As noted yesterday, we suspect the next big move for the market will be lower, therefore, continue to manage risk according

Market Trading Update

Warren Buffett Is Accumulating Cash

This past weekend at the Berkshire Hathaway annual meeting, Warren Buffett offered concern about high valuations in the equity markets. Consequently, as the Bloomberg graph below shows, Berkshire’s cash balance is at a new record high of $167 billion. As Warren Buffet shares in the quote below, he cannot find stocks that are both attractive and large enough for their portfolio.

“There remain only a handful of companies in this country capable of truly moving the needle at Berkshire, and they have been endlessly picked over by us and by others. Outside the US, there are essentially no candidates that are meaningful options for capital deployment at Berkshire. All in all, we have no possibility of eye-popping performance,”– Warren Buffett.

buffett berkshire cash

Jim Coquitt’s Bullish And Bearish Bond Takes

Jim Colquitt of Skillman Grove Research recently published a technical outlook for Treasury bond yields to his Substack subscribers. He leads with the following long-term graph, highlighting critical technical levels. As he shows, the recent high yield of 5% matches two prior highs in 2006 and 2007, as well as a period of consolidation in 2001 and 2002.

technical bond yields

His bullish takeaway is as follows:

The Bull Case (i.e., UST 10-year yields decline) would suggest that the 5.021% we saw in October 2023 is probably the current cycle top. If so, we could be in the process of forming a Head & Shoulders topping pattern.

If we are forming a Head & Shoulders pattern, it is possible that we could see the UST 10-year trade down to the neckline (3.25%), then move higher to form the right shoulder before breaking down and through the neckline towards the target of 1.479%.

I find it fascinating how perfectly the target value matches up with other historical turning/pivot points (see green circles) thus giving further validity to the target we have computed.

The “bullish” case (i.e., one where we reach the target of 1.479%) for the UST 10-year, likely happens as a result of a recessionary environment for the US economy and US equities.

ten year bond yields colquitt

Jim warns, however, that if the left shoulder is broken, “I would suggest that if we clear the high side of the left shoulder (4.335%) and sustain it, you probably want to have your antenna up for a further move higher in yields.” A break above the head argues for higher yields, in his opinion. Per Jim-

“If we break above 5.021%, the following levels are possibilities: 5.522%, 6.06%, 6.79%, and 8.033%.”

Jim favors the bullish case, but his technical road map is worth appreciating as no one can be assured of what the future holds. You can follow Jim’s work at Skilman Grove Research on Substack.

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This Is Nuts – An Entire Market Chasing One Stock

“When you sit down with your portfolio management team, and the first comment made is ‘this is nuts,’ it’s probably time to think about your overall portfolio risk. On Friday, that was how the investment committee both started and ended – ‘this is nuts.’” – January 11th, 2020.

I revisited that original post a couple of weeks ago as the market approached its 5000 psychological milestone. Since then, the entire market has surged higher following last week’s earnings report from Nvidia (NVDA). The reason I say “this is nuts” is the assumption that all companies were going to grow earnings and revenue at Nvidia’s rate.

Even one of the “always bullish” media outlets took notice, which is notable.

“In a normal functioning market, Nvidia doing amazingly is bad news for competitors such as AMD and Intel. Nvidia is selling more of its chips, meaning fewer sales opportunities for rivals. Shouldn’t their stocks drop? Just because Meta owns and uses some new Nvidia chips, how is that going to positively impact its earnings and cash flow over the next four quarters? Will it at all?

‌The point is that investors are acting irrationally as Nvidia serves up eye-popping financial figures and the hype machine descends on social media. It makes sense until it doesn’t, and that is classic bubble action.” – Yahoo Finance

As Brian Sozzi notes in his article, we may be at the “this is nuts” stage of market exuberance. Such usually coincides with Wall Street analysts stretching to “justify” why paying premiums for companies is “worth it.”

Earnings Growth Justification

We Can’t All Be Winners

Of course, that is the quintessential underpinning for a market that has reached the “this is nuts” stage. There is little doubt about Nvidia’s earnings and revenue growth rates. However, to maintain that growth pace indefinitely, particularly at 32x price-to-sales, means others like AMD and Intel must lose market share.

Nvidia Price To Sales

However, as shown, numerous companies in the S&P 1500 alone are trading well above 10x price-to-sales. (If you don’t understand why 10x price-to-sales is essential, read this.) Many companies having nothing to do with Nvidia or artificial intelligence, like Wingstop, trade at almost 22x price-to-sales.

Stocks trading above 10x to sales

Again, if you don’t understand why “this is nuts,” read the linked article above.

However, in the short term, this doesn’t mean the market can’t keep increasing those premiums even further. As Brian concluded in his article:

“Nothing says ‘investing bubble’ like unbridled confidence. It’s that feeling that whatever stock you buy — at whatever price and at whatever time — will only go up forever. This makes you feel like an investing genius and inclined to take on more risk.”

Looking at some current internals tells us that Brian may be correct.

This Is Nuts” Type Of Exuberance

In momentum-driven markets, exuberance and greed can take speculative actions to increasingly further extremes. As markets continue to ratchet new all-time highs, the media drives additional hype by producing commentary like the following.

“Going back to 1954, markets are always higher one year later – the only exception was 2007.”

That is a correct statement. When markets hit all-time highs, they are usually higher 12 months later due to the underlying momentum of the market. But therein lies the rub: what happened next? The table below from Warren Pies tells the tale.

New Highs and bear Markets

As shown, markets were higher 12 months after new highs were made. However, a lot of money was lost during the next bear market or correction. Except for only four periods, those bear markets occurred within the next 24 to 48 months. Most gains from the previous highs were lost in the subsequent downturn.

Unsurprisingly, investing in the market is not a “risk-free” adventure. While there are many opportunities to make money, there is also a history of wealth devastation. Therefore, understanding the environment you are investing in can help avoid potential capital destruction.

From a technical perspective, markets are exceedingly overbought as investors have rushed back into equities following the correction in 2022. The composite index below comprises nine indicators measured using weekly data. That index is now at levels that have denoted short-term market peaks.

Technical Gauge

Unsurprisingly, speculative money is chasing the Mega-cap growth and technology stocks. The volume of call options on those stocks is at levels that have previously preceded more significant corrections.

Stocks net call volume on Mega Cap Growth and Technology stocks.

Another way to view the current momentum-driven advance in the market is by measuring the divergence between short and long-term moving averages. Given that moving averages smooth price changes over given periods, the divergences should not deviate significantly from each other over more extended periods. However, as shown below, that changed dramatically following the stimulus-fueled surge in the markets post-pandemic. Currently, the deviation between the weekly moving averages is at levels only previously seen when the Government sent checks to households, overnight lending rates were zero, and the Fed bought $120 billion monthly in bonds. Yet, none of that is happening currently.

Weekly composite index measures.

Unsurprisingly, with the surge in market prices, investor confidence has surged along with their allocation to equities. The most recent Schwab Survey of bullish sentiment suggests the same.

More than half of traders have a bullish outlook for the first quarter – the highest level of bullishness since 2021

Yes, quite simply, “This is nuts.”

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Market Measures Advise Caution

In the short term, over the next 12 months, the market will indeed likely finish the year higher than where it started. That is what the majority of analysis tells us. However, that doesn’t mean that stocks can’t, and won’t, suffer a rather significant correction along the way. The chart below shows retail and professional traders’ 13-week average of net bullish sentiment. You will notice that high sentiment readings often precede market corrections while eventually rising to higher levels.

For example, the last time bullish sentiment was this extreme was in late 2021. Even though the market eventually rallied to all-time highs, it was 2-years before investors got back to even.

13-week net bullish sentiment vs the market

Furthermore, the compression of volatility remains a critical near-term concern. While low levels of volatility have become increasingly common since the financial crisis due to the suppression of interest rates and a flood of liquidity, the lack of volatility provides the “fuel” for a market correction.

VIX versus the market

Combining excessive bullish sentiment and low volatility into a single indicator shows that previous levels were warnings to more bullish investors. Interestingly, Fed rate cuts cause excess sentiment to unwind. This is because rate cuts have historically coincided with financial events and recessions.

Net bullish sentiment and vix composite versus the Fed.

While none of this should be surprising, given the current market momentum and bullish psychology, the over-confidence of investors in their decision-making has always had less than desirable outcomes.

No. The markets likely will not crash tomorrow or in the next few months. However, sentiment has reached the “this is nuts” stage. For us, as portfolio managers, such has always been an excellent time to start laying the groundwork to protect our gains.

Lean on your investing experience and all its wrinkles.” – Brian Sozzi

CEOs Are Exiting – Should You Follow The Smart Money?

JP Morgan CEO Jamie Dimon sold $150 million of his JPM shares, marking the first time he has sold JPM shares. Jeff Bezos has sold 50 million shares of Amazon since the beginning of the month. Furthermore, Mark Zuckerberg, CEO of Meta, has sold $1 billion worth of stock this year. Because these vast sales are from the CEOs of a few of the largest companies, it may be tempting to follow alongside them. Before pushing the sell button, there are other factors worth considering. For instance, CEOs and other insiders have limited windows in which they are allowed to sell stock. Therefore, the cluster of CEO sales in recent weeks may have more to do with said windows. Further, insiders may sell for various reasons, many of which do not include the expected stock or corporate performance. CEOs and other insiders are not allowed to trade on inside information.

The research is mixed on whether insider sales portend weak stock performance in the future. A study by Dallin Alldredge and D. Brian Blank looked at over 2.5 million insider trades from 1987 to 2019. It turns out the trades of those highest in the corporate pecking order, like the CEO, tend to be most predictive. Insider sales occur for many reasons but keep in mind that CEOs know a lot more about their company than investors. Further, Jamie Dimon has tremendous insight into the economy and the Federal Reserve. Might his $150 million sale be a warning, or is he simply taking a few chips off the table, given JPM’s recent performance?

jp morgan stock

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

The rally continued this past week, spurred higher by Nvidia’s blowout earnings report Wednesday night. After a brief test of the 20-DMA, the market surged to new all-time highs on Thursday, confirming the ongoing bullish trend. As shown, the 20-DMA continues to act as key support for the market for now.

Market Trading Update

The negative divergence in both momentum and breadth (chart below) continues to be of concern, suggesting a short-term correction is likely. With the bulk of earnings season behind us, the focus will return to the Fed and the economy.

Market Breadth

Given the more speculative action taking place in the options market, it is clear that bullish sentiment continues to remain elevated. Historically, the combination of negative divergences and bullish sentiment previously led to short-term corrections. As noted last week, we continue to suggest remaining somewhat diligent on risk management protocols.

“The 20-DMA is now the defacto “Maginot Line” for the markets. A failure at that level will likely lead to a deeper selloff. Continue to manage risk accordingly.”

We don’t know what will eventually lead to a market correction, but one will eventually occur to reverse the more extreme deviation from the 200-DMA. With the market becoming more aligned with the Federal Reserve’s expectations for rate cuts, the current outlying risk for equities is an economic slowdown that impacts earnings.

The Week Ahead

This week, the PCE prices index will be the most watched economic data point. The Fed and bond investors will look to see if PCE follows CPI and PPI higher and exceeds estimates. The estimate for headline PCE is +0.3% and +0.4% for core PCE. That compares to +0.2% for both figures last month. Additionally, regional Fed manufacturing surveys and the ISM manufacturing survey will better inform us of the state of manufacturing. Manufacturing has been in contractionary territory for over a year, but there are indications it may be improving. The prices paid and received components of these measures will also be important.

Per usual, there will be a host of Fed speakers. It has become clear most Fed members do not feel rushed to cut rates. However, with the FOMC minutes from last week alluding to reducing the amount of QT, we will look for comments on when such a reduction could start and how much it may entail.

Bad Market Breadth Can Be Dangerous To Your Wealth

Over the past year, we have written plenty on the bad market breadth. Simply, a few stocks are grossly outperforming the vast majority of stocks. The first two graphs below show the massive difference in the returns by sector and market cap. We must ask the following questions: Is the divergence extreme, and if so, what has happened in similar instances in the past?

We present the third graph below to contextualize the recent poor market breadth and assess what may happen going forward. The orange line shows the price ratio of SPY and the equal-weighted S&P 500 ETF, RSP. As shown, the ratio is approaching the prior peaks of 2008 and 2020. After each peak, RSP grossly outperformed SPY. The blue line is the standard deviation (sigma) of the ratio versus its 200-day moving average. The ratio’s sigma just topped near the two prior peaks. In 2008, the sigma and ratio peaks were aligned. In 2020, the ratio lagged the rapidly declining sigma by a few months.

Assuming the past is prescient, the recent peak should serve as a warning that the dominance of the Magnificent Seven and a few other stocks may be in its last innings. This doesn’t necessarily mean the major stock indexes will fall, but it may signal a change in market leadership.

breadth performance by sector
breadth performance by marketcap
spy rsp ratio and breadth

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Small Cap Stocks May Be At Risk According To NFIB Data

Recently, retail investors have started chasing small-cap stocks in hopes of both a rate-cutting cycle by the Federal Reserve and avoiding a recession. Such would seem logical given that, historically, small capitalization companies tend to perform best during the early stages of an economic recovery.

Market and Economic Cycles

The recent exuberance for small-cap equities is also unsurprising, given the long period of underperformance relative to the S&P 500 market-capitalization-weighted index. The hope of a “catch-up” trade as a “rising tide lifts all boats” is a perennial bet by investors, and as shown, small and mid-cap stocks have indeed rallied with a lag to their large capitalization brethren.

Small and Midcap Stocks relative to the SP500 market

However, some issues also plague smaller capitalization companies that remain. The first, as noted by Goldman Sachs, remains a fundamental one.

“I’m surprised how easy it is to find someone who wants to call the top in tech and slide those chips into small cap. Aside from the prosect of short-term pain trades, I don’t get the fundamental argument for sustained outperformance of an index where 1-in-3 companies will be unprofitable this year.”

As shown in the chart by Apollo below, in the 1990s, 15% of companies in the Russell 2000 had negative 12-month trailing EPS. Today, that share is 40%.

Companies with negative earnings.

Besides the obvious that retail investors are chasing a rising slate of unprofitable companies that are also heavily leveraged and dependent on debt issuance to stay afloat (a.k.a. Zombies), these companies are susceptible to actual changes in the underlying economy.

Rising shared of companies with debt servicing costs higher than profits.

So, is there a case to be made for small and mid-capitalization companies in the current environment? We can turn to the National Federation of Independent Business (NFIB) for that analysis.

The NFIB Report Tells A Very Different Story

The primary economic data points continue to be very robust. Low unemployment, strong economic growth, and declining rates of inflation. As I have heard recently by more mainstream analysts, “What’s not to love?”

Understanding that small and mid-sized businesses comprise a substantial percentage of the U.S. economy is crucial. Roughly 60% of all companies in the U.S. have less than ten employees.

Small Business Breakdown

Simply, small businesses drive the economy, employment, and wages. Therefore, what the NFIB says is highly relevant to what is happening in the actual economy versus the headline economic data from Government sources.

For example, despite Government data that suggests that the economy is strong and unlikely to enter a recession this year, the NFIB small business confidence survey declined in its latest reading. It remained at levels that have historically been associated with recessionary economies.

NFIB Small Business Confidence

Unsurprisingly, selling a product, good, or service drives business optimism and confidence. If consumer demand is high, the business owners are more confident about the future. However, despite headlines of a strong consumer, both actual and expected sales by small businesses remain weak.

NFIB Sales Expectations vs Actual retail sales.

Furthermore, if the economy and the underlying demand were as strong as recent headlines suggest, the business would be ramping up capital expenditures to meet that demand. However, such is not the case regarding capital expenditures and actual versus planned employment.

NFIB Capex Plans vs Real Private Investment
NFIB Employment plans vs actual

There is an essential disconnect between reported economic data and what is happening within the economy. Of course, this brings us to whether investors are making a mistake by betting on small capitalization stocks.

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The Potential Risk In Small Caps

In the short term, some momentum behind small-cap stocks bolsters the arguments for bets on those companies. However, over a longer time frame, earnings and fundamentals will matter.

As noted above, many companies in the Russell 2000 have little profitability and large debt loads. Unlike many companies in the S&P 500 that refinanced debt at substantially lower rates, many of the Russell 2000 were unable. If interest rates are still elevated when that “debt wall” matures, refinancing debt at higher rates could further impair profitability.

Debt wall for companies

Furthermore, the deep decline in sales expectations may undermine earnings growth estimates for these companies later in the year.

Sales Expectations vs Earnings

Of course, there are arguments for investing in small-cap stocks currently.

  • The economy could return to much more robust rates of growth.
  • Consumer demand could increase, leading to stronger sales and employment outlooks for companies.
  • The Federal Reserve could cut interest rates sharply ahead of the debt-refinancing in 2024.
  • Inflation could drop sharply, boosting profitability for smaller capitalization companies.
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Confidence Matters

Yes, any of those things are possible. If they emerge, such should quickly reflect in the confidence of businesses surveyed by the NFIB. As shown, there is a high correlation between the annual rate of change of NFIB small business confidence and the Russell 2000 index.

NFIB Confidence vs Small Caps

The apparent problem with the wish list for small-cap investors is that more substantial economic growth and consumer demand will push inflationary pressures higher. Such would either keep the Federal Reserve on hold from cutting rates or lead to further increases, neither of which are beneficial for small-cap companies. Lastly, the surge in economic growth over the last two years resulted from a massive increase in Government spending. It is unlikely that the pace of the expenditures can continue, and as monetary supply reverses, economic growth will continue to slow.

M2 as percent of GDP growth

Given this backdrop, assuming current accelerated earnings growth estimates for stocks in the future is a bit unreasonable. On a 2-year forward-looking basis, current valuations for the Russell 2000 are higher than the S&P 500 index, where the top 10 largest companies dominate earnings growth.

Current PE based on 2-year forward estimates


Since debt-driven government spending programs have a dismal history of providing the promised economic growth, disappointment over the next year is almost guaranteed.

However, suppose additional amounts of short-term stimulus deliver higher rates of inflation and higher interest rates. In that case, the Federal Reserve may become contained in its ability to continue to provide an “insurance policy” to investors.

There are risks to assuming a solid economic and employment recovery over the next couple of quarters. With consumers running out of savings, the risk of further disappointment in sales expectations will likely continue to weigh on small business owners. This is why we keep a close eye on the NFIB reports.

However, in the short term, there is nothing wrong with being optimistic, and small-cap stocks benefit from the ongoing speculative frenzy in the market. The optimism can last longer with the Federal Reserve set to cut rates and further ease monetary accommodation.

However, regarding your investment portfolio, keeping a realistic perspective on the data will be essential to navigating the risks to come. For small-cap investors, the time to take profits and move to “safer pastures” is likely closer than you think.

The Nikkei Finally Tops 34 Year Old Peak

Japan is in a recession, its population is shrinking, and its debt to GDP is over 250%. However, despite their economic and demographic woes, Japan’s main stock index, the Nikkei 225, just hit a new all-time high. There is much more to the story than the Nikkei stock market diverging from fundamentals. The Nikkei is not just breaking any record; it finally surpassed the prior peak set in December 1989. Over the last 34 years, the Nikkei, excluding dividends, has provided investors a 0% return. The S&P 500 has grown by 1,346% over the same period.

After rebuilding the country from the devastation of World War 2, Japan embarked on an unprecedented economic boom. It quickly became one of the world’s leading economic powerhouses. In 1970, Japan’s GDP was $217 billion. By 1990, it rose to $3.19 trillion, an astonishing 14.4% annual growth rate. Along with an expanding economy was a speculative bubble in real estate and stocks. The bubble popped in late 1989 as stock and real estate prices tumbled. Its GDP peaked in 1995 and to this day remains below that level. It turns out the “Japanese miracle” was a function of massive speculation and unruly leverage.

Their huge economic growth rate came to a halt in the early 1990s, marking the beginning of what is termed “Japan’s Lost Decades.”

nikkei and S&P 500 since 1979

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

With Nvidia’s stellar earnings report Wednesday night, the market surged higher yesterday, reaching an all-time high. As discussed yesterday, the 20-DMA continues to support the bullish trend that began in November. Our only concern continues to be the negative divergence in both momentum and breadth of the market.

Market Breadth

That lack of breadth continues to be evident. As shown, yesterday’s surge was almost entirely a function of the Mega-capitalization stocks and anything remotely related to artificial intelligence.

Heat Map 022224

Nonetheless, the bullish trend remains firmly intact, and the breakout above the recent consolidation range sets the market in place for additional gains. However, I would suspect that with such an outsized gain yesterday, we could see a little profit-taking emerge soon. The 20-DMA is now the defacto “Maginot Line” for the markets. A failure at that level will likely lead to a deeper selloff. Continue to manage risk accordingly.

Market Trading Update

Nvidia Saves The Markets

Much hype and fear surrounded Nvidia’s (NVDA) earnings announcement on Wednesday night. Some proffered that if NVDA failed to meet expectations, its shares would fall significantly and drag the market lower. Given its role in the Magnificent Seven, such turmoil could lead to a new market regime, or so some thought. Today’s Tweet of the Day shows a popular meme all over social media before their earnings. On the flip side, there was speculation the stock could soar.

NVDA again blew the doors off earnings, and its shares are up about 15%. It also provided better-than-expected guidance on future earnings. NVDA reported its earnings grew by 486% over the year on a 265% increase in sales. Its data center is its crucial driver of growth, accounting for $18.4 billion of revenue, more than 5x the amount a year ago. To put the importance of its data center chips into context, its total revenue is $22.1 billion. Lastly, the company points to solid growth ahead as it cannot satiate demand for its chips. Per its CEO Jensen Huang:

“Fundamentally the conditions are excellent for continued growth — calendar 2024 to calendar 2025 and beyond,” Huang said. “We expect that demand will continue to be stronger than our supply provides.”

nvidia stock price

What Is A Treasury Auction Tail?

The following headline scrolled across our screens this week:

Another spicy Treasury auction, this time in the 20Yr: – Tail was 3.3bps, *largest on record* for the 20Yr

Given the recent importance of Treasury auction results, we should explain what an auction tail is. The U.S. Treasury uses a Dutch Auction format to distribute its bonds. Potential buyers submit their bids with information on the desired yields and the associated amount they would buy. The Treasury orders all bids from lowest to highest and fills the orders starting with the lowest yield. Once they meet the auction size, the yield of the last bidder is then applied to all winning bids.

A tail happens when the auction yield is above the yield where the bond was trading when the auction occurred. For instance, if the market yield on a ten-year note was 4.25% when the action ended, and the calculated auction yield was 4.27%, the tail was 0.2%. The larger the tail, the “worse” the auction. Conversely, auctions can come in below the market yield. The correct terminology is “through.” For example, “the ten-year note auction traded .01% through the market yield.”

Yes, the 20-year auction was terrible, but it’s a stretch to say there is no demand for Treasury debt based on one auction. In fact, last week’s 3, 10, and 30-year bonds all traded through the market yield. The auction stats describe the supply and demand environment at the time of the auction. Many factors affect the auction statistics. However, when fat tails become the norm over extended periods, one can presume demand is weak and or supply is too plentiful.

Tweet of the Day

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The Magnificent Two Leaves Five Stocks In Their Dust

The Magnificent Seven hog the headlines and are the envy of many investors. Yet since the start of 2024, only two Magnificent Seven stocks have been beating the market significantly. The graph below shows the relative performance of each stock versus the S&P 500. As shown, the Magnificent Seven traded in a unified fashion from November 1, 2023, when the market started rallying on hopes for Fed rate cuts. However, with the start of the new year, the Magnificent Seven is splintering, with only two stocks leading the way. NVDA and META are handily beating the market. Amazon is the only other stock outside of the “Magnificent Two” beating the market this year. Apple and TSLA, shall we say the “Un-Magnficent Two,” have significantly lagged the market.

The question on many investors’ minds is whether the Magnificent Seven is a bubble or whether their high valuations properly reflect the potential for higher-than-market earnings growth. To put the question in historical context, we wrote Are The Magnificent Seven In A Bubble? The article compares the mania surrounding the seven stocks to the Nifty Fifty of the late 1960s and early 1970s. Surprisingly, it turns out the high valuations of the Nifty Fifty were justified. However, the risk is not just the combination of high valuations and weaker-than-expected earnings growth but, maybe more importantly, a loss of confidence.

magnificent seven relative performance

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

Despite poor guidance from Palo Alto Networks yesterday, which pulled the market lower, it continues to hold onto rising trendline support coinciding with the 20-DMA. As noted yesterday, the selloff this week did trigger a MACD sell signal. As shown, there is a negative divergence between momentum indicators, which are waning, and the rising bullish market.

While such a divergence can last for a while, they usually resolve themselves with lower asset prices and more deeply oversold conditions. With bullish sentiment still very elevated, it is likely that we have more work to do before the current correction/consolidation is complete.

We are watching the 20-DMA very closely, which is our first indication that the recent rally may end. Continue managing risk exposures for now. With Nvidia’s blowout quarter on revenue and earnings last night, the market should get a lift today, defending the bullish trend for now, so no major concerns about a risk-off environment currently.

Market Trading Update

More On The Magnificent Two And Valuations

Our article from the opening (Are The Magnificent Seven in a Bubble?) uses logic by famed investor Jeremy Seigel. 26 years after the Nifty Fifty stocks peaked, he looked back on their high valuations and subsequent earnings growth to determine which stocks were cheap, fairly valued, or expensive at the top of the bubble.

Without the benefit of hindsight, we can’t appreciate how the seven stocks will grow their earnings, but we can calculate the earnings growth that would justify current valuations. Per the article:

For example, as shown in the table below, Amazon (AMZN) has a P/E ratio of 62.30, more than three times the S&P 500 (18.90). Before forming an opinion, consider that AMZN has grown its earnings at three times the rate of the S&P 500 over the last five years. For AMZN to perform in line with the market, assuming its P/E falls to market levels, its earnings must grow annually by 19.54% over the next ten years or 11.08% over the next 26 years.

Whether you are focused on the Magnificent Two or Seven, or for that matter, any stock, the analysis we employ can help investors appreciate whether a stock’s relative valuation versus the market is fair.

implied growth of the magnificent seven using valuations

Is Consumer Confidence About Politics, Not Economics?

The graph below from Jim Bianco is very telling in trying to answer our question. As shown, confidence among Democrats and Republicans shifts with the party of the President. While confidence readings by political party tends to trend in the same direction, they move in opposite directions at the election. Per Jim Bianco:

This is why I call consumer confidence polls “the world’s most useless economic statistic.” Because it is not an economic statistic, it is a political statistic!

We do not necessarily agree with Jim. Many governmental economic statistics are incredibly complex and can not accurately capture the state of the economy or inflation. Similarly, sentiment surveys can be highly biased, as we show. However, the trends of confidence surveys do a reasonable job of telling us whether sentiment is improving or declining. Given the consumer represents about two-thirds of economic activity, changes in confidence should be an important factor in projecting economic growth.

consumer confidence by political alignment bianco

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Corporations Are Hoarding Cash

The Bloomberg graph below provides us with a reason to be optimistic about the earnings and share prices of the largest corporations. As shown, the amount of cash corporations hold is at an all-time high and double the pre-pandemic trend. Large amounts of cash are a good thing for shareholders in today’s high interest-rate environment. In the five years preceding the pandemic, corporate debt securities outstanding rose on average by 3.5% per year. In 2020, corporate debt shot higher by 11% as corporations took advantage of historically low-interest rates to fortify their cash and pre-fund future needs. Consequently, corporate debt issuance has been below average, sparing some corporations the need to borrow at higher interest rates.

Additionally, corporations with excess cash are investing at money market rates that are often higher than their borrowing costs. For shareholders, not only does the situation help the income statement, but the cash allows some companies to buy back their shares and provide an additional tailwind to their stock price. The problem is the actions of a few large companies bias the data. Investor’s Business Daily helps us better appreciate the uneven distribution of corporate cash balances. Per their article, 13 corporations held over $1 trillion of cash or a quarter of the total amount in the S&P 500. For example, in aggregate, Apple, Google, and Microsoft held almost $450 billion of cash as of last September.

Corporations are hoarding cash

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

All eyes are on Nvidia today as they report earnings. While the consensus forecast is $4.20, the forecast for revenue growth over the rest of the year will be critical. The risk of disappointment is elevated, so be ready for some volatility in the market over the next couple of days. NVDA triggered a sell signal yesterday from a very elevated level, which is why we took some profits last week. There is decent support at $600/share, so a correction could be deep and swift to work off the overbought condition.

Trading Update 1

As we noted yesterday, while the overall market remains strong, positioning is becoming very stretched on both a technical and absolute positioning basis. Yesterday’s selloff triggered a short-term sell signal from an elevated level, and the 20-DMA is currently acting as support. A break of that moving average suggests a bigger correction is at play, and we will watch closely for signs of a larger reversal at work. Regardless, the corrective process was needed and should be used as an opportunity to rebalance exposures and move allocations to target levels as needed.

Trading Update 2

Inflation Expectations

The Fed considers inflation expectations as equally important as recent inflation trends. This is a relic from inflation lessons learned in the 1970s. At the time, they failed to appreciate that if consumers thought prices would rise soon, they would buy something today instead of waiting for tomorrow. Therefore, as inflation expectations rose, so did demand. The result was a circular inflation problem.

Minneapolis Fed President Neel Kashkari published a paper last weekend affirming the importance of expectations. The following quote is from his article, Policy Has Tightened A Lot:

“If supply-side factors appear to be contributing meaningfully to disinflation, what role has monetary policy played and how is it affecting the economy now? Monetary policy has played an enormously important role in keeping long-run inflation expectations anchored. It is hard to overstate how important that is for ultimately achieving the soft landing we are all aiming for.”

The New York Fed’s latest inflation expectations survey shows inflation expectations are falling. The first graph shows that expectations for inflation a year from now are closing in on pre-pandemic levels. The three-year inflation expectations have now fallen below pre-pandemic levels, with the low range of those surveyed expecting zero inflation.

1yr inflation expectations New York Fed
3yr inflation expectations New York Fed

Citi Says $3000 Gold is Possible In 2025

Analysis by Aakash Doshi, head of commodities research at Citibank, points to three catalysts that could significantly propel the price of gold. CNBC below summarizes his justifications for a 50% increase in gold in such a short period.

  • “The most likely wildcard path to $3,000/oz gold is a rapid acceleration of an existing but slow-moving trend: de-dollarization across Emerging Markets central banks that in turn leads to a crisis of confidence in the U.S. dollar,” Citi analysts, including Doshi, wrote in a recent note.
  • Another trigger that could drive gold to $3,000 would be a “deep global recession” that could spur the U.S. Federal Reserve to cut rates rapidly. “That means the brakes have been cut, not to 3%, but to 1% or lower – that will take us to $3,000,” Doshi said, noting that this is a low probability scenario.
  • Stagflation — an increasing inflation rate, slowing economic growth, and rising unemployment — could be another trigger, though Doshi said there’s a “very low probability” of such a scenario.
long term gold price

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Are The Magnificent Seven In A Bubble? Ask The Nifty Fifty

Sometimes, a narrative dominates the financial/social media and promotes a mania among investors. Today, the Magnificent Seven is a great example. Seven stocks, including Apple, Microsoft, Google, Tesla, Nvidia, Amazon, and Meta, are media darlings that many investors favor. Fifty-plus years ago, the Nifty Fifty were the stocks to own. They held a similar place as the Magnificent Seven in investors’ minds.

None of the Magnificent Seven companies existed in the heyday of the Nifty Fifty, but a unique valuation and narrative thread aligns the companies.

The experience of the Nifty Fifty “bubble” and its longer-term resolution sheds light on high valuations, earnings growth, and future returns. For the most part, the high valuations of the Nifty Fifty were appropriate. Will we be able to say the same for the Magnificent Seven?

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The Nifty Fifty

The Nifty Fifty was the nickname for a group of highly sought-after growth stocks during the late 1960s and early 1970s. Many of these companies were household names characterized by solid earnings growth, innovative business models, and apparent invincibility. Some prominent Nifty Fifty stocks included Coca-Cola, Kodak, McDonald’s, Philip Morris, and Walt Disney.

At the time there was great optimism regarding the global post-World War 2 global economic expansion and the promise of American capitalism. Investors were enamored by the growth potential of large dominant companies and willing to pay hefty valuation premiums for their stocks. Some claim that traditional valuation metrics were ignored during the Nifty Fifty run. Instead, investors cared more about potential growth.

Investors argued that the fifty companies were so exceptional that growth trajectories could continue indefinitely, thus justifying their high valuations. As we often see, valuations detach from reality, and extreme bullish sentiment leads to speculative bubbles.

The Nifty Fifty fell out of favor during the market downturn in 1973. With economic weakness and increasing inflation and interest rates, investors began reassessing their growth outlooks and questioned expensive valuations. Many of the once-esteemed Nifty Fifty stocks suffered substantial losses.

The graph below, courtesy of YCharts and the Palm Beach Daily, shows the 40+% decline in the Nifty Fifty from 1973 to late 1974.

the market peak for the nifty fifty

The Nifty Fifty Is Not the Bubble People Thought It Was

In aggregate, valuations for the Nifty Fifty stocks were twice that of the broader market. While the stocks fell sharply and valuations corrected, many Nifty Fifty stocks were not in a bubble as was presumed. It turns out the growth outlooks implied by the valuations were close to the mark.

The following commentary and graphics are from Valuing Growth Stocks: Revisiting The Nifty Fifty by Jeremy Siegel. He leads the article with the following:

But is the conventional wisdom justified that the bull market of the early 1970s markedly overvalued these stocks? Or is it possible that investors were right to predict that the growth of these firms would eventually justify their lofty prices? To put it in more general terms: What premium should an investor pay for large, well-established growth stocks?

His conclusion:

Examining the wreckage of the Nifty Fifty in the 1974 bear market, you can find two possible explanations for what happened. The first is that a mania did sweep these stocks, sending them to levels that were totally unjustified on the basis of prospective earnings. The second explanation is that, on the whole, the Nifty Fifty were in fact properly valued at the peak, but a loss of confidence by investors sent them to dramatically undervalued levels.

In 1975 there was no way of knowing which explanation was correct. But 25 years later we can determine whether the Nifty Fifty stocks were overvalued in 1972. Examination of their subsequent returns shows that the second explanation, roundly rejected by Wall Street for years, is much closer to the truth.

He argues that the high valuations of the early 1970s and late 1960s were fair. Instead, investors suffered a loss of confidence.

Those who did not lose confidence as the market swooned and held on to the Nifty Fifty kept pace with the market over the longer term. The table below assesses the Nifty Fifty from the market peak in December 1972 to August 1998, when Siegel wrote the article.

nifty fifty valuations

The Nifty Fifty generated returns over Siegel’s 26-year period on par with the S&P 500. Furthermore, the earnings growth was 3% more annually, calibrating almost perfectly with the high valuations of the early 1970s.

The “warranted P/E ratio” column calculates what should have been an appropriate P/E in 1972 had one known the future earnings growth premium between the Nifty Fifty and the market. The warranted and actual P/E ratios are similar in aggregate, but some stocks were expensive and some cheap.

For example, in 1973, Philip Morris had a P/E of 24.0, a 33% premium to the market P/E. Philip Morris would grow earnings by 17.9% compared to 8% for the market. Given that large difference in earnings growth, Phillip Morris was a steal with a P/E of 24. At the time, the fair value P/E for Phillip Morris was 68.5. Anything less than that was cheap in hindsight.  

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Are The Magnificent Seven In A Bubble or Priced Appropriately

Unlike Siegel, we do not have the benefit of future data to tell us whether the Magnificent Seven is in a bubble or appropriately priced for future earnings growth. However, we can use his logic and appreciate the earnings growth rates implied by current valuations.

We use two time periods, 10 and 26 years, to calculate the earnings growth required to bring the P/E ratios of each stock in line with the market while attaining the same price return.

For example, as shown in the table below, Amazon (AMZN) has a P/E ratio of 62.30, more than three times the S&P 500 (18.90). Before forming an opinion, consider that AMZN has grown its earnings at three times the rate of the S&P 500 over the last five years. For AMZN to perform in line with the market, assuming its P/E falls to market levels, its earnings must grow annually by 19.54% over the next ten years or 11.08% over the next 26 years.

p/e valuations and implied growth for the magnificent seven

Can Amazon continue to grow its earnings much faster than the economy and market? Given their saturation in many markets, continued double-digit growth will become more difficult by the year.

Even if NVDA becomes the dominant AI semiconductor chip designer and maintains or grows its current market share in other products, will the future chip market be large enough for NVDA to grow 830% (24.70% annually) by 2034?

We should be asking similar questions of all the Magnificent Seven stocks.

The graph below, courtesy of FactSet, shows that the high P/E ratios of the Magnificent Seven in aggregate may not be out of line with the market when one considers their earnings growth projections.

peg ratio magnificent seven
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Siegel uses 26 years to justify his stance. Different periods will yield different earnings growth requirements. While we can quarrel with his analysis, the point is high valuations are not necessarily a warning. In fact, as we share with Philip Morris, a high valuation for a stock may not be high enough. The important question is, can a stock live up to the earnings growth implied by its valuation?

The market may be underestimating the growth potential for some of the Magnificent Seven stocks and overestimating it for others. But, Siegel states, the most significant risk in the short term may not be growth potential but confidence. Confidence can fade just as quickly as it was born.

We leave you with a quote from Benjamin Graham:

In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”

Can Midcap Stocks Ignore Bond Yields?

The graphs below show the daily and weekly graphs of MDY, the midcap ETF, alongside ten-year note yields. The midcap index is breaking out to record highs. Such is not surprising given the S&P 500, Dow Jones Industrial Average, and the Nasdaq also reached new records recently. What is surprising is that the midcap index is setting a record high as interest rates are starting to inch higher again.

The smaller graph beneath the daily price graph below shows the running 50-day correlation between midcap stocks and ten-year note yields. From August 2023 through year-end, the correlation was almost perfectly inverse. As yields rose, midcaps fell and vice versa. The inverse relationship is not surprising, as midcap stocks have fewer financing options than larger-cap companies, and their earnings tend to be more sensitive to interest rates. Despite the fundamental relationship, the recent uptick in yields does not concern midcap investors as the index moves upward. The weekly graph highlights the periods when the Fed was actively raising rates. As expected, the correlation was decently negative.

If midcaps can ignore higher rates in the short term and benefit more than larger cap stocks when rates decline, as we think is likely over the medium term, midcap stocks may present an alternative to the S&P 500.

midcaps versus ten year yields

What To Watch Today


Earnings Calendar


  • No notable economic releases

Market Trading Update

With the market closing yesterday during President’s Day, nothing changed from Friday’s close. The two small sell-offs last week, following inflation reports, failed to break the 20-DMA. As such, the bullish trends remain in place for now. As noted last week, the market remains within striking distance of new highs, and we have seen some rotation from the “Mag 7” as shown in the heat map for last week.

Heat Map Market

Overall, the market remains strong, and positioning is becoming very stretched on both a technical and absolute positioning basis shown in both our Technical and Positioning data.

Sentiment Gauges

Furthermore, despite the bullish attitudes of investors, breadth continues to deteriorate.


The risk of correction is elevated, so we suggest rebalancing portfolio risk to hedge against a market pullback. The deviation between the S&P and the 200-DMA is rather extreme, suggesting a 5-10% correction is becoming more probable.

S&P 500 Index vs 200-DMA

The Week Ahead

The FOMC minutes on Wednesday will be followed closely for more information about what the Fed is looking for before it feels comfortable cutting interest rates. Because the minutes are more of an update than the actual minutes, the Fed may share its views on the uptick in CPI and PPI. Even if the minutes are not illuminating, a slew of Fed members speaking this week will elaborate on recent inflation data.

There is little important economic data this week. Again, initial jobless claims are worth following closely to gauge whether the employment markets are weakening.

Market Analogs Reveal Your Biases But Not The Future

A reader sent us the first graph below and asked our thoughts. Our answer was that analogs could tell any story, but most often not the correct story.

1929 was 95 years ago. A lot has changed since then. History may rhyme at times, but just because two line graphs look eerily similar doesn’t mean history will repeat. To help provide context for that statement, consider the second graphic. Nautilus shows two bullish and two bearish graphs that compare prior markets that line up well with the current market. All four have extremely high correlations.

Many times, our biases are revealed with analog graphs. While it’s important to appreciate similar patterns, we must factor in fundamentals, liquidity, geopolitics, economics, and a plethora of other factors that move markets.

1929 vs now market analog S&P 500
bullish and bearish market analogs

PPI Follows CPI Higher

Like CPI last Tuesday, the PPI data was hotter than expected. The headline number rose 0.3%, above the +0.1% consensus estimate. The core PPI was +0.5%, well above the +0.1% estimate. Generally, service prices rose while goods prices continued to decline slowly. While the recent data point to sticky inflation, it’s important to remember that January seasonal adjustments and one-time price changes related to the new year play a bigger-than-average role. Per Zacks:

Also keep in mind that early-year economic prints tend to carry a heavier amount of inflation based on a number of things, including carry-over from the previous year’s holiday shopping season. We may need to wait until March or April to see if our longer-term trajectories remain intact toward 2% inflation.

The tweet below from Carl Quintanilla further elaborates on the January effect. The graph shows that the trends lower in PPI remain firmly intact.


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Don’t Fear All-Time Highs, Understand Them

Don’t fear all-time highs in the market. Such is a natural response for investors who are concerned about market risk. However, rather than fearing market exuberance, we must understand what drives it.

There is an essential concept investors should understand about markets when they are hitting “new records.”

“Record levels” of anything are “records for a reason.”

It should be remembered that when records are broken, that is the point where previous limits were reached. Just as in horse racing, sprinting, or car races, the difference between an old record and a new one is often measured in fractions of a second. Yes, while the market is currently hitting all-time highs, it is a function that, in this case, took two years to occur.

Stock market hitting all-time highs

So, while the media is giddy about markets hitting all-time highs, we must remember that “record levels are NOT THE BEGINNING but rather an indication of a well-underway process. While the media has focused on record-low unemployment, record stock market levels, and surging confidence as signs of an ongoing economic recovery, history suggests caution. For investors, everything is always at its best at the end of a cycle rather than the beginning.

Let’s take a look at a long-term chart of the market. Since 1871, there have been FIVE very distinct bull market cycles. During those roughly 15 to 20-year periods, stock prices rose, hitting new highs. Notably, long periods of flat to declining prices follow bullish periods. In other words, 100% of the total market gains came from five distinct historical periods.

Stock market real index price versus CAPE valuations

At the end of those five bullish trends, markets were at all-time highs. For those invested at those all-time highs, it took an average of 20 years before they saw all-time highs again. Note the level of valuations when those peak bull market periods occurred.

With valuations currently elevated and prices surging to all-time highs, does this mean we are in for 20 years of no returns?

What Valuations Do And Don’t Tell Us

The mistake investors repeatedly make is dismissing the data in the short term because there is no immediate impact on price returns. Valuations, by their very nature, are HORRIBLE predictors of 12-month returns. As such, investors should avoid any investment strategy with such a focus. However, valuations are strong predictors of expected returns in the longer term.

Forward 10-year returns based on valuations.

While valuations suggest that returns over the next 10 years will likely be lower than the last decade, psychology drives short-term markets. Unsurprisingly, there is a high correlation between investor sentiment and asset prices. The chart below shows the 13-week moving average of net bullish sentiment (betail and institutional) versus the market. During periods of rising prices, sentiment increases, creating a buying panic for stocks.

13-week bullish sentiment vs the market

Eventually, something changes investors’ sentiment from bullish to bearish, and that creates the eventual reversion in asset prices. So, while valuations are vital in setting expectations for future rates of return, they are of little value in the short term. As such, this is why using some basic technical analysis can help investors navigate short-term market time frames to avoid excessive risk buildup in portfolios. The chart below is a composite of weekly technical indicators (price close as of the end of the week.) In October 2023, with a reading below 20, the deep oversold condition marked the bottom of the market. Such formed our call for a year-end rally. With the current reading above 90, which is exceptionally bullish, risk-taking by investors has swung wildly into bullish territory.

Technical gauge vs the market.

Of course, given the hype of “artificial intelligence” and the ongoing hopes of a reversal in monetary tightening, it is unsurprising that markets have hit all-time highs.

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Don’t Fear All-Time Highs, Understand Them

In the short term, investors should not fear all-time highs as a harbinger of impending doom. When driven by momentum and psychology, bull markets can last longer and go farther than logic would predict. But even during these momentum-driven rallies, 5-10% intrayear corrections are the norm.

Annual and Intra-year returns

History is pretty clear that when markets hit all-time highs, more will follow as investors become more “fearful of missing out.” But such exuberance will eventually give way to fundamental realities.

Real S&P 500 index bull markets.

What will cause such a reversal is unknown. However, given the current deviation of the market from its long-term exponential growth trend, it will become more challenging for stocks to continue to grow faster than the economy. Notably, such deviations have historically led to extended periods of very low to zero rates of return.

Real S&P 500 deviations from exponential growth trend.

Of course, that is what current valuations already tell us. While Wall Street analysts are very bullish on the future, some factors must be considered. The economic cycle is tied closely to demographics, debt, and deficit. If you agree with this premise and the data, then the media’s optimistic views are unlikely. 

We believe rationalizing high valuations today will likely lead to disappointing future outcomes. However, bullish sentiment is becoming contagious in the short term, making continued “new all-time highs” more likely.

Don’t fear all-time highs. Just understand they are the byproduct of exuberance.

America Is Avoiding A Global Recession, So Far

On Thursday morning, Japan and the United Kingdom reported a negative GDP for the second consecutive quarter. A few weeks ago, Germany also reported consecutive quarterly declines in GDP. Accordingly, all three countries are now in a technical recession. To appreciate their role in the global economy, consider Germany is the world’s third-largest economy, and Japan is right behind them in fourth. The United Kingdom is sixth behind India. China, the second largest economy, has seen sluggish economic activity, its property sectors are highly distressed, and its local governments are fiscally constrained. While China is not in a recession, growth is slowing rapidly. Simply, large swaths of the developed world are in a global recession despite a robust economy in America. Most often, economic activity among the most significant global economies and America tends to correlate well. Therefore, we must ask, is this time different? Conversely, are large amounts of U.S. fiscal stimulus and relatively strong credit-driven consumption keeping America afloat for the time being? Is America destined to join the other countries listed above in a recession? Recent data we have shared on the manufacturing sector and small businesses point to a recession, yet broad economic activity remains robust. As we have said, keep an eye on employment trends. America’s recession warning will come when unemployment starts to rise.
GDP ranking by nations

What To Watch Today

Earnings Economy

Market Trading Update

Yesterday’s commentary noted that the bullish trend remains intact, with the market holding near-term support. To wit:
“The market rebounded off the 20-DMA average yesterday, keeping the bull trend intact for now. The market bounced off the 20-DMA and slightly reduced the overbought condition. Such keeps the current trend positive, keeping equity allocations near full weight. However, the internals continue to weaken, and the market is close to registering a sell signal from an elevated level. Furthermore, the deviation from the 200-DMA remains quite large, likely limiting further upside until a more significant correction occurs to reduce the extension.”
Such remained the case yesterday, with the rally challenging recent highs. What was notable in that rally was that the “Magnificent 7” were NOT in charge. Instead, as shown in the heat map below, Financials, Energy, Healthcare, and Utilities were rising decently. While this was not enough to reverse recent breadth issues, seeing some rotation in the markets was encouraging. This is a healthy change. As we have discussed recently, two ways exist to correct some of the more egregious overbought conditions in the market. The first is a correction that reverses the price. The second is a consolidation, where a rotation from leaders to laggards works off some of the overbought issues. It is too early to tell if a rotational consolidation is in process; yesterday’s action was encouraging. Notably, mid-cap stocks, which got slaughtered on Tuesday, reversed all those losses and set a new high for the week. We are watching mid-caps closely, which are currently extremely overbought but are lagging performance relative to the S&P. Mid-caps are close to potentially setting a new all-time high to join their large-cap brethren. If such is the case, we will look to increase our exposure to some of those names.

Retail Sales

January retail sales fell 0.8%, worse than the consensus estimate of a 0.1% decline. Last month’s red hot gain of +0.8% was revised lower to +0.4%. Retail Sales, excluding automobile sales, were -0.6% versus estimates of an increase of +0.3%. The control number, which feeds GDP, was -0.4%. The following summary is courtesy of Pantheon Macro:
This report is remarkably downbeat, with an unexpectedly sharp plunge in total sales, significant downward revisions .. and only a few signs of light in the details. .. Are consumers starting to tire?”
While drawing assumptions from the report is easy, we offer caution. December and January data are skewed due to the holidays and the seasonal adjustments made to the data. We want to see a few more months of weak consumer activity before declaring consumers are starting to tire.
us retail sales america

Answering A Reader Question On Rent Inflation

A reader asked if we could further detail why CPI rent prices are flawed and why that is an important reason that we (RIA) are not worrying about Tuesday’s CPI data. Shelter costs (OER and actual Rent) are the most crucial variable in the CPI’s largest category. Therefore it is the most significant driver of inflation. CPI shelter prices are well above market prices. The reason is the lag embedded in the BLS calculations. Further, the BLS imputes rents in its owner’s equivalent rent (OER), which can be faulty due to seasonal effects. CPI Rent lags market rents because it doesn’t fully factor in today’s actual rents for new lease signings. Instead, it measures the change in rent among all renters. Given most rents expire annually, over 90% of renters in any month are un-expiring leases. Accordingly, their rent doesn’t change. Also consider the CPI surveys the same renters once every six months. Therefore, if your rent changes a month after the last survey, the new rent is not captured for five months. The first graph below shows the BLS measurement of new tenant rental inflation, which is down over 4% from a year ago. Unfortunately, the BLS only publishes this data every six months. The next report will be in April. The second graph shows the downward trend in the CPI’s measure of rent inflation. The third graph is from Ian Shepherdson. Clearly, OER (imputed rent) is askew from actual rental prices and the BLS rent measure. The bottom line is that we think the lag effect and the odd OER data account for the increase. When they correct, CPI will fall accordingly.
new tenant rent inflation, cpi rent, all tenant rent
cpi rent inflation
zillow rent versus cpi rent and oer

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Fed Chair Powell Just Said The Quiet Part Out Loud

Regarding the surprisingly strong employment data, Fed Chair Powell said the quiet part out loud. The media hopes you didn’t hear it as we head into a contentious election in November.

Over the last several months, we have seen repeated employment reports from the Bureau of Labor Statistics (BLS) that crushed economists’ estimates and seemed to defy logic. Such is particularly the case when you read commentary about the state of the average American as follows.

“New Yorker Lohanny Santos publicly vented her frustration after her attempts to go door-to-door with her CV in hand in the hope of finally landing a job were unsuccessful.

It would appear that other young jobseekers could relate to Lohanny’s struggles. The USA and Canada rank fifth out of seven when it comes to youth unemployment and third when it comes to total unemployment, according to World Bank data based on an International Labor Organization model for 2020, as per Statista.”Business Insider

Even M.B.A.s are finding it difficult.

“Jenna Starr stuck a blue Post-it Note to her monitor a few months after getting her M.B.A. from Yale University last May. “Get yourself the job,” it read. It wasn’t until last week—when she received a long-awaited offer—that she could finally take it down.

For months, Starr has been one of a large number of 2023 M.B.A. graduates whose job searches have collided with a slowdown in hiring for well-paid, white-collar positions. Her search for a job in sustainability began before graduation, and she applied for more than 100 openings since, including in the field she used to work in—nonprofit fundraising.” – WSJ

These stories are not unique. If you Google “Can’t find a job,” you will get many article links. The question, of course, is why individuals with college degrees, no less, are having such a tough time finding employment. After all, aside from record-smashing employment reports, we also continue to see near-record low jobless claims and high numbers of job openings, as shown below.

Unemployment and jobless claims.

The Washington Post touched on part of the problem and why the unemployment rate for college graduates is higher than for all workers.

“Part of the problem is that the industries with the biggest worker shortages — including restaurants, hotels, daycares, and nursing homes — aren’t necessarily where recent graduates want to work. Meanwhile, the industries where they do want to work — tech, consulting, finance, media — are announcing layoffs and rethinking hiring plans.”

Recent grads are unemployed more than others.

As the Washington Post summed up:

“The result is yet another disruption for a generation of college graduates who have already had crucial years of schooling upended by the pandemic. In interviews, many said they’d struggled to adjust to remote-learning in early 2020 and felt like they had missed out on opportunities to forge connections with professors, employers and other students that could have been crucial in lining up for postgraduate work. Now, as they enter the workforce, they say they’re feeling increasingly disillusioned about the economy, which is fueling political discontent and causing them to rethink the financial independence they thought they’d achieve after college.”

Of course, it isn’t just the shuttering of the economy and the shift to working from home causing the problem. It is also the shift in demand from consumers to more service-oriented conveniences, combined with the need by employers to maintain profitability.

Fed Chair Powell Says The Quiet Part

Since the turn of the century, the U.S. economy has shifted from a manufacturing-based economy to a service-oriented one. There are two primary reasons for this.

The first is that the “cost of labor” in the U.S. to manufacture goods is too high. Domestic workers want high wages, benefits, paid vacations, personal time off, etc. On top of that are the numerous regulations on businesses from OSHA to Sarbanes-Oxley, FDA, EPA, and many others. All those additional costs are a factor in producing goods or services. Therefore, corporations needed to offshore production to countries with lower labor costs and higher production rates to manufacture goods competitively.

During an interview with Greg Hays of Carrier Industries, the reasoning for moving a plant from Mexico to Indiana during the Trump Administration was most interesting.

So what’s good about Mexico? We have a very talented workforce in Mexico. Wages are obviously significantly lower. About 80% lower on average. But absenteeism runs about 1%. Turnover runs about 2%. Very, very dedicated workforce.

Which is much higher versus America. And I think that’s just part of these — the jobs, again, are not jobs on an assembly line that [Amerians] really find all that attractive over the long term.

Fed Chair Powell emphasized this point in a recent 60-Minutes Interview. To wit:

“SCOTT PELLEY: Why was immigration important?

FED CHAIR POWELL: Because, you know, immigrants come in, and they tend to work at a rate that is at or above that for non-immigrants. Immigrants who come to the country tend to be in the workforce at a slightly higher level than native Americans. But that’s primarily because of the age difference. They tend to skew younger.

The suppression of wages, increased productivity to reduce the amount of required labor, and offshoring has been a multi-decade process to increase corporate profitability.

Porfits to wages ratio

A Native Problem

Following the pandemic-related shutdown, corporations faced multiple threats to profitability from supply constraints, a shift to increased services, and a lack of labor. At the same time, mass immigration (both legal and illegal) provided a workforce willing to fill lower-wage paying jobs and work regardless of the shutdown. Since 2019, the cumulative employment change has favored foreign-born workers, who have gained almost 2.5 million jobs, while native-born workers have lost 1.3 million. Unsurprisingly, foreign-born workers also lost far fewer jobs during the pandemic shutdown.

Native vs Foreign Born Workers

Given that the bulk of employment continues to be in lower-wage paying service jobs (i.e., restaurants, retail, leisure, and hospitality) such is why part-time jobs have dominated full-time in recent reports. Relative to the working-age population, full-time employment has dropped sharply after failing to recover pre-pandemic levels.

Full Time Employment to Populations

However, as noted, full-time employment has declined since 2000 as services dominate labor-intensive processes such as manufacturing. This is because we “export” our “inflation” and import “deflation.” We do this to buy flat-screen televisions for $299 versus $3,999. Such is also why the economy continues to grow slower, requiring ever-increasing debt levels.

Debt ot GDP growth

For recent college graduates, this all leads to a more dire outlook.

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Immigration Is Needed, But It Has Consequences

To keep an economy growing, you must have population growth. In other words, “demographics are destiny.” As such, there are two ways to obtain more robust population growth rates – natural births and immigration. As shown below, the fertility rate in the United States is problematic in that we aren’t producing enough children to replace an aging workforce.

Fertility Rate

Such is particularly problematic given the rapid aging of older adults versus a declining working-age population. Such means the underfunding of entitlements will continue to grow, requiring more debt issuance to fill the gap.

Working age to elderly population

However, there is a vast difference between immigration policies that import highly skilled workers, capital, and education versus those that don’t. Merit-based immigration policies bring workers who earn higher salaries, create businesses, employ labor, and create tax revenues and other economic contributions. However, current policies are creating a rush of lower-skilled, uneducated labor that will work for cheaper wages, produce less revenue, and are subsidized by tax-payers through welfare programs. As noted above, these workers tend to fill the jobs in the service areas of the economy, thereby displacing native-born workers. Such was a point made by the WSJ:

“Before the pandemic, foreign-born adults were almost as likely as the overall population to hold at least a bachelor’s degree. This was mainly because of higher educational attainment among immigrants from Asia, Africa, and Europe, which offset lower levels of schooling among people from Mexico and Central America.”

Post-pandemic, this has not been the case, which is impacting native-born employment. This is not a new issue, but one addressed by Bill Clinton in the 1995 State of the Union Address:

“The jobs they hold might otherwise be held by citizens or legal immigrants; the public services they use impose burdens on our taxpayers.”

Such is the natural consequence of a change in the economy’s demands and the need for corporations to maintain profitability in an ultimately deflationary environment.


While there is much debate over immigration, most of the arguments do not differentiate between legal and illegal immigration. There are certainly arguments that can be made on both sides. However, what is less debatable is the impact that immigration is having on employment. Of course, as native-born workers continue to demand higher wages, benefits, and other tax-funded support, those costs must be passed on by the companies creating those products and services. At the same time, consumers are demanding lower prices.

That imbalance between input costs and selling price drives companies to aggressively seek options to reduce the highest cost to any business – labor. Such was discussed in our article on the cost and consequences of the demand for increased minimum wages.

  • Reductions in employment would initially be concentrated at firms where higher prices quickly reduce sales. 
  • Over a longer period, however, more firms would replace low-wage workers with higher-wage workers, machines, and other substitutes.
  • As employers pass some of those costs on to consumers, consumers purchase fewer goods and services.
  • Consequently, the employers produce fewer goods and services.
  • When the cost of employing low-wage workers rises, the cost of investing in machines and technology goes down.” – Congressional Budget Office.

Such is why full-time employment has declined since 2000 despite the surge in the Internet economy, robotics, and artificial intelligence. It is also why wage growth fails to grow fast enough to sustain the cost of living for the average American. These technological developments increased employee productivity, reducing the need for additional labor.

Unfortunately, these tales of college graduates expecting high-paying jobs will likely continue to find it increasingly complicated. Particularly as “Artificial Intelligence” becomes cheap enough to displace higher-paid employees.

Lyft Blunder Causes Chaos

Lyft’s earnings announcement Tuesday night was one for the ages. Their quarterly earnings statement reported that its margins rose by 5% or 500 basis points. In other words, for each dollar Lyft receives from its clients, they will earn an additional five cents. That may not seem like a lot, but it is. However, there was a problem with the sharp jump in its margins. The decimal was misplaced. Shortly after the earnings release, Lyft corrected itself, saying the margin only rose by .50% or 50 basis points. Lyft shares went on a rollercoaster ride. The stock initially surged 100%, but as shown below, it quickly gave up a large chunk of the gains. The stock is still poised to have a substantial increase.

Since bottoming in November, Lyft’s stock has nearly doubled. While recent performance may be encouraging, it is still down over 75% since trading at 68 in 2021. Conversely, Uber, its chief competitor, has also surged since November. But, its stock is trading at record highs, about 15% above the 2021 peak. Why? For starters, Uber operates internationally, while Lyft is solely domestic. Furthermore, Uber also offers food delivery and a freight division. Uber had $37 billion in sales for the last year, up 3x since 2018. Lyft, on the other hand, is losing ground. Its revenues of $4.4 billion are a fraction of Uber’s, and its 5-year growth of 80% is well below Uber’s pace.

lyft share price

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

The market rebounded off the 20-DMA average yesterday, keeping the bull trend intact for now. The market bounced off the 20-DMA and slightly reduced the overbought condition. Such keeps the current trend positive, keeping equity allocations near full weight. However, the internals continue to weaken, and the market is close to registering a sell signal from an elevated level. Furthermore, the deviation from the 200-DMA remains quite large, likely limiting further upside until a more significant correction occurs to reduce the extension.

Market Trading Update

Furthermore, as noted by Sentiment Trader yesterday, numerous “risk off” warnings continue to occur in the market.

“Subtle clues regarding the internal strength of the stock market advance continue to emerge, suggesting a backdrop with fewer and fewer stocks participating in the uptrend. The latest indicator to trigger a warning measures participation based on relative performance versus the S&P 500. This system, a member of the Risk-Off Composite Model, registered an alert on Tuesday, indicating the world’s most benchmarked index could struggle over a medium-term horizon. While a concern, the weight of the evidence has not overwhelmingly swung to the bearish side of the ledger. For now, we should remain vigilant regarding additional risks.”

Risk Off Model

Historically, the last half of February and March tend to be weaker periods in the seasonally strong stretch. Continue taking profits and rebalancing risks as needed.

The Lone Dove At The Fed

While other Fed members appear to support Powell and his conservatism toward rate cuts, Chicago Fed President Austan Gollsbee is not on board. In prepared remarks Wednesday morning, he said he “doesn’t support waiting until inflation is at 2% for a rate cut.” Further, he reminded the audience that the Fed’s inflation goal is based on PCE, not CPI. PCE is currently running half a percent below CPI at 2.6% annually. More importantly, it has only risen by 0.87% over the last six months.

One reason for the discrepancy is the CPI assigns a 33% weight to shelter prices, while PCE is 15%. Given that shelter prices used by the indexes are well above real-time prices, the weighting difference skews CPI higher than PCE. Essentially, Goolsbee is telling us to ignore the faulty shelter prices. As we noted yesterday, CPI, less shelter prices, is running at 1.40%.

Goolsbee states he “doesn’t believe the last mile of the inflation fight is the hardest.” Many other Fed members still believe they must keep policy restrictive as further declines in inflation will be increasingly difficult. Goolsbee is but one voter and unlikely to heavily influence Powell, but his comments may sway other members.

Sentimentrader Sends A Warning

The following analysis from Sentimentrader adds more data to their growing pile of research, warning that investors should be cautious of a potential decline. Their latest, shown below, highlights that over the last 20 trading days, the S&P 500 has closed at a yearly high on over half of those days. Yet, the VIX volatility index has failed to reach a 63-day low. Typically, the VIX and the S&P 500 have an inverse relationship. However, at times, usually when the market is overbought, the VIX will rise alongside the market. Such is the case today, which triggered a warning from Sentimentrader.

S&P 500 volatility and market warning

Sentimentrader Sends A Warning For Small-Caps

The following commentary and graph are courtesy of Sentimentrader:

The S&P 500 has been hitting record highs as internal small cap momentum deteriorates. The McClellan Summation Index for the Russell 2000 is well below zero even as the S&P 500 has driven to record highs. This is unusual – usually, small cap momentum ebbs and flows along with swings in the S&P as investors are in gear. The last time they were out of gear like this was in 2021. Historically, this has been a worse sign for small caps than the broader market.

sentimentrader iwm mcClellan summation

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Is Toyota The Next Tesla?

Over the last four quarters, Tesla generated total revenue and earnings of $96 billion and $15 billion, respectively. Toyota’s revenue and earnings are roughly three times larger at $299 billion and $44 billion. Yet Tesla’s market cap is more than double that of Toyota.   

Tesla shares have soared since going public, while Toyota and other major auto manufacturers’ shares have meandered along. Since going public in 2010 at $1.59 (split adjusted), Tesla shares are up nearly 12,000%. That figure is more stunning, considering it’s down 50% since late 2021. The graph below, charting the two stocks since 2018, highlights Tesla’s outperformance versus Toyota and the extreme volatility of its returns. As shown in the second graph, 40-50+% drawdowns are not uncommon for Tesla.

tesla and toyota
tesla stock price and drawdowns

Tesla shares have outperformed Toyota’s and the market because of the significant growth of EVs, a robust outlook for EV market penetration, and forecasts that Tesla will maintain its lead role in manufacturing EVs. Tesla’s market cap relies on all three coming to fruition.

What if one or more of those do not occur? Might hybrids be the preferred technology until a more efficient battery evolves? Will EV competition from established and new auto manufacturers upend Tesla’s market share? Maybe most critical, could Toyota, not Tesla, be at the forefront of a significant technological advance for automobiles?

With a price-to-earnings ratio of 9 for Toyota and 72 for Tesla, the answers to our questions have critical implications for shareholders of both stocks.  


Sales of EVs are multiplying. The latest data shows that EVs will account for 9% of all domestic new car sales in 2024. That leaves plenty of upside for EV manufacturers if the U.S. follows the path of other countries like Germany and China, in which EVs represent approximately a third of all new car sales.

While the transition from internal combustion engines (ICE) to electric is sure to continue, its pace appears to be moderating. There are a few drawbacks affecting the uptake of EVs.

EV Drawbacks

Consider the following:

  • Fewer EV cars are eligible for Federal tax credits.
  • Kelley Blue Book claims the five-year cost to own EVs versus ICE vehicles is 15% higher. 
  • The time to “fill up” an EV is much longer than an ICE car, and the EV recharging infrastructure is inadequate in many places. Consequently, “range anxiety,” or the fear of running out of power at the wrong time or location, is a concern.
  • Per the National Automobile Dealers Association (NADA)- The final cost of the vehicle is its depreciation at resell, the difference between what the consumer paid for it and its worth after five years of ownership. EVs lose an average of $43,515 in value; ICE vehicles depreciate by $27,883.
  • EV batteries are less efficient in severe temperatures.
  • EVs have higher insurance and financing costs.
  • Lithium-ion batteries can catch fire in an accident and on rare occasions when they are not in use.

The obvious benefit for EV owners is fuel costs. NADA estimates an EV owner will save approximately $5,000 in gas and a few hundred dollars in maintenance costs over five years versus an ICE owner.

The market for EVs among early adapters and wealthier, environmentally concerned consumers is starting to get saturated. More car buyers will likely shift from ICE to EV, but that transition will be slower than it has been for the more eager first adapters.

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Tesla Doesn’t Have a Monopoly Anymore

At one point, Tesla’s market cap was almost equal to that of the entire auto industry. Not only were Tesla investors projecting that Tesla would be the largest automaker, but also that some of their other ventures, like energy generation and robo-taxis would do fabulously well. A lot has changed since then.

Tesla no longer has a monopoly on EVs. Almost every auto manufacturer, and a few new ones like Rivian and Fisker, now manufactures EV cars, as shown in the graph below, courtesy of Cox Automotive.

ev market share toyota and tesla

Further, consider the following paragraph from Cox Automotive:

EV transaction prices in Q3 were down significantly from 2022. In an attempt to increase sales volume, Tesla slashed prices, which are now down roughly 25% year over year. The price cuts have helped, as Tesla’s Q3 sales grew by 19.5% year over year, surpassing the industry’s overall growth rate of 16.3%. However, Tesla’s share of the EV segment continues to plunge, hitting 50% in Q3, the lowest level on record and down from 62% in Q1.

Bottom line: Tesla is losing its competitive advantage. They are relinquishing EV market share and cutting prices, ergo profits, to stay competitive.

Hybrid- The Bridge Technology

This discussion of hybrid automobiles does not refer to models with gas engines and battery packs that can be plugged into a power source.

As shown in the graph above, Toyota lags every other automaker, with only 0.5% of sales coming from EVs. However, Toyota has a different strategy regarding producing environmentally friendly vehicles. They are the largest seller of hybrid cars. The hybrid Prius was introduced to the U.S. market in 2000. Toyota’s first mover experience gives them a unique advantage in profitably manufacturing hybrid vehicles.

Hybrid automobiles can get 35 to 50+ miles per gallon. The technology enables a battery to capture a charge through its braking mechanism. This electricity then supplements its internal combustion engine. Consumer Reports estimates hybrids provide a 40% improvement in gas mileage versus non-hybrids.

The graphic below, courtesy of CNBC, shows that U.S. sales of hybrids have easily kept up with EV sales since 2015.

hybrid vs ev market share

Car owners prefer better gas mileage, and we presume many want to do their part to help the environment. That said, most auto consumers are not ready to fully commit to EVs. We listed some reasons for the hesitation, but likely the most important is the price. The CNBC graphic below shows hybrids and ICE vehicles are similar in price, while EVs are costlier.

average price ice vs hybrid vs ev

We think hybrid vehicles can be the transitional technology of choice until a better EV battery evolves. Many consumers seem to agree!

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More On Hybrids

The following is from a recent Wall Street Journal article entitled, Toyota Motor reports rise in quarterly net profit as sales grew.

Executives at Japanese automakers that are strong in hybrids, including Toyota and Honda, say they are skeptical of competitors’ ability to catch up quickly. They observe that it took some two decades for Japanese carmakers to bring their hybrids to profit-margin parity with purely gasoline-powered vehicles. 

Hybrid sales grew last year at a faster clip than sales for pure electric vehicles in the U.S. and some other markets. Signs have emerged that the EV push might have gotten ahead of U.S. consumers who are worried about charging problems and higher prices. That has steered them toward less expensive hybrids, which can be filled up with gasoline. 

Automakers that had been rushing to pivot toward full EVs are now reconsidering.

General Motors said last week it would introduce some plug-in hybrid models in North America after facing pressure from dealers.

Ford Motor said last year it would seek to quadruple its hybrid sales in the next five years.

Solid-State Batteries

We now consider the next potential game changer for the auto industry: solid-state batteries. Solid-state batteries promise to eliminate many problems associated with current EV lithium-ion batteries.  

Lithium-ion batteries are heavy, expensive to manufacture, slow to charge, and have a mileage range considered too short by many. Solid-state batteries vastly improve on those problems. However, whether the technology can be mass-produced at reasonable costs is unclear.

Many experts believe Toyota is the leader in solid-state battery development. Per Forbes:

Toyota’s stated goal is for their solid-state batteries to ultimately have a range of >1,200km, and to go from 10 – 80% charge in 10 minutes or less. This compares to the Tesla Model Y, which currently has a range of 542 km, and fast-charges in 27 minutes.

Other automakers are investing in solid-state battery development. Toyota believes they will be the first to produce cars with solid-state batteries. Production could come as early as 2027. The investment and production costs are enormous, and there are no promises these batteries will make economic sense for consumers or manufacturers.

Tesla does not believe in the viability of solid-state technology, and, as far as the market knows, it is not developing solid-state batteries.

Tesla 4680 Battery Cells

Elon Musk is an innovator. He knows that his current battery technology will fall behind his competitors if it is not improved. Tesla is betting on 4680 batteries instead of solid-state. The 4680 battery hopes to improve cost, weight, and energy density.

Per, the potential benefits are battery weight, which may be about 10% lighter. Additionally, the cost of the batteries could be 15% cheaper, and the driving distance on a charge could improve by 10-15%.

Such would be a decent improvement, but it pales compared to the promise of solid-state batteries.

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Fundamentals and Valuations

So, with an appreciation for the role of hybrids, EVs, and solid-state batteries, let’s compare Toyota to Tesla and better appreciate their comparative valuations and fundamentals.


Before looking at the valuation comparisons below, consider that Tesla is a high-growth company while Toyota is mature. Toyota is the world’s largest auto manufacturer, while Tesla is ranked 15th. Given its smaller size, it is much easier for Tesla to gain global market share. The potential for outsized growth is reflected in the valuations. Tesla trades at valuations 6-8 times that of Toyota, implying 6-8x excess growth for Tesla over the long run.

The PEG ratio, however, tells a different story. The PEG ratio divides each company’s P/E ratio by its 3-5-year expected earnings growth. The ratio helps normalize the P/E ratio for companies with varying growth rates.

Based on the P/E and the PEG ratio, the market implies earnings growth of 19.05% for Toyota and 12.44% for Tesla.

tesla toyota valuations


In addition to growing more rapidly than Toyota, Tesla is more operationally and financially efficient. EV cars have fewer parts, making assembly quicker and cheaper. Additionally, Tesla’s revenue and earnings benefit from EV credits. Lastly, Tesla generates revenue from other sources. While not currently sizable, they skew the data and forecasts.

Toyota’s revenue has been relatively stagnant over the last five years, while Tesla has grown by 33% a year on average. Tesla’s cash flow growth is challenging to gauge as they are heavily reinvesting into production and R&D, as shown by the tremendous growth in its capital expenditures. Another indication that the companies are in different lifecycle stages is Tesla’s lack of dividends compared to Toyota’s healthy 3.55% yield.

Tesla has much less long-term debt than Toyota. However, if they are to continue growing rapidly, debt will likely grow accordingly.

tesla toyota fundamentals

Betting On The Future

Investing in Tesla or Toyota is a bet on the future of automobiles.

Tesla shareholders hope the company will continue improving EV technology, expanding its charging network, and gain valuable market share. Importantly, it’s a wager that some version of the current lithium-ion battery technology is the future of EVs. Tesla has other non-manufacturing ventures that may also be very profitable.

Toyota investors will do well if the company maintains its leadership in ICE vehicles and its hybrid models continue to gain market share. Further, if solid-state batteries are the preferred EV battery, then Toyota may have a huge leg up on Tesla and the industry.

Toyota has a price-to-earnings (P/E) ratio of 9, less than half of the S&P 500 and well below Tesla’s 72. It appears that Toyota offers a conservative investment in the state of the current auto industry with a potentially valuable option for the future via its considerable investment in solid-state batteries.

If solid-state batteries prove to be the next step in EVs, Toyota may be the next Tesla. In such a case, Tesla may struggle if they don’t adapt to comparable technology. However, if solid-state technology is too costly, Tesla may continue to gain market share and meet the lofty goals of its shareholders.

It’s worth disclaiming that other potential technologies, such as hydrogen, exist. While we don’t discount them, we limit this discussion to what is probable over the coming five years.


Toyota appreciates hybrid vehicles’ role in transitioning to more energy-efficient transportation. While losing the EV battle, they make up for it in hybrid sales. More importantly, they may have a better EV battery within a few years. If Toyota can continue to dominate the hybrid space and make significant inroads into EVs later this decade via a solid-state battery, its stock is cheap.

Tesla is a bet on Elon Musk and his proven ability to innovate. Not only did he start the EV revolution, but he is at the forefront of other exciting technologies. How those fold into Tesla is unknown.

While Musk has proven to be a great horse to bet on, Tesla’s price is very high. At a P/E of 72 and a PEG ratio more than 10x its competitors, Tesla investors are hoping for continued tremendous growth. Importantly, they are betting that Tesla will take significant market share from well-established automakers.

Given all he has accomplished, it’s hard to bet against Elon Musk. However, we think Toyota may be the safer investment and the stock with more upside.

Small Businesses Are Struggling Despite The Economy

Per the U.S. Chamber of Commerce, 43.5% of GDP comes from small businesses. The Small Business Administration claims small businesses employ 46.4% of private sector employees, accounting for 62.7% of new jobs since 1995. With an appreciation for the economic importance of small businesses, let’s review Tuesday’s National Federation of Independent Business (NFIB) monthly sentiment index. The index fell by 2 points to 89.9, the largest decrease since December 2022. Jobs and inflation are the two most important factors guiding the Fed. Here is what the NFIB survey says about prices and employment trends for small businesses.

Jobs: 39% of small business owners reported job openings they could not fill in the current period. That is down slightly and the lowest reading since January 2021. Additionally, plans to fill open positions continue to soften, with a net 14% of owners percent planning to create new jobs in the next three months. That is the lowest since May 2020. The graph on the bottom left shows that job openings are back to their pre-pandemic peak, while planned hires are near 8-year lows. Inflation: The net percent of owners raising average selling prices declined 3 points to 22%. 15% of small business owners reported lower selling prices, the highest since August 2020. 20% reported that inflation was their single most important problem in operating their business. That is down 3 points from last month and 1 point behind labor quality as the top problem.

Small business owners continue to make appropriate business adjustments in response to the ongoing economic challenges they’re facing,” said the NFIB’s chief economist Bill Dunkelberg. “In January, optimism among small business owners dropped as inflation remains a key obstacle on Main Street.

NFIB small business survey

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

It was a tough day in the market yesterday, as a hotter-than-expected CPI report pushed rate cut odds out to July. As discussed in yesterday’s commentary, we started trimming positions on Monday with the expectation of correction coming, and yesterday may have signaled the start of a period of consolidation or further correction. Such also tends to align with the latter half of February, which tends to be weaker.

The selloff was board-based and reversed all the gains recently seen in the small and midcap markets which had shown a brief sign of life. However, continued negative sentiment from the NFIB reports suggests that small and mid-cap businesses continue struggling with slower economic growth and higher rates.

Russell 2000 Chart

While a one-day correction doesn’t tell us much, any further concerted selling today could suggest a further retracement is forthcoming. While the CPI report pushed yields higher, we suspect the pressure in bonds will be short-lived. Such is particularly the case if the markets decline further and there is a rotation from risk to safety.


The BLS CPI report was hotter than expected across the board.

  • Core Inflation m/m was 0.4% vs forecast of 0.3%
  • Core inflation y/y was 3.9% vs forecast of 3.7%
  • Headline inflation m/m was 0.4% vs forecast of 0.2%
  • Headline inflation y/y was 3.4% vs forecast of 3.1%

The most significant contributor to CPI, shelter costs, accounting for a third of CPI, rose unexpectedly by 0.2% to .06%. The shelter component lags real-time housing/rent data by at least six months. Rent prices fell, but imputed rent, based on a survey, rose. On a side note, the employment report imputes small business employment activity based on its survey of large companies. As we share in our opening, the BLS’s imputation does not align with what is actually occurring. We must question if the shelter prices are falling victim to the same problem.

Other factors were driving the hot inflation number. Per Goldman Sachs:

The increase largely reflected start-of-year price increases for labor-reliant categories such as medical services, car insurance and repair, and daycare, and we assume inflation in these categories returns to the previous trend on net in February and March.

To wit, auto insurance rose 20.6%, the largest increase since 1976. Nonprescription drugs increased by 9.2%, its largest gain ever. Lastly, the repair of household items grew by 18.2%, also the largest ever.

Stocks and bonds sold off significantly on the news as it implies that the Fed will stay on hold for longer. The Fed Funds market now prices the first rate hike for July. It was in June, prior to the CPI release. Additionally, there are only four rate cuts priced in for the year, down from a peak of seven.

Our take: Many factors that pushed CPI higher than expectations appear to be seasonal and temporary issues. While inflation rates may stay sticky for a while, we still think the overall direction of inflation will be lower. If the Fed stays on hold, that should help the overall inflation picture.

cpi inflation less shelter costs

History Suggests Bond Prices Should Continue Upward

A look back at bond and Fed history offers bond investors optimism. If the Fed’s last rate increase on July 28, 2023, was the last of the cycle, then history says bond yields should continue to fall and prices increase. The biggest risk is what if the Fed raises rates again. We don’t think that will happen as the Fed remains vigilant against inflation.

Thus far, the last hike was 6.5 months ago. Since then, bond yields have underperformed the average path below. However, since bond yields peaked in mid-October, the gains are more aligned with historical averages. We attribute this to the fact that it was not evident that the Fed was done hiking rates in July.

bond returns from last fed rate hike
bond yields fed rate policy

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Divergences And Other Technical Warnings

While the bulls remain entirely in control of the market narrative, divergences and other technical warnings suggest becoming more cautious may be prudent.

In January 2020, we discussed why we were taking profits and reducing risk in our portfolios. At the time, the market was surging, and there was no reason for concern. However, just over a month later, the markets fell sharply as the “pandemic” set in. While there was no evidence at the time that such an event would occur, the markets were so exuberant that only a trigger was needed to spark a correction.

“When you sit down with your portfolio management team, and the first comment made is ‘this is nuts,’ it’s probably time to think about your overall portfolio risk. On Friday, that was how the investment committee both started and ended – ‘this is nuts.'”January 11th, 2020.

As the S&P 500 index approaches another psychological milestone of 5000, we again see numerous warning signs emerging that suggest the risk of a correction is elevated. Does that mean a correction will ensue tomorrow? Of course not. As the old saying goes, “Markets can remain irrational longer than you can remain solvent.” However, just as in 2020, it took more than a month before the warnings became reality.

While discussing the risk of a correction, it was just last October that we discussed why a rally was likely. The reasons at that time were almost precisely the opposite of what we see today. There was extremely bearish investor sentiment combined with negative divergences of technical indicators, and analysts could not cut year-end price targets fast enough.

What happened next was the longest win streak in 52 years that pushed the market to new all-time highs.

Market vs number of weeks of consecutive positive returns

The last time we saw such a rally was between November 1971 and February 1972. Of course, the “Nifty Fifty” rally preceded the 1973-74 bear market. Then, like today, a handful of stocks were driving the markets higher as interest rates were elevated along with inflation.

That 70s show

While there are many differences today versus then, there are reasons for concern.

The “New Nifty 50”

My colleague Albert Edwards at Societe Generale recently discussed the rising capitalization of the technology market.

I never thought we would get back to the point where the value of the US tech sector once again comprised an incredible one third of the US equity market. This just pips the previous all-time peak seen on 17 July 2000 at the height of the Nasdaq tech bubble.

What’s more, this high has been reached with only three of the ‘Magnificant-7’ internet stocks actually being in the tech sector (Apple, Microsoft, and Nvidia)! If you add in the market cap of Amazon, Meta, Alphabet (Google) and Tesla, then the IT and ‘internet’ stocks dominate like never before.”

US Technology Market Cap

Of course, there are undoubtedly important differences between today and the “” era. The most obvious is that, unlike then, technology companies generate enormous revenues and profits. However, this was the same with the “Nifty-50” in the early 70s. The problem is always two-fold: 1) the sustainability of those earnings and growth rates and 2) the valuations paid for them. If something occurs that slows earnings growth, the valuation multiples will get revised lower.

While the economic backdrop has seemingly not caught up with technology companies yet, the divergence of corporate profits between the Technology sector and the rest of the market is likely unsustainable.

Technology EPS vs rest of the market

That inability to match the pace of expectations is already occurring. That divergence poses a substantial risk to investors.

US Trailing Technology EPS not keeping pace with estimates

Again, while the risk is somewhat evident, the “bullishness” of the market can last much longer than logic would predict. Valuations, as always, are a terrible market timing device; however, they tell you a lot about long-term returns from markets. Currently, the valuations paid for technology stocks are alarming and hard to justify.

However, despite valuations, those stocks can keep ramping higher in the short term (6-18 months) as the speculative flows continue.

Tech sector absorbing all market inflows.

However, over the next few months, some divergences and indicators suggest caution is advisable.

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Technical Divergences Add To The Risk

Each weekend in the BullBearReport, investor sentiment is something that we track closely. The reason is that when investor sentiment is extremely bullish or bearish, such is the point where reversals have occurred. As Sam Stovall, the investment strategist for Standard & Poor’s, once stated:

“If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”

Currently, everyone is very optimistic about the market. Bank of America, one of the world’s largest asset custodians, monitors risk positioning across equities. Currently, “risk love” is in the 83rd percentile and at levels that have generally preceded short-term corrective actions.

Global Equity risk

At the same time, retail and professional investors are also exuberant, as noted on Tuesday.

“Another measure of bullish sentiment is comparing investor sentiment to the volatility index. Low levels of volatility exist when there is little concern about a market correction. Low volatility and bullish sentiment are often cozy roommates. The chart below compares the VIX/Sentiment ratio to the S&P Index. Once again, this measure suggests that markets are at risk of a short-term price correction.”

Sentiment / Vix ratio versus the market.

However, while everyone is exceedingly bullish on the market, the internal divergence of stocks sends warning signals. Andrei Sota recently showed that market breadth is weakening despite record highs. Note that prior market peaks were accompanied by peaks in the percentage of stocks above their 20, 50, and 200-day moving averages. To further hammer home this point, consider the following Tweet from Jason Goepfert of Sentimentrader:

Man, this is weird. The S&P 500 is within .35% of a 3-year high. Fewer than 40% of its stocks are above their 10-day avg, fewer than 60% above their 50-day, and fewer than 70% above their 200-day. Since 1928, that’s only happened once before: August 8, 1929.

market breadth

That negative divergence between stocks making new highs and the underlying breadth is a good reason to be more cautious with allocations currently.

As I started this commentary, “This is nuts.”

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So Why Not Go To Cash

This analysis raises an obvious question.

“Well, if this is nuts, why not go to cash and wait out the correction and then buy back in.”

The best answer to that question came from Albert Edwards this week.

“I cast my mind back to 2000 where the narrative around the then IT bubble was incredibly persuasive, just as it is now. But the problem that skeptical investors have now, as they did in 1999, is that selling, or underweighting US IT, can destroy performance if one exits too early.”

Regarding speculative bull markets, as noted above, the “this is nuts” part can remain “nuts” for much longer than you think. Therefore, given that we have to generate returns for our clients or suffer career risk, we must be careful not to exit the markets too early…or too late.

Therefore, regardless of your personal views, the bull market that started in October remains intact. The speculative frenzy is still present. As such, we are reducing equity exposure modestly and rebalancing risk by following our basic procedures.

  1. Trim Winning Positions back to their original portfolio weightings. (ie. Take profits)
  2. Sell Those Positions That Aren’t Working. If they don’t rally with the market during a bounce, they will decline when it sells off again.
  3. Move Trailing Stop Losses Up to new levels.
  4. Review Your Portfolio Allocation Relative To Your Risk Tolerance. If you have an aggressive allocation to equities at this point of the market cycle, you may want to try to recall how you felt during 2008. Raise cash levels and increase fixed income accordingly to reduce relative market exposure.

Could I be wrong? Absolutely.

But a host of indicators are sending us an early warning.

What’s worse:

  1. Missing out temporarily on some additional short-term gains or
  2. Spending time getting back to even which is not the same as making money.

Opportunities are made up far easier than lost capital.” – Todd Harrison

Trueflation Or CPI Inflation?

On January 23, we led the Daily Commentary with a couple of paragraphs titled Is Trueflation A Better Gauge Of Inflation? If you want to learn more about the benefits of the Trueflation inflation calculation versus the popular CPI index, check out the article. About three weeks ago, when we wrote it, the Trueflation inflation index was 1.85%. Today, it stands at 1.35%. That is a significant decline in just three weeks! While we believe it’s impossible to measure inflation accurately, following the trends of Trueflation, CPI, and other inflation gauges is paramount to better forecast how the Fed will conduct monetary policy. Clearly, the trend in Trueflation is lower. Will the CPI report, released at 8:30 ET today, follow?

To help answer the question, the graph below compares Trueflation and CPI since 2020. As shown, Trueflation tends to be more volatile than CPI. It accentuates the highs and lows. However, of great importance is that their trends are highly correlated. Per Danielle DiMartino Booth, they have a correlation of .97. If CPI continues to track Trueflation closely, today’s CPI data and or those coming in the next few months could be well below expectations and likely prompt the Fed to ease the Fed Funds rate.

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

As noted in this past weekend’s newsletter, we began the process of taking profits and rebalancing portfolio risks yesterday. To wit:

“While we have warned of a potential correction over the past couple of weeks, it reminds us much of June and July last year, where similar warnings for a 10% correction went unheeded. As such, we will rebalance exposures next week by taking profits in some positions with significant gains for the year and adding to current positions where we are underweight. We suspect the current environment is much the same as 2022, and the bullish rally will go further to suck the last of the holdouts in. However, we want to make adjustments before the correction comes”

While the changes were minor and only minimally affected portfolio performance, it is the beginning of preparing the portfolio for a period of consolidation or correction. Our weekly market gauge is still on solid buy signals, and it will take some time to trigger an outright sell signal. As such, we want to maintain equity exposure while markets are running. However, with markets becoming well deviated above their running trend line from the Financial Crisis lows and the previously confirmed signals led to decent corrections, we want to start preparing now for what could be a reversal sometime between March and the election.

Market Trading Update

As noted in yesterday’s commentary, while we are highly confident that a correction is coming, the timing of that event is uncertain. However, once signals are triggered, we will become more aggressive in the risk reduction process.

The S&P 500 Is Not Cheap, But It Can Get More Expensive

The comprehensive set of graphs below shows five widely followed measures of valuations for the S&P 500. The top graph, equity risk premiums, shows they are at their most expensive levels in 20 years. However, the four other gauges show valuations are rich but certainly have room to run before they reach their 20-year peaks. The point of sharing this is to remind you that valuations are high. Therefore, future returns may likely be lower, and risks are higher. But, as the saying goes, “Markets can stay irrational for longer than you can stay solvent.”

S&P 500 valuations stocks

Chiefs Win The Super Bowl, But Investors Were Rooting For The Niners

The Chiefs won for the second time in a row and the third time with quarterback Patrick Mahomes. In their prior three Super Bowl Wins, including Super Bowl IV -1970), the S&P 500 has been up two of the three years. The average return was 10.9%. After Super Bowl wins for the 49ers, the market’s preferred winner, the S&P 500, has been up 100% of the time, offering an average gain of 20.2%.

Further concerning for the superstitious is the following Super Bowl Indicator courtesy of Investopedia:

The Super Bowl Indicator suggests that the championship game of the National Football League (NFC) predicts the direction that the stock market will move that year. According to the theory, if a team from the National Football Conference (NFC) wins the Super Bowl, the markets will rise, but a victory by the representative of the American Football Conference (AFC) foretells a year of market declines.

The indicator makes the headlines this time every year. However, we caution you not to read too much into it. In statistics, we call such a relationship between non-related events a spurious correlation.

superbowl chiefs niners S&P 500

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A Major Obstacle to the Energy Transition

The supply side of the energy transition is well on its way, but the demand side of the equation presents a major obstacle to victory. EY published it’s 2024 Energy Transition Consumer Insights Report last week, in which the firm surveyed nearly 100,000 consumers across 21 global markets over three years. As highlighted in the report, the success of the energy transition ultimately depends on one factor: the rate of consumer adoption. Per the report,

Seventy percent of energy transition outcomes will depend on consumers changing their consumption, behaviors and lifestyles.4 Half of consumers’ impact on the energy transition comes directly from shifts in home energy use and transportation

Some consumers are willing to pay higher prices for energy sourced sustainably. However, lofty global inflation over the past three years has heightened the obstacle. The report indicates that consumer fatigue is stagnating progress toward the desired outcomes. EY posits that although 65% of energy consumers know how to do their part, 70% say they won’t spend more time or money doing so.

Our research warns that wavering consumer confidence could become a major handbrake that stalls progress. There simply is no energy transition unless consumers lead the way.

While this is a negative for the energy transition, it presents a valuable opportunity for companies planning to expand fossil fuel capacity in addition to investments in alternative energy sources, such as XOM and CVX. If consumers are unwilling or unable to make the leap due to financial constraints, these players stand to increase both market share and profitability.

Survey Statistics

What To Watch Today



Market Trading Update

On Friday, the market finally broke through 5000. As we had noted in our Daily Commentary:

“Yesterday, the market closed at 4997.91, unable to break above that level. However, such is not surprising given the market remains extended and overbought on many technical levels. Interestingly, we are beginning to see some rotation. Yesterday, the recent leaders lagged while energy and staples outperformed. The action remains spotty, with stocks mostly still trading off earnings reports.”

Well, that rotation didn’t last long. On Friday, the unstoppable advance, driven by the mega-capitalization stocks, topped the psychological 5000 level on the index. With the strong momentum carrying that particular group of stocks, the index will likely try to push higher over the next few days. However, as shown, the market is back to more extreme overbought levels, and bullish sentiment has reached “greed.”

Market Trading Update

Most notably, the deviation between the index and the 200-DMA is getting rather extreme as well, which has typically preceded short-term corrections. As discussed in this week’s newsletter, those extensions and deteriorating internals suggest we should begin rebalancing portfolio risk.

While we are highly confident that a correction is coming, the timing of that event is uncertain. As such, we must maintain exposure to garner performance while we can. However, once signals are triggered, we will become more aggressive in the risk reduction process.

The Week Ahead

This week brings some important economic data to the forefront. We kick off the week tomorrow with inflation data for January. The consensus estimate for headline inflation is 0.2% MoM, reflecting a decrease of 10 basis points from December. Core inflation is expected to remain flat at 0.3% MoM, reflecting an annualized 3.6% rate of inflation. Regardless of how the results pan out, we expect the Fed to continue downplaying the possibility of rate cuts early this year.

Thursday brings the release of retail sales data for January, which will give us insight into how consumers are faring after the holiday season. The consensus expectation is an increase of 0.2% MoM. When paired with inflation estimates, real retail sales are expected to be flat in January, down from 0.3% in December. Finally, Friday brings January’s PPI data and a preliminary look at Consumer Sentiment in February. The consensus expects PPI to rise to +0.1% from three consecutive months in the red.

Euro Area Wage Growth Charges On

The ECB developed a new wage tracker to aid its interest rate policy decisions. It makes data from the new collective bargaining agreements available to central bank officials more quickly than previously possible. While inflation slowed dramatically last year, the wage growth in the Euro Area presents an obstacle to policymakers. Wage growth will be a critical factor in the timing of rate cuts for fear of a resurgence in inflation via “price/wage spiral.” The ECB is likely taking notice of the Fed’s playbook and waiting for clear and convincing evidence of slowing inflation before taking its foot off the brake. According to Bloomberg,

The latest collective-bargaining agreements through end-2023 “do not show a clear indication of a turning point for negotiated wage growth yet and the long average contract duration in some countries could potentially lead to quite some persistence of the current high wage growth rates in the future,” the ECB said.

Euro Area Wage Tracker

The Wealthy Paid-Up to Attend the Big Game

Ticket prices surged ahead of Yesterday’s Super Bowl LVIII in Las Vegas, Nevada. According to CBS News, a fifth of the tickets changed hands in the week leading up to the event. Surging prices in the resale market created a major obstacle for many with dreams of attending. As of Wednesday, the average ticket purchased on StubHub was $8,600. Meanwhile, resellers were asking up to $45,000 for a single ticket.

The chart below illustrates the magnitude by which premium ticket prices have surged over the last few decades. It plots inflation-adjusted figures for the highest-priced ticket sales over time. There are a few staggering aspects about this year’s ticket prices. First, the average ticket price increased over 50% YoY, easily topping the previous record from the attendance-restricted game in 2021. Furthermore, the average ticket price in 2024 was in the same territory as the most expensive tickets prior to 2022. Finally, the asking price for the most expensive tickets surged by over 450% since last year.

The Wealthy Are Driving Up Ticket Prices

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Housing Is Unaffordable. Dems Want To Make It Worse.

The cost of housing remains a hot-button topic with both Millennials and Gen-Z. Plenty of articles and commentaries address the concern of supply and affordability, with the younger generations getting hit the hardest. Such was the subject of this recent CNET article:

“The housing affordability crisis means it’s taking longer for people to become homeowners — and that’s especially impacting millennials and Gen Zers, economically disadvantaged families, and minority groups. There’s not one single driver of the crisis, but several colliding elements that put homeownership out of reach: rising home prices, high mortgage interest rates and limited housing supply. That’s on top of myriad financial challenges, including sluggish wage growth and increasing student loan and credit card debt among middle-income and low-income Americans.”

The chart below of the housing affordability index certainly supports those claims.

NAR Housing Affordability Index

As noted by CNET, there are many apparent reasons causing housing to be unaffordable, from a lack of supply to increased mortgage rates and rising prices. Over the last couple of years, as the Fed aggressively hiked interest rates, the supply of homes on the market has grown. Such is because higher interest rates lead to higher mortgage rates and higher monthly payments for homes. It is also worth noting that previously, when the supply of homes exceeded eight months, the economy was in a recession.

Fed rates and housing supply

At the same time, higher interest rates and increased supply should equate to lower home prices and, therefore, create more affordability.” As shown, such was the case in prior periods, but post-pandemic housing prices skyrocketed as “stimulus checks” fueled a rash of buyers.

Home prices vs Fed funds.

As is always the case with everything in economics, price is ALWAYS a function of supply versus demand.

A Host Of Bad Decisions Created This Problem

The following economic illustration is taught in every “Econ 101” class. Unsurprisingly, inflation is the consequence if supply is restricted and demand increases.

Supply vs Demand chart

While such was the case following the economic shutdown in 2020, the current housing affordability problem is a function of bad decisions made at the turn of the century. Before 2000, the average home buyer needed good credit and a 20% down payment. Those constraints kept demand and supply in balance to some degree. While housing increased with inflation, median household incomes could keep pace.

However, in the late 90s, banks and realtors lobbied Congress heavily to change the laws to allow more people to buy homes. Alan Greenspan, then Fed Chairman, pushed adjustable-rate mortgages, mortgage companies began using split mortgages to bypass the need for mortgage insurance, and credit requirements were eased for borrowers. By 2007, mortgages were being given to subprime borrowers with no credit and no verifiable sources of income. These actions inevitably led to increased demand that outpaced available supply, pushing home prices well above what incomes could afford.

Median and average home prices vs wage growth

This episode in the housing market resulted from zero-interest policies by the Federal Reserve. That policy and massive liquidity injections into the financial markets brought hoards of speculators, from individuals to institutions. Institutional players like Blackstone, Blackrock, and many others purchased 44% of all single-family homes in 2023 to turn them into rentals. As prices rose, advances like AirBnB brought more demand from individuals for rentals, further reducing the available housing pool. Those influences lead to even higher prices for available inventory.

Notably, it isn’t a lack of housing construction. The Total Housing Activity Index is not far from its all-time highs following the 2020 pandemic “housing rush.” The issue is the removal of too many homes by “non-home buyers” from the available inventory.

Total housing activity index

Furthermore, existing home sales are absent. Current homeowners are unwilling to sell homes with a 4% mortgage rate to buy a home with a 7% mortgage. As shown, existing home sales remain remarkably absent.

Existing home sales

All of these actions have exacerbated the problem. At the root of it all is the Federal Reserve, keeping interest rates too low for too long. Oversupplying liquidity and creating repeated surges in home prices. It is not a far stretch to realize the bulk of the housing problem directly results from Governmental forces.

Housing process and the Fed.

So, what does this have to do with the Democrats?

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Dems Want To Make The Housing Problem Worse

Sen. Elizabeth Warren, D-Mass., and three other Democratic lawmakers are pushing Jerome Powell to lower interest rates at the upcoming Fed meeting to make housing more affordable.

“As the Fed weighs its next steps in the new year, we urge you to consider the effects of your interest rate decisions on the housing market. The direct effect of these astronomical rates has been a significant increase in the overall home purchasing cost to the average consumer.” – Letter To Jerome Powell

As discussed above, lowering interest rates is not the solution to lowering housing prices. Lower interest rates would bring more buyers into a market already short inventory, thereby increasing home prices. We can already see the impact of lower mortgage rates on home prices just since October. Prices rose as yields fell on hopes the Federal Reserve would cut rates in 2024. If mortgage rates revert to 4%, where they were during most of the last decade, home prices will significantly increase.

Housing prices vs 30-year  mortgage

The Terrible Terrible Solution

There is only one solution to return home prices to affordability for most of the population. That is to reduce the existing demand. If Elizabeth Warren is serious about doing that, passing laws today would go a long way to solving that problem.

  1. Restrict corporate and institutional interests from buying individual homes.
  2. Increase the lending standards to require a minimum 15% down payment and a good credit score. (such would also increase the stability of banks against another housing crisis.)
  3. Increase the debt-to-income ratios for home buyers.
  4. Return the mortgage market to straight fixed-rate mortgages. (No adjustable rate, split, etc.)
  5. Require all banks that extend mortgages to hold 25% of the mortgage on their books.

Yes, those are very tough standards to meet and initially would exclude many from home ownership. But, home ownership should be a demanding standard to meet, as the cost of home ownership is high. For the individual, such standards would ensure that home ownership is feasible and that such ownership, along with the subsequent fees, taxes, maintenance costs, etc., would still allow for financial stability. For the lenders, it would reduce the liability of another financial crisis to almost zero, as the housing market’s stability would be inevitable.

But most importantly, such strict standards would immediately cause an evaporation of housing demand. With a complete lack of demand, housing prices would fall and reverse the vast appreciation caused by a decade of fiscal and monetary largesse. Yes, it would be a very tough market until those excesses reverse, but such is the consequence of allowing banks and institutions to run amok in the housing market.

Naturally, none of this will ever happen or considered, as there is too much money in the housing market for corporations, institutions, and banks to feed on. But one thing is for sure: if the Democrats get their wish and the Fed cuts rates again, housing prices will become even more unaffordable.

Tesla Is On Sale- Is It Time To Buy?

The Magnificent Seven continue to lead the market higher as they did last year. However, one of the seven stocks is falling woefully behind. Tesla is down 25% this year. Driving Tesla’s share price lower is growing concern that EVs may not be the much-ballyhooed future of automobiles. As evidence, GM and Ford are cutting EV production. Furthermore, lithium miners and battery producer stocks have fallen precipitously over the prior few months. Price cuts for EVs due to weakening demand, growing popularity of hybrid models, and competition from every other automaker also weigh on Tesla. Is it time to buy Tesla?

We will be posting an article next week comparing Toyota to Tesla. The article provides insight into the state of the automobile market, the role EVs and hybrids play, and the potential for a new type of EV battery. However, while you await that article, we share the graph below to provide context for the recent decline. TSLA’s stock is up significantly since 2010, but there have been significant setbacks along the way. The current 55% drawdown from the 2021 peak is among the worst. If you believe that EVs, in their current state, will eventually dominate automobile sales, Tesla may be worth considering. However, as we will share next week, technology and views regarding the efficacy of EVs are changing.

Tesla maximum drawdowns

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

The market has struggled at the 5000 level for the last couple of days. Yesterday, the market closed at 4997.91, unable to break above that level. However, such is not surprising given the market remains extended and overbought on many technical levels. Interestingly, we are beginning to see some rotation. Yesterday, the recent leaders lagged while energy and staples outperformed. The action remains spotty, with stocks mostly still trading off earnings reports.

As we will address in this weekend’s newsletter, there are some reasons to become a bit more cautious over the next month or so. Therefore, we will rebalance portfolio risks by reducing overweight positions, adding to underweight holdings, and increasing cash as needed. Bonds are also getting very interesting again after reversing much of the previous overbought condition, as shown below.

Bond Trading Update

Atlanta Fed Eases Fears About Wage Growth

The bond markets sold off last Friday as the employment number was better than expected. Further concerning for those worried about inflation, wages grew by 0.6%, twice expectations. Accordingly, bond investors presumed that the Fed’s fear of a price-wage spiral would keep them on hold and not cut rates as soon as the markets had expected. The most recent Atlanta Fed Wages Index may calm fears at the Fed and on Wall Street.

The January Atlanta Fed’s Wage Growth Index reading of 5.0% is the lowest in more than two years and puts wage growth below the highs seen in the late 1990s expansion. Its trend continues lower.

atlanta fed wage growth tracker

Will China Export Deflation?

The latest inflation data from China shows that deflation is taking hold. Their CPI fell by 0.8% from a year ago, and PPI is down 2.5%. The CPI decline is the largest since 2009!

The data and weak economic growth help us appreciate why the Chinese government is concerned and intervening on a large scale. From the U.S. point of view, we must consider China is a massive exporter of goods and, therefore, prices. The graph from True Insights below shows the relationship between China and U.S. prices. While U.S. deflation is not likely in the cards in the near term, China’s inflation data certainly strengthens the disinflationary argument. U.S. Treasury bonds did not react to China’s inflation data, but it is undoubtedly another factor arguing for lower yields.

china and us cpi inflation

NY Fed Reports Rising Delinquency Rates

Over the past year, consumers have steadily relied on credit to counter inflation and maintain their spending habits. It appears some borrowers are getting over their skis. The latest New York Fed data warns that consumer loan delinquency rates are rising. The first graph shows that auto loans in serious delinquency (90 days delinquent or greater) picked up in the fourth quarter to the highest rate in over a decade. Similarly, the second graph highlights that credit card delinquency rates (blue) continue to increase, and the pace over the last 12 months (orange) has been nearing levels last seen during the 2008 recession. Consider the following data from Hedgeye:

  • A Q4 surge of $212B has now pushed household debt to a record high of $17.5T
  • Q4 credit card debt rose $50B to $1.13T (another all-time high)
  • Household debt has climbed 23% within 36 months.
auto loan delinquencies Fed credit
credit card delinquencies

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NYCB Is Downgraded And Contagion Fears Increase

Late Tuesday night, Moody’s downgraded NYCB’s credit rating to BB, putting it in junk bond status. The action occurred after NYCB stock had fallen 60% year to date. The lesson from 2008 and, more recently, in March 2023 is that stock investors can seal the fate of a bank. Panic selling by stock investors crushes stocks, as we are witnessing with NYCB. Lower share prices further raise concerns among bond investors, increasing borrowing costs significantly. At the same time, depositors withdraw money, forcing a bank to raise capital when it is expensive and hard to come by. Most importantly, other banks fear lending to the bank. The bank then must go to the Fed, the lender of last resort. Another consideration is contagion.

Last March, many regional bank stocks were struggling mightily in the wake of the Silicon Valley Bank and Signature Bank defaults. At the time, deposits were fleeing the banks, forcing underwater loans and asset losses to be recognized. To stem the problem, the Fed introduced the BTFP funding facility. The program calmed investors’ nerves. However, the BTFP ends on March 11. Given what is occurring with NYCB and the potential problems facing other regional banks, we suspect there is a decent likelihood that, barring a new Fed program, regional bank stocks will stay under pressure. The table below shows the year-to-date losses of the worst-performing stocks within the KRE Regional Bank ETF.

regional banks nycb contagion

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

CLOSE. but no cigar. On Tuesday, we discussed the market reaching the psychological round number of 5000. Yesterday, the market closed at 4995.06 and almost touched 5000 intraday. As we noted in that article:

Nonetheless, with the market surging higher since the beginning of the year, bullish investors are drooling over the next significant milestone for the market – S&P Index 5000. These milestones have a gravitational pull as investors become fixated on them. Interestingly, the time to reach these milestones continues to shrink, particularly after the Federal Reserve became hyperactive with monetary policy changes.

These milestones have very little meaning other than being psychological markers or having the ability to put on an “S&P 5000” hat if you’re in the media. Nonetheless, the bullish backdrop suggests the market will likely hit that psychological level soon, if not already.

S&P Index 1000 Point Milestones

As has been the case all year, this remains a market driven by narrowing breadth. As discussed in this upcoming weekend’s newsletter, breadth has narrowed rather than expanded during this rally, suggesting that a more significant correction process will likely ensue in the weeks ahead.

“While investors’ sentiment remains bullish, it continues to be driven by a narrower participation in the market overall. Within the S&P 500, fewer and fewer stocks have been participating in its most recent gains. The percentage of stocks within the index holding above their 10-day, 50-day, and 200-day moving averages has decreased for weeks. Such declines eventually lead to corrective events in the market.”

Market Breadth

As stated in yesterday’s commentary, a correction is coming. I don’t know when, but a 5-10% decline before the election is very likely. While the bulls are clearly in control of this market, it is worth continuing to manage your risks accordingly.

Market Breadth At Odds With Record Highs

Andrei Sota shares the graph below, which shows that market breadth is weakening despite record highs. Note that prior market peaks were accompanied by peaks in the percentage of stocks above their 20, 50, and 200-day moving averages. Despite setting record highs, the number of stocks above their respective key moving averages has been falling. As we have been writing about, the fortunes of a select few stocks are driving major market indexes higher. All the while, a large number of stocks are not keeping up with the broad indexes.

To further hammer home this point, consider the following Tweet from Jason Goepfert of Sentimentrader:

Man, this is weird. The S&P 500 is within .35% of a 3-year high. Fewer than 40% of its stocks are above their 10-day avg, fewer than 60% above their 50-day, and fewer than 70% above their 200-day. Since 1928, that’s only happened once before: August 8, 1929.

market breadth

Technology or Bust

The chart below, courtesy of The Daily Shot, shows that ETF sector investors are overwhelmingly pouring money into the technology sector while, in the aggregate, pulling it out of just about every other sector. Communications and Industrials are the only two other sectors with positive fund inflows over the past year. Energy and Healthcare have seen the largest outflows.

technology sector fund flows

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We Are Not On The 1970s Inflation Rollercoaster – Part Four

We wrote this four-part inflation series in response to the graph below, implying that prices are on the same inflation roller coaster ride as the 1970s.

the apollo inflation roller coaster

If you have read the first three parts of this series (ONE, TWO, and THREE), you have a better appreciation for some similarities and differences between inflation of the last few years and that of the 1970s. With that wisdom, we share our opinion.

Desert Before Dinner

We always conclude articles with a summary. Given the gravity of inflation on investment returns, we think it is worth starting with our opinion and then providing details to support it.

We strongly believe the recent inflation outbreak was overwhelmingly the result of the pandemic and the governmental, Fed, corporate, and personal reactions to it. The virus and its economic effects were felt around the world, making matters even more impactful,

Unprecedented fiscal and monetary actions amplified the demand for goods and services well beyond norms. At the same time, the production of many goods was severely limited, and transportation lines were broken. Consequently, the supply of most goods and many services was severely constrained, and at the same time, demand was recovering rapidly.

Given such unique events, and barring an unforeseen calamity like the pandemic, another inflation surge is not likely.

The multiple bouts of inflation in the 1970s were not the result of one exceptional incident but many bad decisions. Furthermore, the Federal Reserve and government repeatedly, and unbeknownst to them, employed policies that increased prices for fifteen years. The Fed has learned many lessons since then, which instills confidence in our opinion. However, the government has little regard for them, which does pose a threat to our opinion.  

As the pandemic-related stimulus slowly but surely exits the financial system and the economy and the supply lines fully heal, inflation will continue to fall back to or below the pre-pandemic average.

That said, the odds of another round of higher inflation are not zero, as we will elaborate.

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That 70s Show

Before we start, it is worth reviewing a few snippets from That 70s Show, an article we wrote last December. The article discusses the economic environment of the 1970s and how it differs from today’s.

The first quote and graphs below show how the debt burden has changed over the last fifty years.

While the Fed is currently engaged “in the fight of its life,” trying to quell inflation, The economic differences are vastly different today. Due to the heavy debt burden, the economy requires lower interest rates to sustain even meager economic growth rates of 2%. Such levels were historically seen as “pre-recessionary,” but today, they are something economists hope to maintain.

that 1970s show

Next, the mix of what the nation produces and consumes has reversed.

Such is a critical point. During “That 70s Show,” the economy was primarily manufacturing-based, providing a high multiplier effect on economic growth. Today, the mix has reversed, with services making up the bulk of economic activity. While services are essential, they have a very low multiplier effect on economic activity.

The Federal Reserve Has Learned From The 1970s

The Fed has often admitted it played a significant role in generating multiple waves of inflation in the 1970s. At the time, low unemployment was the primary goal. Such was a lingering relic from the Great Depression. Higher inflation in the name of lower unemployment was acceptable.

Furthermore, the Fed did not appreciate the potential for a price-wage spiral or changes in consumption patterns due to inflation and how they could affect employment.

The Fed’s tragic errors from the 1970s appear to haunt them today and provide instructive guidance.

Consumer Behaviors and Price-Wage Spirals

In August 2021, Jerome Powell stressed evidence that consumer behaviors change with inflation. Per Powell:

The 1970s saw two periods in which there were large increases in energy and food prices, raising headline inflation for a time. But when the direct effects on headline inflation eased, core inflation continued to run persistently higher than before. One likely contributing factor was that the public had come to generally expect higher inflation—one reason why we now monitor inflation expectations so carefully.

In February 2023, Powell made the following statement, assuring the public that the Fed was aware of the potential for a price wage spiral.

“If we continue to get, for example, strong labor market reports or higher and higher inflation reports, it may well be the case that we have to do more and raise hikes more than is priced in,”

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Money Supply > Fed Funds

Even of greater significance, the Fed now realizes that the money supply is a crucial inflation component. However, equally important is money velocity, or the rate at which money is spent. The combination creates inflation or deflation.

The Fed is to fault for inflation. They allowed the money supply to proliferate as they kept doing QE and targeting a zero Fed Funds rate despite the velocity of money rebounding rapidly. The graph below shows how the money supply quickly grew while velocity accelerated and inflation ensued.

net change in m2 and velocity versus cpi

However, starting in 2022, the Fed turned extremely hawkish. Not only did they raise the Fed Funds rate to over 5% in two years, but they initiated QT. The result of their actions was not only to slow the growth of the money supply but also to cause it to contract.

The graph below lines up the money supply from 1966 to 1982 with our recent period. In the 1970s, the Fed never allowed the money supply to shrink. They were singularly focused on the Fed Funds rate. The lesson learned from that day was that managing the money supply is a much more impactful tool on prices and economic activity than adjusting the Fed Funds rate. The last time the money supply contracted, as it is now, was during the Great Depression and World War 2.

m2 vs the 1970s

The Fed and Jerome Powell were willing to endure a recession and higher unemployment to bring inflation back to its target. CBS News titled an article, “The Fed Plans To Sharply Boost Unemployment.” In it, Powell is quoted regarding unemployment: “I wish there were a painless way to do that,” Powell said. “There isn’t.” 

Fed President Susan Collins offered, “I do anticipate that accomplishing price stability will require slower employment growth and a somewhat higher unemployment rate.”

However, The Government Seems To Beg For More Inflation

Unlike the Fed, the federal government did not learn its lessons from the 1970s. After the economy was well on its way to recovery, their reckless spending pushed the money supply higher than it would have been and created a tailwind for inflation. Recent deficits are well below those witnessed in 2020 and 2021 but are abnormally large, given such a robust economy.

In the fiscal year 2023, the federal deficit was 5.7 percent of GDP. This year, the CBO estimates it will increase to 6.8 percent of GDP. The graph below shows the only other times the deficit, as a percentage of GDP, has been higher than today was during World War 1 and 2, the 2008 financial crisis, and a few years ago during the height of the pandemic. Those were emergencies.

federal deficit as a percentage of GDP

Supply Side Factors

One of the significant factors behind recent inflation was the unprecedented global shuttering of the economy. The limited supply of goods and handicapped transportation systems grossly restricted the amount of goods on the market.

While production problems still exist, they have primarily normalized. In the 1970s, the government unknowingly incentivized goods shortages via wage and price control measures. Lacking the ability to raise prices to reflect the increasing costs of their inputs, some companies had no choice but to limit or halt production and curtail supply. Today, the government is not taking action to stop or restrict the production or transportation of goods.

The gross distortions to the supply side of the inflation equation were solely related to the pandemic and should not be forecasted to return in such an impactful way.

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Everything Else

We now run through a litany of other contributors to inflation.

Oil Shock

Our dependency on foreign oil has declined substantially, as shown below. Before 2008, the U.S. depended on imports for about half of its oil needs. Since the abundance of shale oil, we have become energy-independent.

While the situations in the Middle East and Russia may escalate, an embargo like that of fifty years will be much less damaging. However, short term price spurts can happen as oil prices are based on global factors.

oil production and consumption trends

The Unions Lose Power

Throughout 2022, Jerome Powell incessantly fretted about the potential for a price wage spiral. Recent union negotiations with the automakers, Hollywood writers and actors, FedEx, and other companies fueled concerns of a price wage spiral.

Regarding the potential for a price wage spiral, we must consider that in the 1970s, unions carried much more bargaining power, and one out of every five workers was a union member. The graph below from Bloomberg shows that union membership has consistently decreased since. It now stands at only 10% of workers, limiting the potential for unions to drive wages higher for the entire workforce.

union membership

Further new technologies, off-shoring jobs, and the ability to hire remote workers are also helping keep a lid on wages.  

Economic Landscape

Today’s economic landscape, including debt load, demographics, and productivity growth, differs from the 1970s. The Fed projects the nation’s long-term economic growth rate at 1.85%. Such lines up with slowing productivity growth, as shown below.

total factor productivty

From 1960 to 1985, real GDP averaged 3.7%, more than double the current trend growth. In the 1970s, the population grew by over 1% annually. Today, that number is half a percent and is expected to decline steadily.

Also, of incredible importance, debt was not a considerable headwind to growth 50 years ago. Since then, debt has grown four times faster than GDP, as shown below. Given our heavy dependence on debt and, therefore, low-interest rates, the economy’s ability to tolerate higher inflation is much less than in the ’70s.

unproductive debt vs gdp

Fiscal dominance, whereby the Fed must set monetary policy to keep the government solvent, is now necessary. Given the economic and demographic trends noted above and the ever-increasing debt, it’s hard to imagine that the Fed will tolerate above-trend inflation or higher interest rates for sustained periods.

Fiscally fueled demand has been a crucial driver of inflation over the past few years. However, if demand factors, as noted above, resume pre-pandemic trends, GDP will slow, and significant demand-driven price increases are not likely.

Lastly, the government has a negative debt multiplier. Each dollar of debt eventually takes away from economic growth. As recent deficit spending turns from stimulus to headwinds, economic growth will continue to trend lower. With it, inflation will follow.

What Might Change Our Opinion?

The Treasury and Fed introduced a new recession-fighting playbook in 2020. The combination of direct checks and benefits to the public alongside grossly easy monetary policy played a significant role in fueling inflation.

If that playbook becomes the rule and not an exception, we could see periods of higher than trend inflation. But even with such a fiscal reply to a recession, supply line problems will not be the problem they were a few years ago. Given the unlikelihood that the global economy will shut down again, higher inflation due to fiscal and monetary negligence is possible, but not at the levels we witnessed in 2021 and 2022.


At its core, inflation is too much money chasing too few goods. That was the case in 2020 through 2022. This is not the case anymore.

The 2020s aren’t the 1970s by any stretch of the imagination! While the lead graph from Apollo may show recent inflation trends align well with those of the 1970s, we think it is grossly misleading.

China Stocks In Freefall, Government To The Rescue

In early 2021, China’s CSI 300 Index, representing the top 300 stocks traded on the Shanghai Stock Exchange and Shenzhen Stock Exchange, peaked at 5800. Today, three years later, the index sits at 3300, down over 40%. China’s key stock market index rout is not surprising, given China’s economy has been sluggish, its property sectors are highly distressed, and its local governments are fiscally constrained. Declining confidence in China’s economic reform is also not helping matters. Accordingly, President Xi has been under growing pressure to stimulate the economy and boost its stock markets. It appears the plan to stop the stock market decline is coming into focus.

The graph below shows China’s CSI 300 stock index rose over 3% on Tuesday following numerous announcements from the government. As an example, Central Huijin Investment Ltd. committed to buying more ETFs. Furthermore, there is hope that other large institutional investors will as well. Earlier in the day, a government agency limited new security lending, which short sellers must have. Most importantly, President XI is talking publicly about the problem and vowing to fix it. The graph below, courtesy of Bloomberg, shows the multiple news events boosting China stocks on Tuesday. Bloomberg characterizes the situation: “While it’s unclear whether any new support measures will come out of the Xi meeting, traders are hoping this time will be different.”

china stocks get a government boost csi 3000

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

A correction is coming. I don’t know when, but a 5-10% decline before the election is a very high probability. Our weekly S&P 500 risk control chart suggests such is highly likely. The chart is broken down into 3-components. In the top panel is the running bullish trend channel from 2009. Currently, the market is trading at the top of that trend channel, which has previously preceded declines like last summer. The only exception was the stimulus-fueled rally in 2021, which exceeded the top of that channel, but the subsequent correction resolved that excess.

The bottom two panels are intermediate and long-term MACD indicators. Currently, both indicators are trading above their long-term peaks. Again, the exception is the 2021 rally, but the monetary stimulus for a similar surge is not present. While still on buy-signals currently, given the market’s overbought condition, the deviations from longer-term trends, and more speculative bullishness, the ingredients for a correction into the summer are present. As noted yesterday, these conditions exist in conjunction with the short-term overbought and bullish conditions that generally precede weaker periods in the market. While nothing is ever guaranteed, the combination of these conditions suggests a correction is more likely than not. The “timing” and “cause” of that correction are hard.

The point here is that as investors, we should be aware of the risk of a larger correction sometime this year and act accordingly when it begins.

Weekly market trading chart

More On The BLS Jobs Oddities

We are still digesting last Friday’s BLS report, as there are many inconsistencies worth mentioning. Our Commentaries on Monday and Tuesday discuss the wide gap between the BLS household survey and the establishment survey. Similarly, today, we address a few more charts that call into question the notion that the job market is robust.

The first two graphs below, courtesy of Zero Hedge, show that the breadth of the gains in the labor market has much to be desired. Over 100% of the job gains over the past 12 months are from part-time workers. In fact, full-time employment has actually shrunk. As the second graph shows, many part-time workers may also be multiple job holders. If we strip out those with multiple jobs, payroll growth will not be as great as advertised.

The third and fourth graphs show that the recent spike in hourly wages was more than offset by declining hours worked. For the first time in three years, the product of wages and hours worked declined on a three-month running basis. Ergo, aggregate wages paid actually shrunk slightly.

permanent and temporary jobs
multiple jobholders
jobs hours worked and hourly wages
jobs hours worked and hourly wages

Worker Confidence In Their Employers Falter

Per the Glassdoor survey results shown below, courtesy of Bloomberg, U.S. workers are more downbeat about the prospects for their employment than at any time in nearly a decade. Presuming workers are less confident, this survey helps explain why the JOLTS quit rate has been falling. However, it doesn’t explain rising consumer confidence.

workers confidence

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CRE Contagion – Which Banks Are At Risk?

The price of New York Community Bank (NYCB) was cut in half last week as it drastically increased its loan loss reserves. As we noted in a recent Commentary, they took this action partly because of the commercial real estate (CRE) loans they bought from the failed Signature Bank. The work-from-home movement and higher interest rates are crushing CRE values. As a result, the banks that made CRE loans may be on the hook if the borrower fails. On Sunday’s 60 Minutes, Powell admits CRE may be problematic for smaller banks. Regarding CRE, he stated:

We looked at the larger banks’ balance sheets, and it appears to be a manageable problem. There’s some smaller and regional banks that have concentrated exposures in these areas that are challenged.

To help us better assess bank risks, we share a chart from Morgan Stanley. The graph compares the loan loss reserves banks hold for CRE loans versus their overall exposure to said loans. NYCB has high exposure to CRE. Furthermore, before last week’s action, they did not have adequate loan loss reserves. In general, CRE constitutes less than 20% of the larger bank holdings. However, we offer caution for smaller banks with 30% or more exposure and low loan loss reserves. This includes banks like ZION, CADE, VLY, and CBSH.

cre banks exposure vs loan loss reserves

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

The market stumbled out of the gate yesterday, trading a bit weaker following last week’s surge to new highs. Currently, the market is just a “stone’s throw” from the psychological level of 5,000, which is most likely inevitable at this juncture. As noted in yesterday’s commentary, we continue to expect a correction to resolve current overbought conditions, and the month of February tends to trade weaker particularly when following a very strong January advance.


While the market remains in a strongly bullish trend, such does preclude the market from some type of corrective activity to reduce more extreme overbought conditions, as shown in our weekly composite technical gauge. Readings above 90 have historically preceded short-term corrective actions and broader market declines.

Technical Gauge

With the market overbought, pushing into 2-standard deviations above the 50-DMA, and well deviating above the 50- and 200-DMA, the conditions for a short-term reversal are present.

Market trading update

Earnings have continued to support the bullish momentum so far, but by the end of this week, a majority of those earnings will have been reported. Look for weakness in the latter half of February to increase equity exposures as needed.

More On The Jobs Divergence

Monday’s Commentary discussed the recent BLS jobs data and, in particular, pointed out the odd discrepancy between the two surveys used to calculate the report. To wit:

The biggest puzzle is the stark difference between the establishment and household surveys. The BLS establishment figure uses surveys of large companies to calculate the headline +353k number that is widely reported. The household survey gets its data from individuals. This data feeds the unemployment rate. The Household survey reported that the economy lost 31k jobs last month. The graph below shows the growing divergence between the two. In the previous two months, the household survey reported a loss of 714k jobs, while the establishment survey reported a gain of 686k.

An inquisitive client of ours decided to expand on our findings. Therefore, as he highlights below, the 12-month cumulative difference between the two surveys is nearly 2 million jobs. Other than for a brief instance in early 2020, the current divergence is about as wide as it gets over the last 70 years. The second graph smoothes out the cumulative data over three years. As it shows, the establishment survey has reported 3.5 million more jobs than the household survey.

household vs establishment survey 12mos rolling cumulative
household vs establishment survey 36mos rolling cumulative

He correctly sums up his graphs as follows:

However, as the graphs indicate, usually this difference “snaps back” over time.   So, if history serves as any precursor my guess is not only will the BLS be doing their usual revisions to jobs data over time, but the monthly change in establishment Survey will be more in line w the household Survey over time.  

Utilities Are Dirt Cheap

The price of the Utility sector (XLU) is now trading at a 25-year low in relation to the market (S&P) 500. Since peaking in 2008, the ratio of utilities to the S&P 500 has set a series of lower highs and lower lows. Based on the graph, it appears that utilities may be due for a bounce versus the market. Lower interest rates and or a weaker stock market could lead to such an event. However, we caution you that the trend is clearly not your friend.

utilities vs S&P 500

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S&P Index Set To Hit 5000 As Bull Run Continues

In September 2021, I discussed how the markets had set its sights on the S&P 500 index hitting 5000. To wit.

“Yes, the rally off the COVID-19 bottom in March 2020 has been extraordinary, but we think there are further gains ahead. Solid economic and corporate profit growth, in conjunction with a still-accommodative Fed, means that the environment for stocks remains favorable. As a result of our higher EPS estimates, we raise our targets for the S&P 500 for December 2021 by 100 points to 4,600 and June 2022 by 150 points to 4,800. We initiate our December 2022 target of 5,000, representing about 13% price appreciation from current levels.’” – David Lefkowitz, UBS.

Of course, the market peaked in January 2022, just four months later, at 4796.56. Fast forward 2-full years of returning investors to breakeven, and the market is again approaching that magical round number of 5000.

The quest to 5000 for the S&P Index

Nonetheless, with the market surging higher since the beginning of the year, bullish investors are drooling over the next significant milestone for the market – S&P Index 5000. These milestones have a gravitational pull as investors become fixated on them. Interestingly, the time to reach these milestones continues to shrink, particularly after the Federal Reserve became hyperactive with monetary policy changes.

S&P Index 1000 Point Milestones

These milestones have very little meaning other than being psychological markers or having the ability to put on an “S&P 5000” hat if you’re in the media. Nonetheless, the bullish backdrop suggests the market will likely hit that psychological level soon, if not already.

But the question we should be asking ourselves is what most likely will happen next.

Things Are Always The Same

Just a few months ago, in October, with the market down 10% from its peak, investors were very negative about the S&P Index.

More than once, I received emails asking me if “the selling is ever going to stop.”

Then I wrote an article explaining why “October Weakness Would Lead To A Year-End Run.” To wit:

“A reasonable backdrop between the summer selloff, sentiment, positioning, and buybacks suggests a push higher by year-end. Add to that the performance chase by portfolio managers as they buy stocks for year-end reporting purposes.”

Since then, there has been a stunning reversal of bearish sentiment. Investors once again believe that “nothing can stop this bull rally.”

Funny enough, that was the same sentiment discussed in the July 2022 report “Trading An Unstoppable Bull Market.”

“The S&P Index is set to close out its fifth straight month of gains. In addition to being up six out of the seven months this year, returns are unusually high, with the S&P advancing 18% year-to-date. There is little doubting the incredibly bullish tailwind for the US equities despite the Fed hiking interest rates and reducing its balance sheet.”

That was just before the 10% decline into October.

The history lesson is that investors again believe we are in an unstoppable bull market. With the S&P index set to set a historical record by hitting 5000, it seems nothing can derail the bulls. But such is always the sentiment just before it changes. The only question is, what causes the change in sentiment? Unfortunately, we will never know with certainty until after the fact.

We do know that the market currently has all the ingredients needed for a period of price correction. For example, retail and professional investor sentiment is at levels usually associated with short- to intermediate-term market peaks. The chart below marks when the investor sentiment ratio is above 2.5. Those levels have previously marked short-term market peaks. Ratios below 0.75 have correlated with market bottoms.

Composite investor sentiment vs the market.

Another measure of bullish sentiment is comparing investor sentiment to the volatility index. Low levels of volatility exist when there is little concern about a market correction. Low volatility and bullish sentiment are often cozy roommates. The chart below compares the VIX/Sentiment ratio to the S&P Index. Once again, this measure suggests that markets are at risk of a short-term price correction.

Sentiment / Vix ratio versus the market.

Furthermore, our composite gauge of weekly technical indicators has already reached more extreme levels. Historically, we are close to a peak when this gauge exceeds 90 (scale is 0 to 100).

Technical Gauge vs the market

As is always the case, the resolution of more extreme bullish sentiment and technical price extensions is through a short-term reversal. However, such does not mean that the market won’t hit 5000 first, as we suspect it will.

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S&P Index At 5000, Most Stocks Aren’t

Another interesting facet about the current market is that as the S&P Index approaches a psychological 5000 level, that advance continues to be a function of a relatively small number of stocks doing most of the lifting. As we discussed previously, given the weight of the top-10 “Market-Capitalization” companies in the S&P index, which currently comprises 35% of the index, as shown.

Weighting of top 10 stocks

Those stocks disproportionately impact the performance of the index. That impact is represented by the comparison to the S&P 500 “Equal-Weight” index, which removes that effect.

Market cap vs equal weight returns

This narrowness of winners and losers is better represented by comparing the major market’s relative performance since 2014. Other than the Nasdaq, which is heavily weighted in Technology, all other major markets have lagged the S&P Index.

Major market performance

Even within the S&P index itself, except for Technology, all other sectors have underperformed the index since 2020.

market vs sector performance

Critically, while the S&P index is hitting “all-time” highs and hitting the psychological level of 5000, it remains a story of the “haves” and the “have nots.” While Mega-capitalization companies have earnings, and investors are bidding up the market in anticipation of future earnings growth, earnings are declining for everyone else.

S&P 500 EPS with and with Mag 7 stocks.

Here is the data numerically to better visualize the problem.

Maginficent 7 stocks earnings versus the rest of the market.

With markets technically stretched, sentiment bullish, and still weak fundamental underpinnings, the index hitting 5000 as a measure of market health is a bit of a mirage.

At some point, earnings for the broad market will need to accelerate, requiring more substantial economic growth rates, or a more meaningful correction will occur to realign valuations. Historically, it has been the latter.

Notably, such reversions in price have often occurred just after the market hits a psychological milestone.

The Labor Market Is On Fire

The BLS stunned investors Friday morning, reporting that the labor market was hotter than expected. The labor market added 353k jobs in January, almost double expectations for 180k. Furthermore, December’s figure was revised upward by 117k. Of some concern for the Fed, average hourly earnings grew by 0.6%, twice what was expected. However, there are inconsistencies with the data. For instance, hours worked fell by .2, and the labor market participation rate was 0.1% below expectations.

The biggest puzzle is the stark difference between the establishment and household surveys. The BLS establishment figure uses surveys of large companies to calculate the headline +353k number that is widely reported. The household survey gets its data from individuals. This data feeds the unemployment rate. The Household survey reported that the economy lost 31k jobs last month. The graph below shows the growing divergence between the two. In the previous two months, the household survey reported a loss of 714k jobs, while the establishment survey reported a gain of 686k. Per David Rosenberg, the Household survey diverged negatively from the establishment survey before each of the last four recessions.

Given that the BLS data is at odds with other labor indicators, including its own household survey, and that seasonal adjustments are big factors in December and January, we must be careful not to read too much into this round of labor market data.

labor market household vs establishment survey

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

We have discussed the need for a market correction over the last few weeks. On Wednesday, the FOMC statement sent the stock lower as Jerome Powell eliminated the possibility of a rate cut by March. However, a stellar employment report on Friday, which would suggest the Fed stays on hold longer, sent the market surging to all-time highs.

While the media tried to apply several reasons why the market was higher, bullish momentum is intact. The selloff on Wednesday, as shown, tested the rising trend channel and opened a window for buyers to step in. There are only small windows of opportunity to increase equity exposure during substantial, bullish advances. However, as is always the case, the current “bullish stampede” will end, and a reversal will occur.

Market Trading Update

As shown above, the current bullish stampede is very similar to what we saw from March to July last year. At that time, it was the chase for “A.I.” that was driving the market while the majority of stocks dragged. The market remained overbought, trading in a defined trend channel as prices advanced. Then, the markets corrected by 10% into October, which is typical for any given year.

Today, we again see that same “unstoppable advance” with the same bifurcation in the market. While the “Magnificent 7” stocks again drive the markets, another 5-10% correction over the next several months should be no surprise. Such is particularly the case as we approach the upcoming Presidential election, where market participants may want to reduce exposure to offset potential election risks.

Market Cap vs Equal Weighted Index

There is little reason to be overly concerned with the market for now. However, there is little doubt that the market is detached from the economic underpinnings. At some point, fundamentals will matter. But that isn’t today.

The Week Ahead

After a hectic week, markets will get a little break from the deluge of economic data and earnings announcements.

The bulk of fourth-quarter earnings are now behind us, with many prominent mega-cap names reporting last week.

Similarly, with the Fed meeting and employment data last week, there will be less for markets to cue on this week. We suspect Fed speakers will be out in droves refining the Fed’s position on potential rate cuts or tapering QT. Given Friday’s employment report, initial jobless claims will garner more attention. CPI, the following Tuesday, is the next big economic data point.

The Curious Case Of Manufacturing

Over the last couple of weeks, one regional Fed manufacturing report after another pointed to a deteriorating manufacturing sector. Consider the following:

  • The New York Fed index fell sharply to its lowest level since May 2020. New Orders and shipments plummeted.
  • The Philadelphia Fed index fell again and has been negative in 18 of the last 20 months. Both the current and future indexes point to economic contraction.
  • Richmond’s Fed also reported a decline in its survey. It now stands at its lowest level since 2020.
  • Per the Dallas Fed- “The production index, a key measure of state manufacturing conditions, dropped 17 points to -15.4—its lowest reading since mid-2020.”
  • Like the other indexes, the Kansas City Fed also reported a contraction in manufacturing.

Given the poor surveys, we presumed the national ISM manufacturing survey would be similar. On Thursday, ISM surprisingly rose to 49.1%. While a reading below 50 signifies a manufacturing contraction, the index surprisingly was higher than the prior month. New orders, which hampered many of the regional indexes, rose from 47 to 52.5. Employment fell slightly and has been contracting for four months straight. The graph below shows the regional and national surveys correlate well. But, there are instances where they do diverge for a month or two. Stay tuned for the next round of surveys to see how the two data points converge.

ism manufacturing regional fed surveys

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Retirement Savers Are Piling Into Stocks. Is That A Good Idea?

As the financial markets grind higher, retirement savers have consciously decided to add more to equity risk. Such was the result of a recent Bloomberg survey.

“Retirement savers want more stocks in their portfolios as a hedge against inflation, potentially offering a long-term tailwind for equities as societies age, according to the latest Bloomberg Markets Live Pulse survey.

Almost half of the 252 respondents said they were putting more funds into stocks as a response to rising prices – far eclipsing the 6% who said they’d be adding the traditional inflation hedge, gold.” – Simon White

Stock are popular with future retirees.

While the respondents said they were buying stocks as a hedge against inflation, which may be part of the answer, the reality is that a surging bull market over the last 14 years is more likely the real reason. The same psychology permeated into the next question, which asked which asset classes would do the best as society ages. Given the real-world experience of most individuals of skyrocketing home prices and stocks, it was not surprising to see both ranking as top answers.

Stocks and House prices expected to go up.

Given the recency bias of most individuals, the responses were unsurprising given the outsized proportion of market gains relative to the long-term averages. Such was the recent topic of “Portfolio Return Expectations Are Too High.” To wit:

The chart shows the average annual inflation-adjusted total returns (dividends included) since 1928. I used the total return data from Aswath Damodaran, a Stern School of Business professor at New York University. The chart shows that from 1928 to 2023, the market returned 8.45% after inflation. However, after the financial crisis in 2008, returns jumped by nearly four percentage points for the various periods. After over a decade, many investors have become complacent in expecting elevated portfolio returns from the financial markets. However, can those expectations continue to be met in the future?”

Bar Chart of "Arithmetic Average S&P 500 Annual Total Real Return Over Different Periods" with data from 1928 to 2023.

That last sentence is critical.

A Staggering Shortfall

There are a couple of apparent reasons individuals are willing to take on increased risk in portfolios, the most obvious being the rather significant savings shortfall. For example, a previous survey by CNBC found that most Americans will need $1.3 million to retire comfortably.

“When it comes to how much they will need to retire comfortably, Americans have a “magic number” in mind — $1.27 million, according to new research from Northwestern Mutual.

The survey found that respondents in their 50s expected to need the most when they retire — more than $1.5 million. For those in their 60s and 70s, who are close to or in retirement, those expectations dropped to less than $1 million.”

How much do US adults have saved for retirement.

The problem with that data is that most individuals are nowhere close to those levels of savings.

“A recent survey conducted by Clever Real Estate polled 1,000 Gen Xers born between 1965 and 1980 to find out how they fare regarding personal finances and the road to retirement. A staggering 56% of Gen Xers said they have less than $100,000 saved for retirement, and 22% said they have yet to save a single cent.

While the desire to retire may be there, the money just isn’t. A whopping 64% of respondents said they stopped saving for retirement not because they don’t want to but because they simply can’t afford to.

Approximately, how much do income brackets have saved for retirement.

Furthermore, a LendingClub survey shows that 61% of U.S. consumers live paycheck to paycheck.

It’s a dire situation for most Americans, particularly those retirement savers. As such, it is unsurprising that more individuals are looking to the stock market as a solution to make up the shortfall.

However, therein lies the risk.

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The Risk Of Risk

One of the incredible genetic traits of humans is the ability to forget pain. The trait is essential to the survival of the species. If cavemen clearly remembered the agonizing pain of being attacked by a predator, they would have likely never left their caves to hunt. If women vividly remembered the excruciating pain of childbirth, they would probably never have more than one. In the financial markets, investors all too soon forget the painful memories of bear markets, particularly when the bull is stampeding.

Currently, the bull market that began in 2009 remains firmly intact. Despite a mild stumble in 2022, the long-term trend remains higher, and investors feel confident that the trend will remain indefinitely. However, a risk has been overlooked amid above-average returns over the last decade. That risk is liquidity, which we discussed in more depth in “The Markets Are Frontrunning The Fed.” 

“The psychological change is a function of more than a decade of fiscal and monetary interventions that have separated the financial markets from economic fundamentals. Since 2007, the Federal Reserve and the Government have continuously injected roughly $43 Trillion in liquidity into the financial system and the economy to support growth. That support entered the financial system, lifting asset prices and boosting consumer confidence to support economic growth.”

Government interventions and the stock market.

The risk of reduced monetary liquidity may become problematic for stocks to sustain current returns. As shown below, nearly 100% of the index returns from 1900 to the present came during the 4-periods of multiple expansion. With valuations currently very elevated, the reduction of monetary liquidity may lead to the next secular period of “multiple contraction,” which would yield much lower rates of returns.

Bull and Bear Market Cycles

In other words, retirement savers currently allocating more savings to equity risk could well be setting themselves up for an extended period of higher volatility and lower expected rates of return.

Real returns and valuations.


As Jeremy Grantham previously noted:

“All 2-sigma equity bubbles in developed countries have broken back to trend. But before they did, a handful went on to become superbubbles of 3-sigma or greater: in the U.S. in 1929 and 2000 and in Japan in 1989. There were also superbubbles in housing in the U.S. in 2006 and Japan in 1989. All five of these superbubbles corrected all the way back to trend with much greater and longer pain than average.

Today in the U.S. we are in the fourth superbubble of the last hundred years.”

Therefore, unless the Federal Reverse is committed to a never-ending program of zero interest rates and quantitative easing, the eventual reversion of returns to their long-term means is inevitable.

It is hard to fathom how forward return rates will not be disappointing compared to the last decade. However, those excess returns were the result of a monetary illusion. The consequence of dispelling that illusion will be challenging for retirement savers.

However, throughout history, investors have repeatedly invested the most into equity risk and the worst possible times. For retirement savers, this time will likely be no different.

The Banking Crisis May Not Be Over

Interestingly, the Fed removed the following statement from Wednesday’d FOMC statement: “The U.S. banking system is sound and resilient.” We bring that up because New York Community Bank (NYCB) fell over 40% earlier that day. Therefore, we must ask- are the banking problems from last year resolved, or is the Fed worried? NYCB reported a $260 million loss amidst expectations for a gain. Additionally, they reduced their dividend by 70%. Last March, NYCB bought a large percentage of the failed Signature Bank from the FDIC. The current loss is partly due to a significant build of loan loss reserves from Signature Bank assets.

This news comes a month before the Fed’s emergency loan program (BTFP) expires. Bond and loan prices are still below when the Fed enacted its BTFP bailout. Therefore, the risks to banks’ balance sheets are still present. Accordingly, closely watch the stock performance of the regional banks to help assess if this is a one-off problem or if the market is concerned that commercial real estate and other banking problems are starting to simmer again. As shown below, NYCB is now trading below the levels it traded at last March.

nycb stock

What To Watch Today


Earnings Calendar


Economic Calendar

Market Trading Update

A big reversal day in the market yesterday recouped most of the decline following the FOMC meeting on Wednesday. Overall, the market remains mildly overbought, but as discussed yesterday, that market held the trend channel support, keeping the bullish trend intact. So far, earnings remain mostly in line with lowered expectations, and the market’s focus continues to be on when the Fed’s rate cuts are coming.

Yesterday, after the close, Amazon (AMZN) reported better-than-expected results, with revenue climbing 14%. Meta (META) also beat on better-than-expected results and announced a first-ever dividend payment. These two companies are set to drive the market higher this morning.,

We used the open yesterday to add to some of our Dividend Equity Model holdings. We suggest continuing to use any weakness to rebalance risks accordingly.

Market Trading Update

Price To Sales For the Magnificent 7 Offers Concern

At the peak of the dot-com bubble, Scott McNealy of Sun Microsystems sternly warned shareholders as follows.

‘At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?’

At the time, Sun Microsystems traded with a price-to-sales ratio of 10. The graph below, courtesy of Kailash Capital Research, shows the entire technology sector trades at a price-to-sales ratio similar to that at the peak of the dot-com bubble. More stunning is the price-to-sales ratio for the Magnificent 7, which is currently at 10.3. McNealy cautions that it’s very tough to justify paying such a premium. In time, the Magnificent 7 will have incredible growth rates or, more likely, correct to a more sustainable valuation. The second graph shows the fate of Sun Microsystems (SUNW).

price to sales technology sector and the magnificent 7
sun microsytems

BLS Preview- Challenger Job Hires and Jobless Claims

Given that Powell now believes the labor market and inflation are on equal ground regarding future policy, the market will pay even more attention to tomorrow’s BLS jobs report. Thursday’s Challenger report showed that job hires in January hit their lowest level since at least 2004 at 5,376. For context, the prior three years and three years before the pandemic averaged approximately +50k jobs in January. Accordingly, this data confirms the weak hires data in the JOLTS report earlier this week.

Initial jobless claims jumped higher than estimates to 224K. Such is the highest weekly print since August. Continuing jobless claims reached 1.898 million, the highest since mid-November. Both are relatively low numbers but have begun trending higher.

Meanwhile, unit labor costs came in at +0.5%, more than half of estimates. This indicator should comfort the Fed that a price-wage spiral is not likely.

challenger job hires

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