Friday Afternoon Update

I’m going to try to speak plainly. I still think that the averages can add some more to the upside, which for me means the S&P trading above $4200. However, broadly speaking, I’m not liking what I’m seeing; whether it’s market breadth, credit, economically sensitive groups like semiconductors, transports not to mention the regional banks.

For the bulk of the rally off the October lows, it was easy for me to find a lot of bullish signals, the only question was which area would perform best. My assessment in October was the Dow would perform best (it had the best looking base), then my assessment was that the mega-caps would rotate in and would perform best (as yields were less of a threat). Even in the interim between rotation from one group to another (rotation is bullish), when I wasn’t exactly sure which group was most likely to lead next, market breadth was so strong there was simply no way I could be bearish on the market. Markets with breadth that strong aren’t selling off. That market breadth strength is not there anymore. It’s not so bad that mega-caps can’t overcome it for a while, but it’s noticeably weakening.

I don’t recall if I called out any bear flags in the averages from October to February, but I don’t remember any. Now they’re starting to pop up here and there. What’s now turned into 6 weeks of lateral trade speaks to a real lack of conviction. Other than the mega-caps, the market seems to have lost its way, and its next step.

All of this — from the mega-caps being the last to rotate in, to weaker market breadth, the weaker price action and in many cases, bearish price action developing more and more frequently — is exactly what I expected as the Fed ended the rate hike cycle. I expected it to be a “sell the news” event. While the Fed hasn’t officially ended the rate hike cycle, they’ve sent messages and hints, the bond market says they’re done. The Fed Funds Futures are even pricing in reasonably high probabilities, all things considered, that the Fed cuts in July and that the Fed Funds Rate is 75 bp (three 25 bp cuts) lower by the end of the year.

In the current environment, meaning the last year or so, that would have been greeted as bullish news by most investors, but the Fed isn’t going to cut with inflation still sticky unless they absolutely have to. That means if the Fed cuts rates, it’s either a recession that is doing its job and bringing down inflation quickly, but perhaps the recession is too deep; and/or something in the financial system broke. The Regional Banks have already strongly hinted at that possibility of something breaking badly and spider-webbing out in second order effects in a dozen different directions that few saw coming or were prepared for. The Fed cutting rates isn’t going to be a bullish development – at least not the first 2/3rds of the rate cut cycle.

I don’t want to come off as too bearish yet, I just want to impress that after a half year of being bullish on the market, or at least expecting the primary downtrend to morph into an intermediate lateral trend, I’m seeing things change.

There are still some bright spots, but there are fewer and fewer. A bright spot…

Alphabet/GOOG (60m) not only in breaking out of a big bullish ascending triangle this week, but on a day like today when the mega-caps are out of favor, price is acting beautifully in a small bullish consolidation. Beyond the mega-caps as a group through, I’m seeing fewer bright spots and more dark stains.

Again, I want to impress that I’m not running the red flag up the flag pole or fear mongering, I’m saying that something is changing (as expected and about the time expected) and it’s not constructive. I don’t feel like it’s a great time to start trading from the short side yet in a meaningful way, but I do think it’s time to start thinking about how you want to position your portfolio for a recessionary environment.

Again it’s been a very dull week. At the time I’m writing this here’s how the averages stand on the week:

SP-500 -0.7%, Dow -1.5% (Transports -2.95%), NASDAQ-100 +0.25%, Small Caps -1.4%

As for S&P sectors, the pro-cyclicals are down from -1.5% to -2.5%. The defensively oriented sectors are down less, half down -0.35% and half down -1.35%. The three mega-cap heavy sectors range from -0.6% to +1.95%.

The Mega Caps as a group (MGK +0.35%) outperformed the S&P 500 Equal Weight Index (-1.45%) by 180 basis points. That’s not bad on such a dull week.

Yields are fairly little changed, around 2 to  4 basis points higher across the curve.

Next week we have Fed speakers just about every day except Wednesday as far as I can tell. Here are some of the more notable economic releases:

Monday: Empire State manufacturing survey

Tuesday: U.S. retail sales, Industrial production, Capacity utilization, Business inventories, Home builder confidence index

Wednesday: Housing starts and Building permits

Thursday: Philadelphia Fed factory survey, Initial jobless claims, Existing home sales U.S. leading economic indicators

Friday: Fed Chairman Powell and former Fed Chairman Bernanke on panel

There will be no live stream this weekend, but I’ll likely have a video out. Have a great weekend!