The stock market has continued higher in recent weeks as the “soft landing” – i.e. no recession – narrative has continued to gain steam. Additionally, investors are looking forward to the end of the Federal Reserve’s rate hike cycle as inflation has continued to moderate. Market action in the past few weeks, particularly the advances in smaller and more economically sensitive stocks, has improved the market’s condition. However, forward looking economic indicators still provide reason for caution.
For most of this year, the gains in the market have been driven by a handful of large technology stocks. In our Mid-Month market calls we have discussed how this has created divergences in the market between the price of the indices and broader measures of market health. Such divergences have occurred more than 3 dozen times in the post WWII era, and, according to studies from Lowry’s Research in all but 3 instances (1963, 1988, and 1995), a significant market decline ensued. That list of outliers may expand to include 2023. In recent weeks, the gains in the market have been broad based, and sufficient to erase the negative divergences in most indicators. The broadest indicator of market health, the NYSE advance-decline line, reached an all-time high in recent days.
Meanwhile, forward looking economic indicators have not deviated from their cautious message. They continue to be consistent with prior recessions. These indicators cannot guarantee us the timing, severity, or even if there will be a near term recession. But just as we must listen to the message of the market described above, we must also pay attention to economic indicators. Monetary policy works with a long and variable lag; just because the dramatic increase in interest rates hasn’t caused an economic decline yet doesn’t mean that it won’t happen.
It is in an environment like this that we highlight the fact that we believe that it is prudent to look at the market through multiple lenses. If we relied only on fundamental analysis and economic data, we could be paralyzed by getting far too conservative and missing more upside in the market. Having a process that also incorporates “listening to the market” with technical analysis has kept us mostly invested and thankfully tilted towards areas of the stock market that have demonstrated market leadership.
The recent market advance has led it to extended territory; some cooling off or a pullback is likely. However, given the improvement in overall market conditions, that pullback may be smaller than previously anticipated. With muted overall corporate earnings growth, we will be particularly selective on any companies we may buy in coming months.
