It’s a busy time in the economic year. Earnings season has started, there’s an election coming up, and we’re transitioning into the strongest part of the year, historically. Let’s just strap in and get going.
First, a quick technical analysis. For the first time since late August, technical indicators show a short-term risk-reward deterioration for stocks, which is a significant change from the last six weeks.
Two down technical signs are a slowdown in momentum and waning breadth. The market’s breadth had expanded significantly since July, but there’s been a recent slowdown.
Second, knowing that transports are a leading indicator for the market, we're now seeing a negative divergence in that sub sector.
Next, additional technical indicators like the Elliott Wave Theory show signs of stocks slowing.
There are also some early indications of complacency risk. One includes low equity put-to-call ratios.
So, purely from technical indicators, there is an increased risk of a minor, short-term pullback in the next few weeks leading up to the election. This aligns with our theory of markets still being in a “tricky” period from September to Election Day.
Still, this has been a strong market with a seemingly unending underlying bid. We expect investors to continue to “buy the dip,” even if this one is seemingly more painful or quick.
That’s basically the bad news.
The counterbalance to these short-term indicators is that, while it’s still early in the third-quarter earnings season for S&P 500* firms, it’s been quite good so far:
Even more impressive, revenue growth is now tracking at almost 5%, which is consistent with the 4%-6% growth for each of the past five quarters:
The reason the sales growth is so impressive is core inflation has fallen like a rock from 7% in 2022 to 3% in 2024 while revenue growth has held steady:
This may seem incongruent. If you recall, the bearish take was that if or when inflation fell from 2022 levels, corporate earnings would tank because top line growth would crumble. We now have data showing that’s not been the case.
In our opinion, there are three ways to interpret this, all of which are positive for stocks (we don't know which of these three it is, but it must be one of them):
- Core inflation did not reflect true inflation in the economy.
- S&P 500 revenue growth was not correlated to inflation.
- S&P 500 companies are outperforming inflation.
So, take your pick. Regardless of the answer, “real” revenue growth (S&P 500 revenues less the core consumer price index), is accelerating:
Real revenue growth went from -3.9% in 2023’s third quarter and is now headed towards 2%, which is a massive swing. It implies the quality of current per-share earnings growth is significantly stronger than a year ago.
Perhaps this explains why stocks have been so strong in 2024, even in the face of the persistent, lovable bears.
When The Tide Goes Out
Understanding the power of real revenue and earnings growth, it might not come as a surprise that the market has reached rare air – MAPsignals’ trusty Big Money Index has hit overbought territory, as of this writing.
The BMI is a 25-day moving average of netted “big money” professional investor stock buys and sells. It’s a great macro indicator with an impressive track record.
A year ago, the BMI was in the basement. But extreme oversold conditions ignited a rally for the ages:
Our readers may remember last October, when it felt lonely for us to suggest any massive rally was coming. But when you're armed with evidence-rich data at that time, it's easier to make that kind of call.
For those keeping score, the S&P 500 and the Nasdaq 100# are both up 35% since then. It’s another example of how the BMI being oversold is one of the most powerful risk-on signals you'll find.
Considering the current technical factors mentioned above and the fact that the BMI is overbought, today's message does somewhat signal a shift in tone. But please note: OUR LONG-TERM BULLISH STANCE IS NOT CHANGING.
Overbought conditions do not last forever. It’s important to heed the data on both ends of the extreme because markets are constantly moving.
For us, the trusty BMI helps gauge when the pendulum has swung too far. Since 2018, there have been seven extreme oversold readings and 10 overbought readings:
In this time, when the BMI reaches oversold, the average 12-month forward gain for the S&P 500 is 26.1%. While this is a limited window, the winning percentage is 100%.
Stocks rarely hang around the extreme zones forever. That's why it is important for us to note that last Thursday morning we pierced the overbought zone, with the BMI hitting 80.9%. That means 81% of “big money” buy and sell signals have been green, which is extreme.
Don’t go thinking we've turned into bears overnight, though. We merely respect the data.
Keep in mind that going back to 2014, the BMI stays overbought on average for almost 22 days. That's about a month of trading. But there have been times when the BMI stayed overbought for 80 or more days. There have also been times when it was overbought for just a few days.
With it being an election year, and considering the weak short-term technical data, we must continue to watch data-based indicators even more closely to know where this year stands relative to history.
Once the BMI falls out of overbought territory, stocks historically struggle. When the tide goes out, equity prices fall. When the BMI breaks below 80% after being overbought, both large- and small-cap stocks tend to historically be negative up to two months out:
But again, with the unique nature of this year and where we are leading up to the election cycle, we must keep a close eye on this while also keeping in mind that our long-term bullish narrative is not changing. This forecast should be a minor blip on the trail of massive long-term growth.
This Rally Has Staying Power
Let’s now discuss the longer-term outlook. There has been some chaotic action when zooming in. But if you zoom out, you see a 26% total return for the S&P 500 in 2023 and the index up another 20% or more this year, depending on when you look.
This rally has staying power. The breadth in the second half of this year has been extraordinary. That’s clear in the S&P 500 Equal Weight Index, which rose 9.1% in the third quarter after underperforming for much of the year. It easily beat the tech-heavy S&P 500’s 5.5% advance. Yet again, as one sector cools off, another one steps up to power the market’s next leg higher.
Everything mentioned in this post so far might make you think there’s nothing left to buy. But to finish things off, here are six bullish macro tailwinds that support new all-time highs once any near-term choppiness fizzles.
First, while the news likes to make us think geopolitical risks are going to be detrimental, we know geopolitical scares typically don't hold stocks back for more than a few weeks.
In 29 geopolitical events since 1940, the S&P 500 averaged short-term losses of 1.4% and 0.9% after a week and a month, respectively. But on average, stocks were healthy three, six, and 12 months later:
Second, the market loves lower oil prices:
While oil declines in recessions, prices are falling now because of excess supply. Global demand has been steady, even in the face of geopolitical risk. Also, lower oil prices mean more money in the consumer's pocket.
Third, the stock market loves the collapse in long-term bond yields that’s been a function of falling inflation, not weak economic growth. The economy is healthy, as shown by the Federal Reserve Bank of Atlanta’s latest GDPNow forecast of 3.1% growth (and it’s been around that range for months).
Sharp drops in oil prices and long-term interest rates are positive for the economy, earnings, and stocks. History suggests these stimulative benefits aren't even fully priced in yet:
The fourth tailwind is the last macro one, but it’s important: persistent dollar weakness. Some S&P 500 companies generate roughly 40% of their sales overseas, led by the technology and materials sectors:
It's no surprise that the S&P 500 bull market started when the U.S. dollar’s last bull market ended in October 2022. The dollar index is now down 11%, with half of that decline coming in the last year.
We expect the dollar to remain soft as the Federal Reserve continues cutting rates. That will make the dollar less attractive to global investors and supportive of earnings growth.
Fifth, technical investor positioning continues to be key for stock performance. This is a contrarian indicator, but when everyone's bullish, it's time to lighten up because there's no one left to buy. On the flip side, when everyone is scared to death, it's time to back up the truck.
Right now, the market’s huge run up and Wall Street’s long list of worries have investors hedging their bets. They’re crowding into low-volatility stocks, including countercyclical sectors like utilities, staples, telecom, and other defensive corners of the market.
The chart above shows how high-beta stocks normally outperform low-volatility stocks by 2.5% in any six-month period. But low-volatility stocks have outperformed high-beta stocks by 8% over the last six months. That's a whopping 10.5% better than average and shows the crowd is still cautious.
This investor positioning is a bullish signal for the overall stock market from a longer-term perspective. Remember, when bull markets end, investors are tripping over each other while reaching for risk. The opposite is true today.
And finally, perhaps the best tailwind for new equity highs is EARNINGS:
The five previous data points combined are what lead to outperformance in earnings. We're already seeing it in the third-quarter numbers.
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*Past performance does not guarantee future results.
* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
# The Nasdaq 100 is an index of the 100 largest non-financial companies listed on the Nasdaq Stock Exchange.
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