Broker Check

An Unemotional Approach Is the Preferred Path

| March 25, 2024

Last week’s big data event was the Federal Reserve meeting. Going into it, we at Cornerstone thought there could be a mini rally after the rate decision, especially after the recent day-to-day volatility of the past couple weeks.

That thinking emanated almost from a sense of relief from the meeting and subsequent commentary for five primary reasons:

1. Historically, when the market was soft going into Fed meetings, a rally took place afterwards in four of the last seven occurrences:

2. Data indicates a short-term peak for interest rates:

3. The market likely already priced in the “bad news” of fewer rate cuts occurring later than expected in 2024:

4. Fed Chair Jerome Powell was uncharacteristically dovish in front of Congress on March 6-7 (his comments last week reinforced those tones):

5. There's currently a strong technical setup for an S&P 500* rally, perhaps up to 5,250 or so.

Oddly enough, the continuing skepticism towards equities creates the ability for a sense of relief from data to initiate positive short-term moves in the market. Many investors, especially institutions, are essentially incredulous that stocks rose in 2023 and keep rising in 2024.

Certainly, these investors have their reasons, as outlined below. However, stubbornness could be at play too.

  1. Inflation data has run hot…yet stocks went up.
  2. Interest rates rose…so did stocks.
  3. Recession concerns are mounting due to a softening labor market…and still, stocks go up.
  4. Consumers are running out of excess savings…stocks still up.
  5. An expected recession near the back half of 2024…markets look forward and stocks are up.
  6. Valuations are “extreme”…but stocks are up.
  7. Only seven companies are driving the rally…stocks are up on wider breadth.
  8. AI is mostly hype…stocks are up, especially for AI-related companies.

You get the picture.

That said, we’re unaware of anyone who’s successfully modeled any of the four recessions in the past 32 years. And yet, many skeptics seem confident enough to predict a 2024 recession with absolute precision.

For us, the best predictors of future contractions are bond market liquidity and function, which sputtered prior to each previous recession. But today, none of those signs exist yet.

In our analysis, the Fed is becoming increasingly dovish even if the number of interest rate cuts this year is reduced. Currently the market is expecting about three cuts of 25 basis points each. But even if there’s just one cut, the Fed is still arguably dovish from an equities tailwind perspective.

Additionally, we continue to see market broadening, especially during the last two weeks of increased pressure. A few weeks ago, the year-to-date performance for the S&P 500 equal weight and market weight indexes were 2.48% and 6.69%, respectively (a difference of 4.21%). However, as of last week, those numbers stood at 3.81% and 7.28%, respectively, for a difference of 3.57%:

That may not seem like a big move. But remember this involves trillions of dollars.

Money has flown out of the technology sector and into the broader market. Alone, that rotation is a net positive. But because of the concentration of a trillion dollars of market capitalization in the tech sector (where the outflows are coming from), it may prove to be the catalyst for a post-earnings correction.

Interestingly, the tech sector recently had its first week of more selling than buying in quite a while:

What’s more, while the S&P 500 has been down marginally for the past two weeks, the moves were small. Since they weren’t outsized, the index still managed to register a fresh all-time high on a closing basis two weeks ago and again last week.

We maintain vigilance and realize a 3.0-5.0% correction can come at any time. Most importantly, if inflation begins declining again (as we expect), it will likely spur the Fed to begin the anticipated interest rate cuts.

Remember, the closer to this year’s election the Fed starts cutting rates, the more political it will appear. Forced to choose, we think the Fed will end up cutting at least three times before the election. If so, the stock and bond markets would be happy.

How do we prepare? Of course, an unemotional approach is the preferred path. There are endless stories to stoke worry and fear, which could cost the emotionally susceptible investor untold amounts of money. But look at 100-year performance of stocks:

That chart reinforces the existence of volatility and painful periods. The path to glory isn’t linear. That said, the path is undeniably real. Since 1900, the Dow Jones Industrial Average# has grown over 127,000%.

However, just a handful of stocks account for that success. So, discipline is a must. As quantified by Hendrick Bessembinder of Arizona State University, 4.0% of stocks account for all the net gains of stocks over bonds in the past century.

It's almost a conundrum: investing in stocks over time is a seemingly sure thing, but you're wasting your time with 96.0% of the market. Thus, to beat the market you must own some or all of those “4.0% stocks.”

How do you find them?

To maintain consistency over time with our investment strategies, we use an unemotional, rules-based approach as our foundation. It’s based on three requirements:

  1. Superior fundamentals: this includes sales and earnings growth, positive earnings, profitability, and managing debt – they all reflect a well-run company.
  2. Strong technicals: The “4.0% stocks” have upward momentum and are bought on rising volumes.
  3. Unusual buying: when institutional investors deploy massive amounts of money, they disrupt markets; when they buy big, follow the money.

Aligning these factors improves our odds of success significantly over time when coupled with discipline. When there’s short-term uncertainty, we especially focus on market assessments, market conditions, and identifying where money is flowing.

For now, equities remain strong. But volatility could arise since earnings season is complete. To be sure, we must maintain discipline over the next six weeks or so to navigate any choppy waters.

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* 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 Dow Jones Industrial Average is a stock index tracking 30 large, American, publicly owned blue-chip companies and is generally considered representative of the broader U.S. economy.

Securities sold through CoreCap Investments, LLC.  Advisory services offered by CoreCap Advisors, LLC.  Cornerstone Financial and CoreCap are separate and unaffiliated entities.