Broker Check

Higher Highs and Higher Lows

| March 06, 2023

January brought an unexpected jump in markets. February saw consolidation as bears and bulls battled. Now, we want to reflect on data with forward-looking eyes, ears, and minds for March and April, which historically are two of the strongest months of the year:

Inflation is still coming down, but not fast enough to please the Federal Reserve. Thus, markets are expecting three more quarter-point interest rate hikes by the Fed’s July 2023 meeting.

If that occurs, the federal funds rate would reach the Fed’s base level in July, which corresponds with what Cornerstone has been saying since last year – it could be chaotic until things settle down in the latter half of 2023. That said, the fear case is that in March the Fed will use the data to justify a 50-basis-point increase in interest rates, implying an increase of 100 basis points instead of 75 through July. That means fed funds rate of 5.5%-5.75%.

Yes, the prospect of “higher rates for longer” has been everybody’s base case (ours included) for about a year. The February action for bonds and stocks reflected this fearful potential. But we don’t think it’s completely justified. As of this writing, the CME FedWatch Tool that analyzes Fed rate change probabilities puts only a 27% probability of a 50-basis-point hike at the Fed’s next meeting:

Clearly, the narrative of the Fed being “tighter for longer” has been accepted. The fear-based consolidation retracement at the end of February was the market’s response. On the positive side, the S&P 500 retraced back to its 200-day moving average (solid black line), but held:

Technically speaking, this is strong support for the concept of higher highs and higher lows. Some thought we’d return to October 2022 troughs, but we haven’t. Consolidation was inevitable. But the market floor seems to have risen as of now, helping ballast portfolios.

What seems almost contradictory is the angst over the recent personal consumption expenditures (PCE) price index report. Spending is robust, despite high inflation:

Usually, robust consumer spending would be positive. But in this weird, upside-down world, it's not. Instead, investors think it’s reason for the Fed to raise rates.

We know the Fed has a target of 2% inflation. But we’d argue that it’s past time for the central bank to re-evaluate its position to match reality. From the Fed’s birth in 1914 until 2023, the consumer price index (CPI), a favorite inflation gauge, historically averages about 3.3%.

This is where it can get interesting for markets. It seems plausible that the annual rate of inflation can get back down to that historical reality of 3.3%. If so, investors should cheer.

The Fed’s 2% target is unrealistic, especially with a protracted war in Ukraine and geopolitical tensions between the U.S. and China. The notion of a sub-3% CPI is akin to the Garden of Eden and should’ve been tabled long ago.

What matters from a timing perspective is that whatever becomes the terminal rate – the “higher for longer” settling point (i.e., somewhere in the 5%-5.75% range) – it presents a real opportunity for investors to lock in long-term bonds as the market transitions to a more bullish environment for stocks. So, up through the middle of this year, traditional fixed income could finally prove attractive again.

This pivot to equity bullishness could come in the latter half of 2023. Currently, pricing in the bond futures market points to July. Support also exists when examining data from stocks and “big money” investors (e.g., institutions, pension funds, etc.). Encouragingly, when many datapoints align, investors can really cook.

Robots and Liquidity

Loyal readers know our friends at MAPsignals produce the Big Money Index (BMI), a 25-day moving average of “big money” investor activity. The BMI hit overbought territory on Feb. 8. The rest of February was volatile, leading to consolidation. The BMI subsequently fell:

Many want to blame these gyrations on the news. But narrative alone doesn’t move markets – certainly not like data. So, we wanted to look at the forward returns after an overbought market. Once again, MAPsignals led the way. As expected, near-term returns are choppy, but longer-term returns are promising (The six- and nine-month readings would coincide with the aforementioned July time frame):

So, the news cycle will likely continue to say inflation isn’t falling enough and the Fed has more damage – I mean work – to do. But inflation has stabilized since last summer, meaning we’re probably past peak inflation. There's no evidence suggesting it will rise higher than in June 2022, when the year-over-year CPI hit 9.1%.

Of course, these days a strong consumer means too much of a good thing is actually bad. So, again rates will be “higher for longer” in the eyes of investors. But if we understand that, we can plan for it.

Stepping back, remember last October’s market lows brought big stock buying. It eventually intensified, causing broad indexes and the BMI to ascend quickly. Early January brought a slight breather, but then stock buyers threw gas on the fire, and we hit overbought territory:

Since then, selling didn’t explode, buying dropped off. In our opinion, this is a form of liquidity drying up. Don’t confuse buying and selling pressure with volumes. When buying fades, selling slightly grows, and volumes stay consistent, liquidity matters more than volumes.

It means sellers are in charge and the bid-ask spread on stocks widens. That brings opportunities for algorithms and high-frequency traders to thrive. They can muscle stocks around with wider spreads and lower liquidity. Remember, markets aren’t linear, as was proven in late February:

The robotic traders test liquidity up and down until there's a tipping point for a few volatile days. This is what happened with stocks at the end of February:

And with exchange-traded funds (ETFs):

None of this was unexpected. The data leading up to the February volatility was signaling a pullback. This is all normal.

Now as we enter two of the historically strongest months of the year, the question becomes: is the market tanking, or has hot consumer spending provided opportunity liquidity tests?

We’re not sure it matters. History and bond market futures indicate optimism for positive returns in the months and year ahead. So, don’t fret about the reason(s). Instead, pay attention to data-driven details.


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