With the last quarter now in the rearview mirror, we want to touch on some of its high points and look to the second quarter of 2023. All in all, it was an odd quarter, but one that we survived intact.
Even with the craziness, the S&P 500 ended with a solid gain. Volatility temporarily mitigated late in the quarter, which could partially be in anticipation of the Federal Reserve’s interest rate hikes (hopefully) ending soon.
Still, corporate earnings were “better than feared.” The sturdy nature of corporate America contributed to a forward-looking growing hope, leading the S&P 500 to rise more than 7% for the quarter, despite the Fed’s actions and multiple bank failures.
Even with significant headwinds, markets showed strength. That seemed to put greater weight on the looming end to rate hikes, continued declines in inflation, and quick, effective responses to regional bank failures. Yes, there were (and are) problems, but markets are eyeing the end of those issues and looking to the resulting positive effects.
Yes, doubts like inflation, economic growth, Fed rate hikes, containment of the banking crisis, and so on, remain. We haven't completely gotten away from those issues. But how does the market absorb them this quarter?
Naturally, we turn to data. It shows market resiliency, even after hitting lows in October. Looking at MAPsignals’ trusty Big Money Index (BMI), a 25-day moving average of stock buys versus sells from “big money” investors, we’re still seeing higher highs and higher lows:
Continuing to follow our base thesis, in the short-term markets will likely stay volatile as headwinds persist. That probably means a short-term sideways market while still having bounced off the new most recent floor. Thus, we continue to look to the second half of the year for renewed market strength.
Eyeing the last week of March, data showed a reversal of heavy selling and a slight increase in buying (remember a few weeks ago we saw nearly 1,200 sell signals):
A recent example to show why short-term volatility and sideways markets are the most likely scenarios is the market confusion caused by the push-and-pull outlook between Fed Chair Jerome Powell and Treasury Secretary Janet Yellen. A couple weeks ago, the Fed’s decision to raise the target rate only 25 basis points caused stocks to jump. Chair Powell reiterated the soundness of the U.S. banking system. However, at the same time (literally as Powell was speaking), Secretary Yellen said there was no consideration to guarantee all bank deposits. That caused the initial rise in markets to reverse and invite declines.
We point this out again because it typifies the landscape investors face today. Volatility, instability, and skittishness are prevalent right now. Thus, we want to look at market mechanics for further context.
Typically, there’s a near-constant appetite for stocks. But that disappears when bears show their heads. In those cases, the demand for cash increases. That’s exemplified today – cash holdings are at their highest levels, even more so than at the peak of COVID-19:
This may not seem intuitive, but these ample cash holdings are really a bullish signal for stocks. That’s because the cash will need to come off the sidelines eventually. When it does, it will buy stocks in droves. This is part of the fuel that will fire a second-half market ascent.
In early April we said a new low may be in but that more data was needed. We’re now seeing confirmation as the BMI bounced up from nearly being oversold and it doesn’t seem to be pausing (yet), rising to 37.8% as of this writing:
The reasons for this are a slight uptick in buying, but more so that selling vanished (note the lack of red bars at the end of March):
Is this just a pause before another market pullback (i.e., a bear market rally), or the beginning of a bullish run higher? Well, that is the question of the second quarter in a nutshell for most people. If we pull back though, we can see there’s already been a new uptrend even with the pullbacks, with the S&P 500 making higher highs and higher lows since October 2022:
The bullish case is the disappearing selling turning into buying if first quarter 2023 earnings begin to pleasantly surprise to the upside. That would continue the recent trend, because even though earnings weren't great, they still surprised to the upside last quarter.
That said, we still think the Fed will increase interest rates by another 25 basis points. At that point, we should enter the back half of the year coasting, which is consistent with our base thesis. Should that occur, we expect markets to improve and volatility to significantly decrease. Thankfully, additional backing for a pause in rate rises and a strong second half for markets shows up in recent economic data.
One example is the Bureau of Labor Statistics’ Job Openings and Labor Turnover Survey (JOLTS). Open jobs fell to less than 10 million, down from 10.8 million in February and below the expectation of 10.5 million. Like Paul Revere warning of the British, the JOLTS report is proclaiming that the labor market is slowing.
Another example is a slowdown in manufacturing, which should lead to decreased economic activity. The ISM Manufacturing Purchasing Managers Index (PMI) declined to 46.3% (below 50% indicates contraction):
Lastly, the March private payrolls report from ADP showed a rise of 145,000 jobs. That’s down from 261,000 in February and well below the expectation of 210,000.
In essence, this is exactly what the Fed has been seeking. So, we hope they will make the right decision and pump the brakes on interest rate increases, which should lift markets down the line.
Yes, investors are facing the highest interest rates in decades, significant geopolitical tensions, and economic uncertainty from recent bank failures. Still, we must recognize how the underlying U.S. economic fundamentals and recent U.S. corporate earnings proved incredibly resilient through the first quarter.
Remember, steady economic growth and strong earnings are the real long-term drivers of market performance, not the latest disconcerting headlines. We’ll keep weathering short-term volatility and managing risk and returns with an eye towards the second half of this year.
Successful investing is a marathon, not a sprint. Intense volatility is unlikely to alter the potential of a diversified approach set up to meet your long-term investments needs.
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