Going into last week’s Federal Reserve Federal Open Market Committee (FOMC) meeting, we expected some stock market volatility that would depend on the Fed’s language, not necessarily the baked in 25-basis-point increase. Thus, we’ve been eyeing three key points that will help determine the longer-term reaction:
- Some signal that the Fed would not hike rates more in September.
- A light at the end of the tunnel in terms of rising interest rates.
- Will the Fed push back hard on the stock market’s big gains so far in 2023?
Typically, we would prefer a dovish tone from the Fed at this stage of the rate hikes indicating an acknowledgement of positive recent inflation data. Powell toed the line between hawkish and dovish language this time around in an attempt to balance to stronger U.S. economic data, wage inflation, falling inflation and the Fed’s own desire to keep its options open.
Last week Fed Chair Jerome Powell said, “We’ve come a long way. Inflation repeatedly has proved stronger than we and other forecasters have expected, and at some point that may change. We have to be ready to follow the data, and given how far we’ve come, we can afford to be a little patient, as well as resolute, as we let this unfold.”
Markets initially reacted with gains. Stocks took off in early trading the next day (Thursday, July 27), though by the end of the session, indexes were down but began to rebound again Friday.
What’s more important in our opinion is the course of federal funds rate futures for November and any reaction there to the Fed’s news. As of now, it could go either way as the Fed wants to keep its options open, though would bet on futures continuing to fall:
While the June consumer price index (CPI) report was a positive surprise, the Fed likely wants to see more CPI decreases before becoming firmly dovish. Still, the 2023 core personal consumption expenditures price index (PCE) is tracking below the Fed’s summary projections, where the Fed sees 3.9% and the street consensus sees 3.7% year-over-year by the end of 2023:
Perhaps most surprising is previously bearish Goldman Sachs economists now see the PCE ending at 3.6% this year (see above) and think rate hikes may be near their end:
For all these reasons, we don’t view any short-term volatility coming out of the Fed meeting as a harbinger of doom either way. We would chalk it up to normal market behavior.
Breadth and Buying
Turning to market data, stocks continued rising and market leadership keeps broadening, furthering 2023’s strong start. Investors who relied on data this year and stayed invested have done extraordinarily well.
As of this writing, we’d argue the data suggests there’s more to come, though we expect short term bumps throughout the rest of the summer. That means it may be one of those times where it’s smart to sit and do nothing.
But what does “do nothing” mean exactly?
Well, the market has been rising and many people can’t believe it. If anything, this year has proven that it’s better to be invested than to be on the sidelines.
What we think is somewhat unbelievable is the market has soared while record amounts of cash have not just sat it out, but the cash pile has grown. According to the Fed, there is $5.7 trillion sitting in money market accounts (up $0.7 trillion since the market’s October 2022 lows):
Those investors missed out – the S&P 500* has rallied about 29% since October 12, 2022. Seemingly, the masses have been waiting for the inflation war to be over and it’s been a costly wait.
More recently, the 10-year Treasury once again moved significantly below the all-important 4% threshold (see below). As mentioned last week, the data-focused “smart money” seemed to know ahead of time that this year would produce a solution to last year’s vicious inflation.
Once we begin to get consistent, reassuring language from the Fed, the coast is basically clear. It will be like the lifeguard letting everyone back into the pool. At that point we’ll probably see those ridiculously high money market balances begin to drop as that cash is invested. When that happens, it will be additional support for the stock market to rise, possibly even more than we have recently witnessed.
Recently, as the market has broadened, we've already seen signs of this support in other sectors outside of growth tech. For example, leading into and through earnings, financials have begun to experience immense buying:
Maybe even more incredibly, 2023’s unloved energy and materials sectors have recently begun to see significant buying (more evidence of breadth):
Additionally, smaller stocks continue to be bought at a big clip (see below). That indicates an appetite for growth as “big money” continues to invest in smaller companies on a broad basis. But notice too that larger companies are being purchased as well – these are continuing signs of increasing breadth.
Obviously, growth areas have undisputedly led the market higher as you can see in the table below. But the cash is still on the sidelines and the recent uptick in “big money” buying in unloved sectors supports additional market growth, especially once we get out of the summer doldrums.
Zooming out, MAPsignals’ Big Money Index (BMI), which is a 25-day moving average of “big money” investor buys versus sells, is starting to flatline, but it’s not dropping yet:
When the trusty BMI begins to drop, it will indicate the expected short-term volatility is right around the corner. But as we sit here today, the winning move is to do nothing as money is flowing into the market and still lifting stocks higher. Let it continue to do that until the data points indicates it won't. For now, those signs don't exist.
As a result, the winning data-based move right now is to do nothing. Remember, rallies have a habit of happening before anyone realizes it. Do you remember the “rally bells” ringing last October? Neither do we.
Patience allows us to stay consistent with our data-based approach. That will be important if hype sweeps people up in the next six weeks or so as markets likely consolidate.
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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.
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