Broker Check

Things Aren’t Always as They Seem

| May 08, 2023

Sifting through distracting narratives can be fun. However, facts and data are often absent. In other words, things aren’t always as they seem.

For instance, investors have basically been downtrodden since October 2022. Perhaps not coincidentally, the general narrative has been firmly pessimistic. But data shows a different reality. Since last October, markets have risen quite a bit – roughly 15% – with technology and discretionary stocks pacing the gains.

Does anyone realize this big jump took place? It doesn’t seem so. If you’re regularly stuck in the news, you probably haven’t noticed. A gain of 15% in six months is positively noteworthy.

Over the last few weeks, we’ve laid out an optimistic, data-driven case for positivity moving forward – not to mention our base thesis of market strength in late 2023/early 2024. Here’s why:

  1. Corporate earnings are largely working
  2. The Federal Reserve is likely done with interest rate hikes
  3. Inflation if decreasing

Our readers know we predicted short-term volatility through earnings season. That’s exactly what’s happened. We think the choppiness is due to fresh selling focused on taking profits (remember the 15% gain since October 2022) and negative banking news headlines, not deteriorating fundamentals.

Still, is the bumpiness reason to worry?

Again, we said to expect short-term volatility. Looking at the trusty MAPsignals Big Money Index (BMI), which is a 25-day moving average of “big money” investor buys versus sells, it’s been trending higher despite near-term pauses:

Minor dips can be expected at the end of earnings season because fundamentally based announcements (i.e., profits, revenues, etc.) are tailing off. The BMI pauses are justified, given the slight increase in selling due to taking profits:

Even with the selling, it's interesting how the BMI has barely sniffed pauses while continuing to rise overall. This is notable because sometimes the BMI can fall when the market is still rising. In such scenarios, all may not be well underneath the surface. That’s what happened in January 2020:

For the sake of clarity, this doesn’t seem to be occurring now – quite the opposite, in fact. The market has basically been sideways while the BMI has continued to chug along.

This can be seen when examining activity in exchange-traded funds (ETFs), which cover broad swaths of the market. There’s hardly been any “big money” ETF selling during earnings seasons, indicating a lack of underlying pressure:

Still, the recent news narrative is that there’s been big selling in the leading market sectors since the October market lows. Yes, there has been some selling:

But is the tech/discretionary run over? Well, some context is needed here.

Again, we think the recent selling is profit realization (notice above how there was also tech and discretionary buying). Diving in deeper, nearly half of the “big money” selling was in semiconductors:

The media suggests it’s due to tensions between the U.S. and China. But we don’t buy that reasoning because the PHLX Semiconductor Index has gained 34% since October 2022, even including the recent pullback. That screams profit taking, with institutional investors using the headlines to gain liquidity after a huge run up.

Additionally, despite this recent pressure, discretionary and tech continue to be the strongest sectors overall, which is additional support that the selling is not fundamental based, but driven by earnings season profit taking:

While there has been “big money” selling of late, upon further inspection, it’s likely an attempt to gain liquidity rather than a pivot out of unfavorable positions. Understanding that, let’s turn our focus to earnings volatility and the broader macro picture.

Remember, earnings drive stocks. What we're seeing right now is that smart investors are looking through the widely projected earnings softness in early 2023 to position for what is expected to come in 2024.

Don’t forget, we’re in the midst of the most anticipated recession in history! Stocks aren’t priced on today's value, but rather what's to come. The 2024 S&P 500 earnings expectations are pegged at $248, which represents a modest forward price-to-earnings (P/E) ratio of 16.5 times earnings:

For many investors (us included), the first quarter of 2023 is already in the rearview mirror. Accordingly, there’s new second quarter data from FactSet that’s quite interesting. More precisely, even with the current concerns in the market, analysts have not meaningfully lowered their earnings per share (EPS) expectations for Q2 2023:

That 0.8% decrease is a smaller margin than average. This is important because in a typical quarter, analysts usually reduce earnings estimates early. Comparatively, the average decline for the average bottom-up EPS decline in the first month of the quarter was:

  • 9% in the past 5 years
  • 8% in the past 10 years
  • 2% in the past 15 years
  • 7% in the past 20 years

Analysts then tend to raise expectations later. Thus, when looking for declines, eyeing April is a good idea. And so far, the analyst cut expectations are much smaller than historical averages. Perhaps most interestingly, while the bottom-up EPS expectations for Calendar Year (CY) 2023 initially declined by 0.2% during early April, recently they’ve increased by 0.4%, which is positive when looking forward:

This all begs the question – what can really get this market moving upward? Of course, it’s our good friend the Fed.

Without continuing to beat a dead horse, there’s pressure on the Fed. Inflation is coming in quickly, regional banks are still on uneven footing, and the American consumer may be getting worn out by the rate hikes. We’ll point again to a chart from last week showing the federal funds rate and the consumer price index (CPI) nearly at parity for the first time since before COVID-19:

Lastly, we can’t ignore the record amount of cash sitting as “dry powder” in money market accounts, which are sporting their highest balances ever:

In summary, we’ve put forth lots of data and stated how the first quarter earnings trough is now in the past. Is there still support for our base case of stocks lifting in the latter part of 2023/early 2024? We think so:

  1. Low liquidity
  2. No “earnings apocalypse”
  3. Record cash
  4. Fed nearing the end to rate hikes
  5. Declining inflation

So, is the negative narrative we hear justified? Or is there truth in the data-driven case of the market not being as bad as it seems? Well, as this Knowledge Ninja chart shows, news can be misleading:

We’ll continue to trust data.


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