Earnings season continues to roll on, with the majority of companies beating expectations on both the top and bottom lines. The resilience in the face of what we have seen with the rocketing interest rates is impressive to say the least. Let’s not ever forget that it is earnings that drive stock prices, and it is the fact that those earnings are continuing to grow that has resulted in the upward move in all the major indices. The big jump in mega-cap tech that pulled the market-cap weighted S&P 500 (SPY) and Nasdaq (QQQ) during the first quarter of 2023 can be discounted. The broad-based rally we saw beginning in the second quarter and continuing through the end of July cannot. Despite the naysayers (and for good reason), I believe a new bull market has begun, CARA (Cabana’s Cyclical Asset Reallocation Algorithm) agrees and has now signaled the transition to a new bull cycle. This does not mean we won’t see pullbacks and volatility, but it has been a very reliable indicator of higher equity prices over the medium term. Some of you may remember that we got this same signal in February. It quickly reversed in the face of the bank failures we saw in March. That is the only time I can recall that we have ever seen a whipsaw with this indicator. These are unusual times for sure and anything is possible, but history shows CARA as being reliable with this signal and she is supported by objective technical and fundamental evidence.
We are entering the weakest period of the year for stocks and are coming off two strong months, so I expect some form of pullback or digestion of the gains witnessed to date. Bull markets take two steps forward and one step back. We have seen the two steps forward so don’t be discouraged by the one step back that is coming down the line. I do not know what the catalyst will be and maybe it has already begun on the back of the Fitch downgrade of U.S. debt earlier this week. As of this writing on Friday, August 4, we are seeing all indices down for the week. We also just saw a daily drop of more than 1% in the S&P 500 for the first time in several months on Wednesday of this week. A pullback feels imminent, but I wouldn’t bet against this market. It has crushed short sellers all year and turned even the biggest bears into apologists. I am even starting to hear “goldilocks scenario” whispered. This suggests rising earnings, cooling inflations and, dare I say it, a peak in short term interest rates. If inflation continues to trend down and the Fed pauses in September, we could see a very Merry Christmas for investors.
As everyone knows, I am very sensitive to the yield curve inversion we have witnessed over the past year. That inversion has reached 100 basis points (or more) on several occasions. While we have been hit with a precipitous jump in rates this week, it is longer term rates that are now rising faster. As one of my partners Jeff Mitchell pointed out to me yesterday, the inversion has now dropped below 70 basis points. This trend toward normalization is a good thing and may be early evidence of a healthier economy down the road. Just another positive in my view.
At Cabana, we are bullish and in our Transitional Bullish Scene. We also have removed duration from our fixed income allocations to potentially take advantage of what we believe to be incredibly good ultrashort term treasury rates, while reducing long bond volatility.
