All the major stock indices continue to digest the large gains seen in May, with particular emphasis on the Nasdaq 100 and market cap weighted S&P 500. We noted two weeks ago that the leaders of this rally were overbought and ripe for a pullback and some consolidation before attempting to move higher. This remains a work in progress.
The rest of the stocks out there have been trying to keep their heads above water and stay positive for the year. We have finally started to see some catch-up in other sectors over the past few weeks – and that is good. I have discussed the market breadth problem several times and won’t belabor that point here again.
Way back in late January, I suggested that a new bull market could be starting (see my commentaries from January 26 and February 2). My perspective at that time was based solely on technical price, but price tends to be omniscient. My partner Taylor Woodard loves to point that out to me.
Right after I wrote those commentaries the market started selling off – and selling off hard. The S&P 500 dropped more than 3% in February (Source: stockcharts.com). It turns out that a looming bank crisis was lurking below the surface and the market sniffed it out before it was announced that two of the largest banks in history were failing in the face of the unprecedented rise in interest rates we have seen since March of last year. But guess what? The selloff remained orderly, and the technical bullish picture remained intact. Big tech stepped up and led the way forward just like it led the way down last year. Whether it is the AI phenomena, the end being in sight of the Fed’s herculean effort to raise interest rates or simply a bounce from the shellacking the Nasdaq took in 2022 – mega cap technology has kept the bull on the “pitch” (that is the one soccer term I know from watching Ted Lasso). This run made by a few companies has been so remarkable that they are now being called the “Magnificent 7” tech stocks. It has also forced all the naysayers out there to have a major case of FOMO (“fear of missing out”). Trillions of dollars of institutional money is sitting on the sidelines wondering what to do if this baby bull market is for real. This alone is enough to cause prices to move higher as professionals have no choice but to buy in despite all the “obvious” risks out there. This buying due to FOMO can become a self-fulfilling prophecy as the buying begets more buying. A few months down the road it has suddenly become an “obvious” bull market. I am not saying we are anywhere near that point but I believe the first step is for that buying to begin to spread out to all the companies that make up the economy, and that seems to have started.
I spend much of my days reading economic reports and analysis by so-called experts, most of whom have widely varying opinions on what is going to happen. Why I read these I have no idea other than to torture myself. I tell people all the time to avoid watching CNN and listening to experts. It’s my belief that CNN is out to make money and stir up whatever they can to grab viewers and that experts would not be talking to anyone if they actually knew something. Despite being acutely aware of this, I still can’t help myself. So, I will point out two articles that caught my attention and got me to looking at charts. The first was prompted by my taking a look at what prior bear markets say about big moves up in tech that are not supported by the rest of the economy. This led me to an article written during the 2020 Covid-induced bear market. This analyst pointed out that tech has a history during bear markets of violent rebounds only to be followed by a resumption in selling and new lows. He pointed out all the monster tech rallies of the 2000-2003 bear market when nothing else followed suit and it was all a big head fake, with the biggest crash still to come. Lo and behold, there is quite a bit of evidence to support the idea that a Nasdaq-led rally like we have just witnessed does not mean that the bear market is over. Another article was about the severely inverted yield curve and all the impending damage that is going to be inflicted on borrowers and lenders as balloon notes mature. Since the 1960s every recession has been preceded by an inverted yield curve and the average time between maximum inversion and recession is 15 months. This would put the recession as starting in October of this year. The author pointed out for good measure that bottoms in stock markets usually don’t happen until the recession is formally announced. All really good points and worthy of consideration.
So, what do we do when the technical price action of the broad indices suggests a new bull market is beginning and most everybody else says a painful crash is ahead? Well, I will tell you two things that I have found to be true in this most difficult of businesses during times like this. First, as my good friend and tennis buddy told me years ago when I was complaining and asking how it could be possible that my portfolio was going down when everybody on the planet knew those positions should be going up. He has managed money for more than 40 years and has seen a lot. He simply smiled and said, “The market does whatever it takes to hurt the most people…. but not always”. Food for thought. The second thing I can say that I believe to be true is that it helps to have a process. The process won’t always be right, and I have certainly been on that side of it for some of the past 18 months, but the process gets you through when you are unsure and allows you to focus on the longer-term big picture. Nobody really knows what will happen tomorrow, next week or next month but over the next five years, history gives us some pretty good guidance. That history says if I can hang around and avoid getting crushed during the bad times, the sun will eventually come out and I will be ok. No guarantees on that, but it is what history says.
When it comes to Cabana’s portfolios, I fully understand that some of our family office clients and even more of our professional partners have been frustrated that we have not be “in” soon enough during rallies and then “in” just before another sell off begins, as this bear market has whipsawed up and down. I can only say that we have a process based upon a lot of data, which we are continually incorporating as time goes by and as conditions evolve. Our goal is now and has always been, to manage risk first. I would rather not make a dime in this business for anybody than to lose a client’s hard-earned money. That fundamental principle is where our process starts. This business of investing unfortunately requires acceptance of risk and losing money sometimes and we acknowledge that fact. But we take on risk when we believe it can be measured and when the odds are in our favor. It doesn’t always work out and it can be frustrating, but I wouldn’t do it any other way. It is not for everyone, and we do not claim to be better than anyone else out there. We do work hard every day and we follow our process.
Right now, we are in our Transitional Bearish Scene (improving) after adding equity exposure earlier in the month. Our Safety Valve is always engaged, and we are prepared to reallocate should it be necessary.
Please note that due to the 4th of July holiday, we will not be putting out a market commentary next week. I hope everyone enjoys some time with family, friends and sunshine!
