Kevin Gordon is a senior investment strategist at Charles Schwab and, more importantly, a co-winner of the FTAV charting contest.
In the markets, it's impossible to go through a day without being overwhelmed by the reasons why stocks are rising or falling. Or why they should go up or down. Everyone is always looking for a narrative.
However, in the past few months, the abundance of novels has increased dramatically, making trying to describe the current market almost painful. It is human nature to demand to know who is responsible for any given event. But it is also human nature to choose our own adventure, and thus choose the narrative that suits our personal bias at the time.
The following list is not exhaustive, but at least captures the major themes emerging in recent presentations, events, and talks. Perhaps not surprisingly, all of these matters are presented in both positive and negative lights; Each of them may be responsible for the next big market “crash” or “crash.”
As such, each story faces several holes, which means that – depending on how you look at it – either all or none of these holes help explain what moves the stock. ¯\_(ツ)_/¯
Amnesty International
Let's deal with the big problem first. The AI narrative has dominated the landscape for much of the past year. Investors have become excited (to say the least) about chatbots and chips, hoping that they will spark a massive productivity boom and revolutionize the world.
The interesting part is that this is very similar to the late 90s with the advent of the Internet. The worrying part is that this is very similar to what happened in the 1990s, where there was bubble-like behavior.
Maybe both are true, but the obsession with knowing which parts of the technology world (AI creators) will benefit most is a bit strange. Looking at the top 10 performing companies in the S&P 500 from the beginning of 2023 through March 2024, four are in technology, but three are in industrials and two are in consumer discretionary. It seems we have already seen the love shared between AI creators and adopters?
Paid
Speaking of the late 1990s, momentum entered the chat. Now, after widespread adoption, momentum has risen to become one of the best-performing factors this year (if you use the S&P 500 as your proxy).
In fact, through the end of March, the S&P 500 Momentum Index was up 22.3% year-to-date. With the index highly correlated with the technology sector – and gaining strength as seen in the run-up to the tech crash of the early 2000s – the bears are out in full force to warn of a major bubble and a looming “momo collapse.”
However, things are different today. Going back to the late 1990s, the momentum factor was highly correlated with stocks that had negative earnings. Today, momentum is more closely associated with companies with stronger fundamentals, such as higher returns on equity, free cash flow returns, and profit margins.
Brilliant 7
This member is probably the most vulnerable, not least because two of the members (Apple and Tesla) are already down by double-digit percentages this year.
Even if you look at the performance in 2023, yes, the Mag7 has already lifted the broader market considerably. However, not all members had great performances (Apple ranked 63rd).
Mag7's performance coverage might make one think the group is the only game in town. However, since the S&P 500's October 2023 low, the MAG 7 has risen 37.6 percent through the end of March 2024. The equal-weighted S&P 500 is up 26.7 percent — slightly less than the S&P 500 500 has a maximum weight of 27.6 percent. Earn a cent. In other words, the other 493 weren't completely left behind.
breadth
This equally strong performance of the S&P 500 means that the “expansion” narrative has now taken over.
Sectors that used to receive little attention – energy, financials, and materials, to name a few – are now beginning to show more relative strength; If not in terms of performance, then certainly in terms of core breadth.
Many investors are happy that this is finally happening. This is not a recent phenomenon, though. The gains actually started in October. In fact, from the October low through the end of last March, the financials sector was the best-performing sector in the S&P 500.
Federal interest rate cuts
One narrative that has waned this year is that the pricing of the 2024 Fed rate cuts will coincide with a correction in the stock market.
On the surface, that didn't happen (at least in the big-cap world), given the S&P 500 rose 10.2 percent in the first quarter, while the federal funds futures market went from pricing in nearly seven cuts to less than three. . On a more granular level, there has been more corrective activity beneath the surface of indices like the Russell 2000: the average member saw a maximum drawdown this year of -21 percent.
Good news is bad news
This was a stronger narrative last year but has faded slightly in 2024. In essence, this is consistent with the idea that the relationship between changes in stock prices and bond yields has turned negative: yields rise, stocks fall (and vice versa).
This negative correlation was very strong in 2023, but has now declined; In fact, with the S&P 500 rising 10.2 percent in the first quarter, the yield on 10-year US Treasury bonds rose from 3.88 percent to 4.31 percent.
Looks like we can have it both ways!
Inflation is sticky
Just as the stock market has become more comfortable with rising interest rates, it seems the same can be said about inflation.
Over the past couple of years, talk about firmer inflation being a negative for stocks stemmed from the fact that we had a bear market in 2022, just as inflation rose at a rate not seen in decades and the Fed was forced to aggressively raise interest rates. Rates.
Regardless of whether you think the last mile of fighting inflation is harder, we have not yet reached the 2 percent target. In fact, the Consumer Price Index rose – on an annual basis – from 3 percent last June to 3.2 percent as of last February.
Whether that's consistent inflation or just trends that rarely move in a straight line is in the eye of the beholder, but it's clearly been ignored by the stock market for now.
One novel to rule them all
Nothing is easy in the markets, but one thing we can rely on is looking at investor sentiment to gauge the extent to which animal instincts have taken hold. Now, they are pretty much in control.
Optimism is everywhere, as evidenced by a high percentage of bulls in an American Association of Individual Investors survey, strong flows into stock ETFs, or a low buy-to-sell ratio (among other metrics).
Simply put, investors feel good about the stock market, which makes them want to buy stocks. When those stocks do well, it makes them feel better, so the cycle continues. As we've learned throughout history, periods of optimism and exuberance eventually end (sometimes messily), but trying to time it is a fool's errand, because it can last for a while.
Maybe the market simply has no regard for which narrative we choose?
