A Wile E. Coyote Market

This is purely and solely a momentum driven market

Highlights

• Central banks dominate the week ahead

• Don’t look down — plenty of air beneath this momentum-driven market

• The recession is beginning to show in the real-side macro data

• Labor hoarding is behind the slow rise in the unemployment rate

While We Were Sleeping

It is another big week ahead — last week was all about the data, and this week is all about central banks: the BoJ and RBA tomorrow; the Fed on Wednesday (Iceland’s monetary officials also meet that day and are widely expected to cut; ditto for the Czech central bank); and then a trio of the SNB, Norges Bank, and BoE on Thursday. We also have a slate of February data out of China today to dissect (see below) — retail sales, industrial production, and fixed-investment. Canada, Japan, and the U.K. all release their inflation figures for last month while we will see a slate of PMIs out of the Eurozone as well as the key ZEW and Ifo surveys out of Germany.

What is most important from the Fed is less the press statement and any tweaks made to the dot-plots and forecasts and more the Q&A session when Powell heads to the podium on Wednesday at 2:30 p.m. in the afternoon. Best to fade what happens at 2:00 p.m. based on the pattern of the past (as an aside, a June cut is now seen as a coin flip by the swaps market and is pricing in -71 basis points of cuts for all of 2024, down from the -150 basis point expectation at the turn of the year). The BoJ meeting could be a watershed moment if the Japanese central bank finally has the nerve to move out of NIRP in the aftermath of what proved to be the biggest surge in annual pay negotiations (over 5%) in more than three decades. On the U.S. data front, we have the March NAHB index today at 10:00 a.m., February housing starts to contend with tomorrow, and then the Philly Fed manufacturing index on Thursday (for March) along the Conference Board’s leading economic indicator and existing home sales (both of these are for February).

On the financial side, after accounting for 80% of last year’s market advance, the top ten stocks in the S&P 500 have been responsible for two-thirds of this year’s gain so the issue of this being a highly concentrated market has hardly been resolved despite a recent broadening out. But in the overnight trade, U.S. futures are pointing to a higher open, European markets are up fractionally, while Asia ripped: Japan’s Nikkei 225 (+2.7%; and our preferred market is now up +18.8% for the year), China’s Shanghai Composite and Taiwan up +1.0% a piece, Korea (+0.7%) and India (+0.3%). Both Thailand and Singapore were flat on the session. Leading the way in the Asian trade was not tech but rather the defense stocks which soared on the back of a suspected ballistic missile being fired by North Korea in reaction to Secretary of State Blinken visiting Seoul to take part in the Summit for Democracy.

Bond markets are quiet (even with a bearish front-page FT piece today titled High Fed Rates Required For Longer Than Markets Expect, Say Economists and Suspense Builds For the Federal Reserve As Growth Downshifts and Inflation Lingers on page B10 of the WSJ) as is the FX space, with the DXY dollar index at 103.4 and back approaching the 50-day trendline in this current countertrend rally. Brent crude just touched a four-month high of $85.83 per barrel (+0.6%); Bitcoin has hit a wall (-0.4% to $68,019) and gold is little changed at $2,152 per ounce (all market quotes are time stamped to 4:30 a.m. EDT). The resource market surely received a show of support on page 6 of today’s FT: Commodity Traders Build War Chest Of Up to $120bn (lots of dry powder in those mines).

The Chinese data that just came out were a tad above market expectations: Industrial production for the January-February period popped to +7.0% YoY and was the best performance in two years (consensus was +5.2%). Retail sales rose +5.5% YoY, in line with expectations and actually a tad below the +7.4% December pace. Growth in fixed-investment came in at +4.2%, the fastest pace since last April. The one snafu was the rise in the unemployment rate to a seven-month high of 5.3% from 5.2% in January and 5.1% in December. And I should add that on a sequential seasonally-adjusted MoM basis, retail sales in China did slip -2.2% in what was the worst showing since November 2022 and the +0.6% MoM increase in production, was the softest showing since last December. Perhaps less than meets the eye. But the fact that production growth of +6.7% year-over-year is running at double the pace of retail sales (+3.4%) is a sign of how the supply and demand curves in China are moving in what can only be described as a disinflationary pattern. The expanding “output gap” in the world’s second-largest economy is not only being flagged by the rising unemployment rate but also by the declining industry capacity utilization rate which, at 75.9%, is far below the pre-Covid level of 77.5%.

We also received a data-point out of Japan that was none-to-good: core machinery orders fell -1.7% — the first setback in two months — and the fact that the Nikkei soared is a testament to the view that the bull market in Japan is more secular in nature than it is cyclical (as in the radical reforms being made on the corporate governance front). Not even the broad expectation of a snugging in BoJ policy could stand in the way of this Japanese equity market rally, making the move all the more impressive. See Bank of Japan Rate Decision Likely to be a Close Call on page 8 of the FT (moving out of NIRP as well as removing the cap on 10-year JGB yields).

To show how misinformation can spread, the WSJ article on page B10 cited above quotes an economist stating that the February headline manufacturing production data “bodes well for equipment investment in the first quarter” even though growth in this sector is running at a -1.8% annual rate below the Q4 average (contracting through the first two months of the quarter!). That would make it three quarters in a row of decline in manufacturing activity, so there is no doubt that the production sector in the U.S. has swung back into a recession of its own.

Stock Market Rally Presses The Pause Button

The Dow and S&P 500 endured a rare dip last week, and the Nasdaq Composite was off -1.0% and falling below its 21-day moving average (as well as the 16,000 level) in the process. The tech-laden index has now slipped for two weeks in a row for the first time since October (though it is still up +6.4% for the year) and has dialed its way back to where it was over a month ago on February 12th . The small-cap Russell 2000 sank -2.1% as market breadth was poor. The market rally is now in the midst of a pause (or pullback) that commenced with Nvidia's March 8th downside reversal. A number of breakouts or buy signals from the past couple of weeks have struggled or failed.

To show just how much is priced into the S&P 500, we estimate, based on normalizing the forward P/E multiple benchmarked against the risk-free rate, that the market is effectively pricing in +45% EPS growth for this year. That is a 1-in-30 event. Heading into today’s action, we have now gone through 268 trading days without a -2% drawdown in the S&P 500 — all the way back to February 21st , 2023. The S&P 500 has also managed to notch monthly gains in November, December, January, and February, and even with the positive seasonal influences, this has just happened 16 times since 1928 — call it a 1-in-7 event. Another milestone recently reached was 17 record closings so far in 2024, the most for any start of the year since the onset of the last Tech bubble in 1998. Then tack on the fact that the highest-momentum stocks in the index have seen their share of the market cap soar to more than +30% over the past year, a development that occurred in 1929, 1973, and 2000.

The “Magnificent Seven” stocks (recently pared to a fantastic four, actually) are collectively trading at an average forward P/E multiple of 33x, up from 26x at the end of 2022, and a massive premium to the 21x multiple for the overall S&P 500. That’s the backdrop against which I receive these emails: “But this is nothing like the bubble of 1999-2000,” or “but these companies have earnings, and the dotcoms did not,” and so on and so forth. The bottom line is that even if you don’t see a bubble here, the overall market is trading at a multiple that represents a near-2 standard deviation event. You will never hear me say that I would deliberately chase a market that is so egregiously overpriced, whether it deserves a “bubble” monicker or not.