October 6, 2021
Good morning,
Inflation! It rumbles on and has been the singular focus of European markets overnight, with a rise in inflation breakevens over there moving spectacularly higher, powered specifically by natural gas. Overnight headlines seem like they are straight out of the 1970’s – soaring any prices, rising yields, and even a French strike for good measure. Equities on our shores are not enjoying the history lesson and Futures are down 1% at 8am ET.
Inflation scares can be rough on equities, we just had one in March. With the 5% drawdown threshold finally broken last week, the question from here is whether this bout of market weakness is yet another in a series of rotations that hit mega-cap names slightly harder than the last one in March, or is it the first phase in a larger correction – or is it a hybrid of the two. The conservative bet is the hybrid. I’m not going to chart you up on this because feedback from readers sours when these notes gets too charty and technical. However, the bottom line currently, and this is NDR specifically, is that “the weight of the technical/quantitative evidence does not support more than seasonal weakness (Sep-Oct) that can continue into November before a year-end rally”.
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As I try to do each month, the following is a reprint of the cover letter on the monthly performance reports hitting client e-mail boxes this morning. As always, apologies to clients for the redundancy but I think there is a benefit to the broader reader base –
The steady flow of bad news late last month was finally too much for what had been an historically resilient stock market. Global supply chain disruptions, soaring energy prices, COVID-19, stalled infrastructure bills, inflation fears, and looming Fed taper – finally weighed on the market, resulting in the end of two notable streaks. First, the S&P 500 fell 4.8% in September, stopping the number of consecutive monthly gains at seven. That was tied for the 20th-longest stretch since 1925 and was the longest since the 10 months ending in January 2018. Second, the S&P 500 closed 5.1% below its September 2 record high, ending the streak without a 5% pullback at 211 trading days, or since October 30, 2020. According to NDR’s research database, it was the 13th-longest on record and also the longest since January 2018. For perspective, the average rally between 5% pullback lasts 72 trading days.
There’s a message for the bull’s in the above paragraph and it is: don’t cry because it’s over; smile because it happened. Of the 12 longer streaks between 5% drawdowns, 11 occurred during the secular bull markets. It’s at least a historical confirmation of a continuing bull market, probabilistically. The exception (the 1 in 12) was the 219-day streak that ended on 2/11/04 with a decline of only 8.2%.
If we assume we are still in a cyclical bull market (started March 2020) within the secular bull market (started in 2009), we are at a point historically where we must be watchful over their sustainability. We are keeping an eye on the bond yield advance and its potential impact. How long will it last and how high will yields go? Will the equity impact become significantly negative, and if so, when? To what extent will short-term rates take part, how will the yield curve be affected, and what are the major sector implications? What are the current and potential messages from credit spreads and the performance of risk-on proxies relative to risk-off proxies? The answers will have implications for both bull markets’ (cyclical and secular) sustainability.
From a technical/quantitative markets analysis perspective, the current expectation is that the interest rate advance will not likely prevent global equities from entering a year-end rally, especially now that the September rise of pessimism has left global equities oversold and positioned to advance in line with seasonal tendencies. We could use some renewed rallying with strong breadth signals (advances overwhelming decliners) to confirm that outlook for at least the rest of the year.
Be well,
Mike