August 12, 2022
Good morning,
Recall the stock market’s ability to handle last week’s blowout employment numbers without breaking stride. This week, it took Wednesday’s better than expected inflation news and ran right through its overhead resistance level just below 4200 on the S&P 500 Index. Now what?
Our now month-old equity rally continues to confound the majority who, from the beginning, labeled it a sure-to-fail bear market rally. Straying from the data for just a minute, it’s worth pointing out that this is what the market does – It fools the most. It’s possible that this rally will ultimately fail precisely when investors start talking about it as the new cyclical bull market. This fool-the-most market characteristic is very real, but it isn’t part of the calculus that drives portfolio management decisions.
Back to the data and portfolio management. Our rally has produced a few good breadth thrust signals, enough to turn the balance of short term signal evidence bullish. However, while the balance of short-term evidence now leans bullish, it is by a thin margin (un overwhelming) and the rally’s strength has not yet moved the intermediate or long-term signals. Recall the risk reduction asset allocation move in the spring where equities were downgraded from overweight to underweight. Our rally has shown enough grit to upgrade equities to neutral weight now.
Let’s put aside what the absolute value of what neutral weight means to a portfolio because neutral allocation targets (for equities, fixed income, cash) vary by portfolio as a function of investor risk tolerance. Instead, I’d like to focus on the investment behavior one might exhibit according to the three allocation regimes: over, neutral, and under, weight regimes. An overweight regime translates into buy weakness (buy the dip as it is commonly called), underweight translates to selling strength (selling into rallies), neutral is akin to do nothing.
Could our rally fail in the weeks, or months ahead and earn the bear market rally label. Yes. The allocation upgrade from under to neutral weight does not define the rally as necessarily sustainable or taking us to new all-time highs on the major indexes. The allocation shift to neutral does stop us from selling strength on the current rally. Neutral regimes don’t normally last long, and if the market begins to stumble over stubbornly high inflation or a Fed misstep, for example, we’ll get defensive again and downgrade to underweight. An upgrade to overweight from neutral will require more positive evidence in the longer-term market data.
I’ve heard it said many times recently, by several Investment Hall of Fame-ers (Marks, Cooperman, Druckenmiller to name a few), there is no historical analog to today’s market, it’s going to be very tough to navigate markets ahead.
Over the next few years, what do you think will happen first to the market; a new high or a new low? I’m beginning to think neither.
Happy Friday – hope you have a great summer weekend.
Be well,
Mike