/ June 19 / Weekly Preview
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Monday:
N/A
Market Closed
Tuesday:
Building Permits
Wednesday:
UK Inflation (8.4% exp.)
Powell's Testimony
Thursday:
Powell's Testimony
Friday:
N/A
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Monday:
N/A
Tuesday:
FedEx FDX
Wednesday:
N/A
Thursday:
Darden Restaurants DRI
Accenture ACN
Smith & Wesson Brands SWBI
FactSet FDS
Friday:
CarMax KMX
Announcing Millennium Smart Beta Portfolios and the Sigma Society
Before we get into today’s newsletter, we would like to introduce the Millennium Portfolios. These are 4 Smart Beta portfolios, nearly 100% allocated to equities all of the time, that aim to offer exposure to varying investing styles:
General Alpha, focused on outperforming the S&P 500
Volatility Targeting, focused on outperforming the S&P 500, without any added daily volatility
Momentum, benchmarked to the Momentum Factor ETF (MTUM), and emulating this portfolio construction style
Vision, benchmarked to ARKK, the popular "Innovation" ETF
You can sign up to follow their trades using our new Trade Alert feature.
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The Bear Market is Over
Now back to our regular programming.
Since our last analysis, SPY has smashed through R1 resistance at $431, and has now stalled somewhere between that level and the next upside target (S2 @ $449). After that, only the all-time highs remain, as a near-term target.
However, it’s doubtful that we’ll get there in a straight line. The market is now reasonably overbought, with many bears having to close their short positions and contributing to the melt-up. Many professional and retail investors have gotten substantially more bullish over the last two weeks. There is no denying that transaction volume has spiked on the recent rise, contributing to the positive technicals, and implied FOMO.
SPY Analysis
The MACD has become reasonably extended, at levels that have previously denoted declines
With realized (as well as implied) Volatility declining to some of the lowest levels recorded recently, such is a moment where a 5% to 10% correction would not be surprising. We would in fact come to expect such a correction, based on extended sentiment values.
However, this would only constitute a decline within an ongoing bull market, and an opportunity to increase exposure to equities. Since the performance of the broad market is still not quite up to par with SPY itself, we would assume a further advance requires a broadening of the rally. The chart below exemplifies the difference between SPY’s Z-Score and the average Z-Score of the top 1000 stocks. It is still the highest divergence on record.
We could assume that a pause and consolidation in SPY’s rally will pull back the highly extended sectors: Tech (XLK), Communications (XLC), Consumer Discretionary (XLY). It would benefit all of the other sectors, as capital rotates to unloved investment themes (all things NOT A.I. apparently).
Notably, the market has now turned positive on a 2 year time horizon. It has hit a fresh 52 week high, after a 300 days of not being able to achieve this feat. This has been the longest stretch, without a 52-week high after the Financial Crisis. Previous 300-day stretches have a high percentage of favorable future returns.
What about the Fed?
The past week, the Fed has opted to pause rate hikes, after an apparently soft inflation print. CPI was up 4.0% year-over-year, versus 4.9% in April and 4.1% expected; Core-CPI rose 5.3% year-over-year, versus 5.5% in April; the shelter index (+8.0%, and a lagging component) accounted for over 60% of the total increase. These figures gave Powell and Co. an excuse to “monitor the lag effect of their previous actions on the economy”. To wit:
“Nearly all committee participants expect it will be appropriate to raise interest rates somewhat further by the end of the year. But at this meeting, considering how far and how fast we’ve moved, we judged it prudent to hold the target range steady. The committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”
This is by no means a dovish statement. It clearly leaves the door open to further rate hikes, and the current market advance is not something that would contribute to lower inflation. Yet, it is a historical fact that the Fed has never hiked rates directly after a pause. The only action following a pause has been another pause or easing.
The equity market has chosen to disregard the Fed’s statement, for now. The treasury market, however, does not seem convinced the Fed will lower rates anytime soon. In fact, the rally in near term treasuries has faltered, and rising yields could start to pose a problem if they maintain the same trend.
Takeaway
This remains a challenging market to navigate. On one hand, technicals are clearly bullish, and our next move will be to diversify away from our large SPY position in the Sigma Portfolio, into individual stocks. The counterpoint is that there are plenty of things that can “go wrong” in the next period. Namely the Fed is in a difficult position as rising equity prices boost consumer confidence (and that should translate into sticky inflation).
Gold has been an interesting addition derived from our automated portfolios. Treasuries have not rallied this year as we had been expecting, and Commodities have been on a roller-coaster ride DOWN since last spring. Economic weakness has not materialized up to this point, despite massive interest rates.
We’ll follow our tried and tested discipline meanwhile. That unequivocally calls for buying on weakness at the current juncture, and dumping cash as an asset class.