/ March 03 / Weekly Preview
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Monday:
ISM Manufacturing PMI (50.8 exp.)
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Tuesday:N/A
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Wednesday:
ISM Services PMI (53 exp.)
ADP Employment Change (140K exp.)
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Thursday:
Initial Jobless Claims (340K exp.)
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Friday:
Non Farm Payrolls (133K exp.)Unemployment Rate (4% exp.)
Fed Chair Powell Speech
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Monday:
GitLab
Okta
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Tuesday:Target
AutoZone
Best Buy
ON Semiconductor
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Wednesday:
Foot Locker
Marvell Technology
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Thursday:
Broadcom
Costco Wholesale
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Friday:
N/A
February Weakness And The Outlook For March
Last week we saw how continued bullish exuberance and high levels of complacency can quickly turn into volatility. This has been a common theme for the whole month of February, which started on reasonably firm footing, following an upbeat January. By February 19, investors had pushed the S&P 500 to all-time highs, with many technical indicators pointing to overbought conditions.
With little fundamental upside left and seasonal tendencies favoring bears, it was no surprise to go through the recent period of drawdown. As is always the case, whenever investors are crowded on “one side of the boat,” it is often a decent contrarian signal to be a bit more cautious.
Regardless, the media jumped on the chance to explain away the volatility using various narratives — growth concerns, tariffs, geopolitics, inflation, and even a new Covid strain. Consequently, investors have become unusually downbeat, with the AAII sentiment survey (bearish percent) at over 60% — a measure which has usually aligned either with major bear markets or market bottoms.
From a contrarian view, this extreme negative sentiment, combined with decently oversold conditions, provides a good base for a rally in March. As it happens, March has a seasonal bias to the upside. As we approach the end of the quarter and the final phase of the seasonally strong period of the year, January, March, and April typically deliver the highest early-year returns, with March and April boasting the greatest success rates.
A relatively expensive market (historically speaking) limits potential long-term upside, however. Current P/E levels for S&P 500 companies exceed previous pre-Covid valuation “tops”. As a consequence, capital gains as a function of valuation expansion will probably become harder to achieve in 2025. Instead, for price appreciation to occur, companies will need to actually produce EPS growth.
Since EPS growth has been eminently elusive in the broad market since 2022 (the chart below assumes an equal weight for each S&P 500 company), we expect increased volatility this year as expectations align with reality. We will study this predicament more in our upcoming quarterly review.
For now, given the downbeat sentiment and decently oversold conditions among many index constituents, there is the possibility of a decent tradeable rally over the next month or so. Loss aversion is one of the psychological factors that leads investors to long-term underperformance, and many “paper hands” have folded by now.
Weather an investor should use this rally to sell into or add to his equity positioning is an entirely different issue, depending on one’s previous allocation. There are a couple of reasons to not be overly optimistic on economic outcomes, and today we’d like to highlight consumer sentiment, which was sharply revised lower recently.
Weaker employment numbers and rising layoffs are becoming an entrenched trend. Interest rates are still very high for the average person. There is a clear disconnect from how consumers are feeling and an otherwise exuberant stock market. In order for economic activity to pick up, we would need to see more robust employment and higher wages to drive optimism and spending. With the U.S. being 70% a services based economy, consumer spending becomes the dominant driver of economic expansion.
At the moment, we are not seeing any indications of an “economic resurgence” to support elevated earnings expectations in the stock market.
Our Trading Strategy
Wall Street analysts often try to sell an overly optimistic outlook that tends to overshoot actual outcomes. As noted, earnings growth typically aligns closely with economic activity, with deviations occurring due to macroeconomic influences such as monetary and fiscal policy changes or recessionary conditions. This predicament is unlikely to “be different this time”.
As such, we will maintain a healthy allocation to stocks in our portfolios, with decent hedges in place. Bonds should work fine in compensating equity risk this year. Furthermore, we have made several smaller adjustments to our stock portfolio composition in order to maximize risk-reward and align exposure with outperforming sectors and factors.
For the moment, no major shifts are required, as there is still some decent upside available for SPY, even using more conservative targets. We continue to monitor risks and macroeconomic indicators in order to get ahead of potential meaningful downturns. Soon, we will publish our updated quarterly report, which will shed more light on the direction of the stock market, from a fundamental perspective.
In light of the current market enthusiasm, concerns regarding historical overvaluation, and the dependency on buybacks to maintain price levels, investors might find it worthwhile to explore hedging strategies and safeguard their portfolios.
Signal Sigma PRO members will be notified by Trade Alert of any live portfolio changes (if subscribed). If you’re not on this plan yet, you can get a free trial when you join our Society Forum. If you need any help with your trading strategy (or would like to implement one on your account), feel free to reach out!