/ March 17 / Weekly Preview
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Monday:
Retail Sales MoM (0.7% exp.)
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Tuesday:Building Permits (1.450M exp.)
Housing Starts (1.375M)
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Wednesday:
Fed Interest Rate Decision (no change expected)
FOMC Economic Projections
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Thursday:
Initial Jobless Claims (224K exp.)
Existing Home Sales (3.92M exp.)
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Friday:
N/A -
Monday:
N/A
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Tuesday:N/A
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Wednesday:
Super Micro Computer
General Mills
Signet Jewelers
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Thursday:
Darden Restaurants
FactSet
FedEx
Lennar
Micron
NIKE
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Friday:
NIO
Carnival
Sell-off Continues as Recession Fears Escalate
Last week, the equity market sank to new lows within the current corrective phase, as pervasive negativity weighed heavily on investors' risk appetite. The price action remains similar to Trump’s first mandate, with Wall Street trying to anticipate the impact of tariffs on earnings. By our estimation, the market is close to digesting and appropriately pricing in all of the news. In theory, we should see a rebound once the outlook becomes predictable again.
Not all investors ran for the hills, as it turns out. There has been significant “buy the dip” interest expressed by high-net-worth individuals, according to BofA. Affluent and high-net-worth investors’ inflows to US equities hit 2% as a share of BofA’s assets under management (AUM) last week, the third-highest on record. The last time comparable buying was recorded was September 2022, near the bottom of the bear market.
With the market down ~9% from the peak in such a short period of time, the MACD, relative strength, internal breadth and most other technical indicators are currently at levels not seen since the October 2022 lows.
Although Trump’s tariffs and pessimistic headlines dominate, it’s worth noting that corrections are normal within any given investing period. While this doesn’t rule out the possibility of a broader and deeper sell-off in the making, it suggests that the market may be primed for a technical rebound simply as a function of severe oversold conditions. With Friday’s bounce, the market has retraced 23.6% of the rally from the lows, establishing a foundation of support for an upward move.
Again, this is not to say that “the market has bottomed” and all-time-highs will print next quarter. There are other technical warnings suggesting that we may be in for a longer corrective/consolidation process. For one, the options market was extremely pessimistic last week, with SPY recording a very low level of bullish activity in the short and (more concerning) in the medium term as well.
Enterprise, our main asset allocation model, remains in “defense” mode, with an allocation designed to reduce volatility in portfolios. As such, for the moment, we will use rallies to rebalance away from risks until a clear bullish trend is re-established and our models transition to a more aggressive allocation.
As is always the case during painful corrections, the media needs to explain away why selling is occuring. Nevermind the phenomenal run over the past two years. Talking heads need to rationalize investor actions. At the moment, the prevailing narrative centers around the return of a recession due to tariffs and inflation.
Betting website polymarket.com shows a 40% chance that such an event will occur - perfectly encapsulating investor sentiment. Of course, recessionary fears always have a way of periodically emerging. The 2022 “most anticipated recession ever” not only failed to occur, but also preceded one of the best bull runs in recent history.
To make a more grounded assertion of recession odds, we tend to look not at betting markets but at economic activity indicators, most notably the LEI (Leading Economic Index). At the moment, there is little to suggest that a recession is on the horizon.
An impending recession happens when: 1) the six-month diffusion index lies below 50, shown by the black warning signal lines in the chart; and 2) the LEI’s six-month rate of decline falls below the threshold of −4.3%. The red recession signal lines indicate months when both criteria are met simultaneously—and thus a recession is likely imminent or underway.
In the chart below, there is absolutely nothing to suggest that the current environment resembles the early 2000’s, 2007-08 or 2020. The Conference Board will update this index during the week.
As we have discussed several times, there are many reasons one can expect the economy to slow. But slowing does not mean “contracting” (aka recession). Primarily, a slowing economy will hit stock valuations, not EPS.
To that end, the trailing PE ratio for S&P 500 companies has already taken a significant hit. While still in the above-average zone for the current cycle, valuations have now reverted to more “normal” readings. As such, it is now safer to invest, at least with a longer time horizon.
As noted in both our quarterly fundamental assessment and the below graphic from SoFi, expected earnings have remained consistent, despite the sell-off.
Our Trading Strategy
Given all of the above data, the current correction seems more like a technical event based on “fears” rather than a facts-driven selling process. There is still more work to be done for the market to reach “fair” valuations in the current environment, but that does not mean the markets must decline sharply from here on out. An extended period of consolidation in the markets with little to no return would achieve the same revaluation process.
Sometimes, “fears” do translate into hard facts. More often than not, the price action is overblown and fear eventually makes room for greed again. At the moment, the tarifs issue can be solved by the stroke of a pen. This was not the case for the Covid pandemic or the subprime crisis.
As such, we need to determine at which point valuations have re-aligned with economic realities. This will take some back and forth adjusting, with volatility remaining predominant. That is why our focus remains on risk management, not on trying to predict the future. Once the revaluation process is completed, the markets will rise again — that is a certainty.
The M2 money supply has been steadily expanding. Eventually, this pool of liquidity will find its way into risk assets.
From a contrarian perspective, unwarranted negativity has often provided the best money-making opportunities for those willing to turn against the herd and invest at times when it “feels bad” to do so.
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!