Bullish Bets Gather Momentum

Last week, we have discussed how the recent bounce-back in the equity market has most likely spelled the end of the latest correctionary period. We now have a confirmed break above the 50-DMA for all major stock indices, with additional confirmation from the MACD indicator, suggesting short term strength.

Historically speaking, the following 3 month period (June-August) of a presidential year 4 cycle tends to be positive. The corporate buyback window has reopened following Q1 earnings season. And then there’s softening economic data which is currently helping stabilize the bond market. We’ll explore all of these tailwinds in the article today.

Technically, SPY has closed the week above the key R1 level, a bullish condition we were looking for. There is still a possibility that a retest of the 50-DMA will fail and the correction will continue and transform into a 200-DMA retracement ($469, -9.94%). The probability of this outcome is getting slimmer by the day, however.

Instead, a much more likely scenario is that SPY will decline to $512 (-1.6%), where the 50-DMA currently resides. Bulls are looking for a confirmation that indeed this level provides support for a further rally into the summer months. Upside stands +5.41% higher at $549 (R2).

The MACD signal is now short term overbought, signaling that a slight correction is in order - the 50-DMA retracement and support confirmation would fit this bill nicely. On a medium term basis, SPY is also overbought, with a 87/100 score.

While the April drawdown episode is most likely over, there still remains a decent possibility of another correction before the Presidential election in November. This tends to follow statistical seasonality, as shown in the chart below:

Of course, these are all “average” numbers, so the actual outcome will be better or worse. For example, this year, the H1 correction occured in April, not May, as seasonality suggests. But such a chart does provide a pretty clear roadmap for assigning risk exposure in the months ahead. Right now, all the signs are in place that the bull market may have some room to run up until late August.

With Q1 earnings season mostly wrapped up and healthy technicals underpinning equities, another potential support factor are corporate share buybacks. The window for buybacks will remain open until June 14th:

“Companies have announced share repurchases of more than $383 billion in the last 13 weeks, up 30% from the year-earlier period and the largest sum since June 2018, per research from Deutsche Bank. The total includes Apple’s $110 billion plan, the largest buyback in history.” - Yahoo Finance

Goldman Sachs has recently published research suggesting that an estimated $934 billion of buybacks are scheduled in 2024. U.S. corporations will again be the number 1 purchasers of equities in the market this year. Under current assumptions, 17.3% of annual executions will take place between May and June 14th, or an estimated $162 billion running at $5.5 billion per trading day.

The only factor that could trip up this bull run are changing expectations regarding economic growth and the path of monetary policy. The Fed is currently walking a very tight rope: on one hand, an economy that runs too hot creates inflation pressures which cause bond yields to spike. Higher yields translate into weakness for most stocks for two reasons:

- Companies (especially small caps and regional banks) find it harder to turn a profit in tight financial conditions;

- Multiples compress due to the way Cost of Capital is impacted by yields in DCF valuation models; all things being equal, higher yields lead to a higher cost of capital, and a lower Price Target

On the other hand, slowing economic growth also translates into a lower EPS growth for corporations, again leading to a valuation problem. The ideal regime (also dubbed “Goldilocks”) is one where growth is positive and inflation is under control.

In any case, equity valuations (as well as buybacks) are heavily dependant on both actual EPS growth and inflation. For the moment, we are reasonably certain that buybacks and earnings will support higher asset prices over the next two months. But things become less certain once we enter the year’s second half. As the next earnings season approaches, (much) higher than average valuations will need to be justified by actual results:

For now, analysts are optimistic. Their projections are naturally bullish for the broad market. But there is a caveat, when we break down earnings data within S&P 500 companies: all earnings growth is not equal.

The S&P 500 index’s earnings growth centers on just six (6) companies. If you strip out the earnings of those six companies, earnings growth is actually negative.

This leads to the observation recorded in our Market Fundamentals instrument for S&P 500 Revenue Growth: there’s no notable rebound just yet! In other words, economic growth is likely weaker than headlines suggest (at least when equally weighting index constituents, like our calculation does).

Here’s the conundrum: Personal consumption accounts for two-thirds of economic activity. Therefore, the means by which consumers can spend is essential for forecasting economic growth. The San Francisco Fed just released an article warning that a significant source of spending since the pandemic is no longer available:

“The latest estimates of overall pandemic excess savings remaining in the U.S. economy have turned negative, suggesting that American households fully spent their pandemic-era savings as of March 2024.“

“Consumers could use debt—such as credit cards and personal loans—to further support their current spending habits, although the current elevated interest rate environment means that the cost of using credit is higher than in the decade preceding the pandemic recession.“

Unfortunately, a reversal in economic strength might be around the corner. While recent “slowdown” readings have been welcomed by both the treasury and the equity market, such may not be the case for long:

• Initial Jobless Claims spiked to 231K (versus expectations of 210K)

• Michigan Consumer Sentiment for May came in at 67.4 (versus 76 expected)

Both of these measures are suggesting that consumers will become constrained in their spending soon enough. Morgan Stanley expects the three-month annualized rate of core PCE inflation to fall to 1.81% for Dec. 2024. This would be very bullish for bonds. For stocks, “it depends”.

Our Trading Strategy

For now, we will be using weakness to add to our equity and treasury risk allocation. The short term outlook is positive, and potential headwinds will take time to fully manifest.

With earnings season now behind us, attention will turn to inflation data and how this will affect the Fed’s monetary policy. YoY Inflation and Core inflation will be reported on Wednesday. Economists are expecting the former to come in at 3.4% and the latter at 3.6%.

PPI will be reported on Tuesday, and economists are projecting a 0.3% increase from the previous month.

A host of Fed speakers will guide market expectations on Thursday and Friday. We are continuing to monitor risks and respond to the market as the macro and micro environments evolve.

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