Equity Troops Lead Generals Higher

Healthy Bull markets witness broad participation by the small cap and value troops, while frothy markets occur when the big cap Generals are leading the charge without their soldiers. Many should have heeded the warning signs during the 2nd half of 2021 when the troops were all in their bunkers while the mega cap Generals were all alone on the front lines. Investors didn’t care that the 6 horsemen of the apocalypse had swelled to over 25% of the entire S&P large cap index of 500 stocks. In 2021, as more of the FAANG+M entered the Trillion Dollar club (Facebook, Apple, Amazon, Netflix, Google & Microsoft), the small cap stocks were floundering. One instrument that revealed this disparity was the cumulative advancing issues minus declining issues (A-D) of the broad NY Stock Exchange (NYSE). By July of 2021, every new high in the major equity averages was unconfirmed by the much broader universe of stocks, such as the NYSE or various Russell indices. After months of wildly waving Yellow flags for the general stock market to stop its advance, most analysts gave up forecasting when the cradle would fall. Throughout the January to October 2022 Bear market that ensued, the A-D line was in sync with the negative trend in the stock market. At its October nadir, the S&P 500 lost 27%, while the tech heavy Nasdaq fell 37%. With the US and global markets today holding at higher levels for the past 4 months without a new low, we are currently experiencing some positive signs from the A-D line and many longer-term indicators. While it’s not a Bull market divergence Buy signal by the A-D line, the broad net gain in advancing issues of the NYSE is clearly outpacing the benchmark S&P 500 Index. This is the first month since the momentum top in June 2021 that the broader market is outpacing the major indices to the upside.

The A-D line is a nice tool, but investors lacking access to this data can almost mirror the indicator by simply comparing broader small cap price indices to the major averages as seen in the next chart. While many of the Russell or S&P small and mid-cap indices can be used, we compared the actual NYSE index of 2134 stocks here with the benchmark S&P 500 index to show a similar pattern of small cap outperformance recently. While the Dow, Nasdaq and S&P 500 struggle to rise above their highs of just 2 months ago, the NYSE and most smaller cap stocks are testing 9-month highs. 

Supporting this rally from a fundamental perspective is the long-term view of Durable Goods (planes, trains, cars…). New Orders typically turn lower or at least plateau before an economic recession triggers. However, today we see an unrelenting uptrend accelerating in December as a new swath of plane orders arrive for Boeing. Boeing hired 14,000 workers in 2022 and plans on another 10,000 in 2023, which will push its workforce beyond its pre-pandemic levels. Airbus is adding at a similar pace. With Aircraft orders surging, travel spending still on the rise, full employment and pent-up consumption from China’s long-awaited reopening, it’s hard to envision a major decline anytime soon in production. Personal consumption has dipped recently, but thus far it’s just cooling slightly from a vastly overheated level of spend. 

With economic cycle lows due in about one year and inflation falling sharply despite full employment, the concerns of a severe earnings correction beyond current expectations appear limited for now. In fact, forward earnings estimates are trending higher and earnings shortfalls this quarter are being received calmly thus far. Higher lows and higher highs in most stock indices in the US and around the world offer a favorable medium to long term assessment for the health of the stock market and future economy. The somewhat ebullient commentary above needs to be balanced with the growing overbought nature of the short to medium term technical picture. Excessive Call option buying, persistently low volatility (Vix) readings, the peaking of Dumb Money and Fear gages, all warn of a need for corrective price action this week and after a final top within a few weeks. Our forecast has been that a February peak should set up an important correction into March/April. New Bear market lows would be devastating for the technical health of the market, but currently we favor a higher low where we expect to sharply increase equity allocations.



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