Bent, Not Broken: The Market’s Uptrend

Marc (00:00):

Hello everyone, and welcome to the latest edition of the LPL Research Market Signals Podcast. My name is Marc Zabicki, Chief Investment Officer at LPL Financial. Joining me today is Adam Turnquist, our Chief Technical Strategist at LPL. Adam, how are you today?

Adam

Doing good, Marc. How are you?

Marc

Not doing too bad. You know, off the long weekend markets close yesterday, and we are talking to you Tuesday, February 21st for this Market Signals podcast, you know edition. It is going to be important for us to kind of talk about the goings on in capital markets. Frankly, Adam, in terms of the market's been a little bit softer over the last couple weeks or so, and we're, we're going to touch on some of that.

Marc (00:59):

You know, you're not seeing a whole lot of softness in these numbers as we present them. The global equity market returns, look, we'll call it flat-ish, over the last week. They've been a little bit higher in the small cap space. And you know, a little bit below the zero line in European equity markets. The equity sector activity has been a little bit hit and miss. Energy has been under some considerable pressure. And really the, the one of the key winners for U.S. markets from a sector perspective is really utilities and staples, which is a little bit more of a defensive areas of the market that are doing well, kind of part and parcel of what we're seeing over the last week or so, in a couple weeks actually, in equity market activity on markets been under a little bit of additional pressure.

Marc (02:00):

Obviously we had this long run months, months long run, at least through January, of gains in the bond market. And some of that activity has been paired back as bond markets over the past week have been under some slight pressure, yields on the rise a little bit more. And we're going to discuss that just a little bit. Today we had, or we are going to have, this week’s PMI numbers from the U.S. economy, all important FOMC minutes come out on Wednesday, and we're expecting to see some semblance of a little bit of a dovish tone from those minutes. We'll see if that that changes over the next several months due to what's going on in the inflation world today. A little bit more of a stickier inflation period that we're kind of going through right now.

Marc (02:59):

Now, U.S. GDP numbers will also get on Thursday, and part of that inflation story is actually going to be written in Friday's Personal con consumption expenditure number. Again, this is the Fed's key inflation data point that it pays attention to. That'll be on Friday. In non-U.S. economic conditions, a lot of PMI activity across the Eurozone, the U.K., including Germany, and most of it was better than expected. Germany was a little bit weaker than expected in general terms, but broadly Eurozone and U.K. services and manufacturing activity was a little bit better than expected, probably because, you know, since about October you've seen a rollover in inflation. Inflation peaked in September/October of last year in the U.K. in the Euro zone, and now it's beginning to kind of roll over.

Marc (04:02):

So sentiment in those markets have been a little bit better. And perhaps that's been read through in a lot of the PMI surveys that we've witnessed over the last couple weeks or so from, or actually the last couple months or so in the Euro zone in the U.K. In the U.S., key issues upcoming this week. It's really basically about the FOMC minutes and the PCE number on Friday. You know Adam, just bringing you in on just some general comments. I know we're going to get some charts, but some general comments on the weakening market condition over the last couple weeks or so and how investors should think about that.

Adam (04:54):

Yeah, so as you alluded to earlier, it's definitely softened a bit, and a big part of that is just what we've had to absorb over the last week or two. Last week we had hotter-than-expected CP I on the consumer side, also on the wholesale side or producer side. PPI came in above estimates, retail sales came in above estimates, so all that translated into higher rates and ultimately a higher fed funds futures market. So that readjustment really poured some cold water on this rally that we've seen off the December lows. On the technical side though, we're really not seeing major technical damage. You know, right now it kind of looks like a pullback from overbought levels. We'll watch to see how far this drawdown goes and some key support levels on the upcoming charts.

Marc (05:46):

Yep. And you know, interestingly enough this morning, Walmart, Home Depot reported numbers, and all indications were that they're expecting a softening consumer activity throughout the balance of 2023. So we balance that with a labor market that is still tight. We balance that with consumers, although they're expecting to kind of soften their pace of money spending in 2023, they still have this excess savings that they're working through. And that may have been putting a little bit more of a stubborn pressure into inflation readings as of late. So it's a little bit of a give and take, and I know the market has had trouble with that over the last couple weeks because as you mentioned, there's more expectations that the Fed may in fact have more work to do in terms of rate increases, and we're getting fits and starts of softening indications in the economy. So it's really no surprise that the market's having a little bit of trouble with that over the last couple weeks or so. Is that fair?

Adam (07:03):

Yeah, I think that's fair. I, I mean it's really looking at the catalysts that are in place, earnings as well, I think it is a relatively low bar in terms of the earnings set up for this quarter, but I don't think the market's looking for catalyst to new highs. It's really catalyst for more of a market bottom and I think technically we're seeing those play out.

Marc (07:26):

Yeah, and we've seen that play out through the balance of February largely. We've kind of moved sideways through the month of February and the Federal Reserve and the questions around policy, certainly you know, the main issue there. Turning to you, Adam, on your technical setup for U.S. equity markets. As you mentioned, there's been some technical damage, but we still are holding strong in terms of the trend. What's your take?

Adam (07:58):

Yeah, so as I mentioned, we've had this pullback from overbought levels. If you think about it, we were up 10% in 25 days going back to those December lows. So we had a significant rally that actually took out a key area of resistance at 4,100 that was a key level for the S&P 500, and now we're starting to see a pullback from overbought levels. You know, that's taking out support at 4,100. Of course, it's not a linear path higher. That was a pretty significant trajectory of the market clearly that was not sustainable. So now we're starting to see a healthy pullback, we'll call it, from those overbought conditions. On the chart that I brought today, you can see in the bottom panel that looks at the percentage of stocks within the S&P 500 that are overbought based on their relative strength index, you were close to 30% when we put in a top back earlier this month.

Adam (08:57):

Now you've reset to single digits. So again, I think it's corrective, but we're really not seeing a break below this developing uptrend. That's really the key thing that we're watching on the technical side is are we going to retest this uptrend. It does coincide right around the 200 day moving average. So that support level that we're watching is, call it right around 39.50. You know, if we start to get below that level that would be a much bigger concern as we're now violating an uptrend. I think ultimately though, I guess to consider this a bear market rally versus sustainable bottom, you really need to take out the December lows. That's at 37.83, so we're still above that level collectively, when you look at the damage internally in terms of market breath, you can see in the middle panel, that's the percentage of stocks that are above their 200 day moving average.

Adam (09:58):

You know, you're at 69% as of this morning. So we're not seeing a lot of stocks break below their key moving averages. I would also note just the composition of market breadth is very bullish when you're looking at financials close to 85% of the financial sector is above their 200 day the industrials are doing well, and some of the other consumer discretionary and tech are all exerting the best market breadth right now. And you compare that to more of the defensive sectors, for example, consumer staples and utilities, they actually have the weakest breadth right now. So this is exactly what you want to see when you're coming out of a market bottom. Of course, like I said, it's not going to be a linear path, so expect these pullbacks, especially when things get over by.

Marc (10:45):

Yeah. Good point about the linear path. Adam, I think in no way did we expect the strength that we saw on the month of January to continue through in that linear path. It is going to be a difficult market in 2023, even though we are what we call cautiously constructive on equity exposure. So we're looking at this really as a constructive pullback as opposed to a more definitive rollover in our position. We are still cautiously constructive relatively, you know, bullish, on U.S. equities and global equities in general. Even though we've seen markets kind of soften here that position is unchanged. One of the reasons of the softening, as we've talked about already this this morning and for this edition of Market Signals, is that the Fed has kind of maybe changed the game in terms of what it may think about policy. At least that's what the market is telling us. What does this chart show?

Adam (11:54):

Yeah, this is one I've been updating for a while, and I would say this is the biggest jump that I've seen in, I'm calling it rising Fed expectations. The blue line is where the Fed fund's futures market was about a month ago. The orange line is the current fed fund's futures market. So we're really seeing this game of chicken play out with the Fed versus the fed fund's futures market. And after last week's inflation data and some of the retail sales, data looks like the futures market finally swerved and kind of realign closer to the Fed's messaging, which is higher for longer. And that's really what this chart is showing. You can see how the terminal rate for fed fund's futures has been pushed significantly higher just over the last month. And it's also been pushed outward.

Adam (12:42):

So meaning we might not see a peak in the Fed funds rate until potentially August. That's what this chart is really showing. Previously it was maybe spring, we were looking at maybe May, then it went to June, and now it's been pushed out to August, and it's also significantly higher. You know, we went from four 90 for a terminal rate, now we're at five 30. But if you look at how the markets reacted, which I think is really notable, I'd still consider it a relative win just considering the S&P is still up over 1% during this timeframe, which I don't know Marc, if I told you that we repriced fed fund futures this much higher and, you know, the S&P would be higher or the NASDAQ 100 is up, I was looking earlier, almost 5% during this timeframe. So, yeah, there's definitely some complacency, I think with just the end is near with the Fed fund's rate hike cycle.

Marc (13:38):

Yeah, it looks like the market's telling you it may be willing to look beyond any near term machinations in give or take of where the exact terminal rate would be. I think it seems that market participants are comfortable in saying that whether it's May, June, July, August, it's going to happen relatively soon. And that the deceleration and inflation does tell us that what is the 10 Year Treasury Yield tell us.

Adam (14:10):

Yeah. I know the market has absorbed a lot of that rate hike expectations. It does not mean there's not there's no risk for higher rates. And that's what we're seeing with the 10-year treasury yield right now. Obviously that's higher rate expectations have played right into higher 10-year treasury yields. You can see here, technically we've had this pretty big bounce off the rising 200 day moving average just over the last call it several, well, two to three weeks we'll call it. And now you're bumping into key resistance right around 390. Why is that 390 important? That 390 level important, that goes back to your prior highs back in the December timeframe. And it also lines up with an uptrend that's been in place going back, you know, to last year. So if we do see a breakout above three 90, that would put some risk on rates moving higher.

Adam (15:05):

You know, the next major levels are going to be 4%. And if you get above 4% that, you know, the really next major resistance level is going to be that 4 24 25 range that we did see play out in right around those October lows. One positive sign though is just that you're seeing the negative correlation between yields and stocks ease a little bit, so there's less sensitivity to higher rates, and that's what the bottom panel here shows can see that it's a rolling three month correlation between the S&P and tenure yields, and it's starting to move a little bit higher, still negative, but again, just less sensitivity around rising rates.

Marc (15:47):

Yeah, and to put kind of this chart and what's happened with lately with the 10 Year Treasury Yield into some context our asset allocation committee still expects the 10 Year Treasury Yield to end the year between three and a quarter and 3 75. A again while we saw rates fall rather dramatically over the last, call it 30 days or so that wasn't going to happen in a straight line. And our yield expectations kind of indicate that. So again, we're expecting the 10 year treasury yield to end the year somewhere between three and a quarter and 3 75. Taking a look at this chart and maybe furthering your commentary, Adam on that the market seems to be reacting a little bit better, even though interest rates have been back on the rise just a bit.

Adam (16:46):

Yeah. So just along the lines of that, that negative correlation easing a little bit, we went and back tested every time the 10 year yield jumped 40 basis points or more over a 10 day period, which is a significant rise in treasury yields. From a historical perspective, we went and back in and back tested it since March of last year, and we found eight different unique periods, and this looks at the S&P 500 returns during those 10 day periods. So you can see, you know, obviously it's a very negative response when rates move higher, especially at a 40 basis points in 10 days negative returns for the S&P ranged right around three and a half to, you know, negative 6%. What's notable, this is the first time the S&P actually traded higher during that 10 day period. It was up 0.5% based on the model that we ran. So pretty notable change in reaction to a surge in in longer duration yields.

Marc (17:49):

Yeah, and good, good point there. You know, again, that the market seems to be willing to look past higher rates just a little bit. So a couple key takeaways I know you have Adam, one is the home builders, and then we're going to take a look at develop markets. What what do you have on the home builders side?

Adam (18:09):

Yeah, home builders have also been able to kind of look past higher rates, and really weak economic housing data. We did see existing home sales come out today, they were down for a 12th straight month. And if you look at even last week yet, housing starts and building permits, both disappoint but home builders have really bucked the rising rate trend. And so why am I talking about home builders today? I  think as a technician, we think price leads fundamentals, and that's really what we're seeing with the home builders stock. So there's a clear sign of a bottom in the Home Builders index that I brought with today. This is the Dow Jones U.S. Select Home Builders, and it's really been climbing out of a bottom. If you go back since the October lows outperforming the S&P 500, here, you're seeing a little bit of a pullback from overbought levels that lines up really well with this rising price channel that's been in place.

Adam (19:03):

I think it looks like a pullback opportunity. And one thing I'd also note in terms of the economic data, we did see the National Association of Home Builders Housing Market Index post back-to-back monthly increases. That's notable, just given that it was, that's, that follows 12 straight months of declines in 2022. So we're seeing home builders sentiment finally start to improve. And when you do see home building home builder economic data bottom, that usually coincides with the market bottom. So the next key data point that we're looking for is for building permits to inflect higher. Haven't seen that yet. So something to watch as we go forward here

Marc (19:48):

And on developed international markets. This is something that's caught our attention clearly in our Strategic and Tactical Asset Allocation Committee discussions throughout the most of, or the entirety of 2022, we were domestically biased in terms of our asset allocation preference for U.S. markets relative to the rest of the world. That is begun to change just a little bit, and we're raising our eyebrow at developed non-U.S. markets. And this chart certainly points out though as to why that is. Adam, what do you think?

Adam (20:23):

Yeah, you've had a notable change in the MSCI EAFE Index. Just over the last few months here, you've reversed this declining price channel that's been in place going back to last year, and now you're climbing above a lot of key areas of overhead resistance. You're formed a new uptrend that's been in place since September. You're back above your key moving averages, and then the relative trend on the bottom panel. That's, you know, we didn't go back. This is just  a two-year, three-year chart. This is really a reversal of a secular downtrend, meaning we're starting to see developed international outperform the S&P 500. It is early innings of this reversal pattern. But it is notable, given the duration of the downtrend that was in place before, it was several years that we've had developed international underperformed the S&P 500.

Adam (21:16):

So now we're starting to see evidence of a potential new uptrend develop here. And if you look at just  the fundamental side, I was looking just where this trades relative to history and then relative to the S&P 500, just given this sizable rally that we've seen. And it actually looks cheap on a forward PE basis. So I think it's trading about one turn below its 10 year average, and then also about two turns below it's relative forward PE average to the S&P. So fundamentally, or valuations look cheap, technicals look good here. So we're seeing this brief pullback on the MSCI EAFE Index, but overall, the technical setup here continues to improve.

Marc (22:01):

Yeah, and the bottom there coincides with those early readings that that U.K. and Eurozone inflation  was peaking and beginning to kind of roll over when we saw that in the fall months of last year. Again, as an asset allocation committee, we've raised our allocation to developed non-U.S. markets. And we expect this trend to kind of continue, and we'll probably end up getting a little bit more constructive here as we go if this trend does in fact continue, and inflation continues to subside in in those markets. So, Adam, just one last comment from you just on the overall setup. I know again, we said it a couple times already, is that we're still cautiously constructive. I mean, the market's been a little bit messy here over the last, several weeks, but not outside of expectations. And we've got some things to figure out in terms of when the Fed is actually going to stop, et cetera. But it's in no way a sign that we're expecting any material change to our previously constructive view.

Adam (23:19):

Yeah, exactly. I don't think there's any reason to panic here. This looks like your typical pullback off overbought levels. Of course there's catalysts that always play into that, but technical damage, like I said, has been relatively minimal underneath the surface, things are holding up well. We're still seeing signs of cyclical leadership outperform. So like what we're seeing, not saying the market's making new highs, but I do think there's technical evidence that really does suggest the bear market lows were set last October.

Marc (23:51):

I appreciate that Adam. Well said. And folks, thank you for joining us for this edition of Market Signals podcast for Adam Turnquist. I am Marc Zabicki, and we will see you next week.