This is a complicated market, and there is really no better image to prove this point than comparing the transportation juggernaut, UPS, to the big tech juggernaut, META. While UPS has broken below its October 2022 lows and is currently in free fall, META’s uptrend is incomplete, and needs one more push higher to at least the $370 level before completing.
The majority of other sectors are confirming a continuation of the 2022 bear market, meanwhile, a handful of big tech names, with outsized weighting in the major indexes, suggest that they want to go higher. Though this pattern of narrow leadership where the market is held up by 7 stocks is unsustainable and a warning of an unhealthy market, it can continue, and likely will, at least into late 2023/early 2024.
With markets continuing a nearly 3-month correction, the consensus is now confirming what we have been saying since July.
“We do not believe a recession is priced into equities, and that it is inevitable. However, this doesn’t mean that we can’t see higher levels from here, before a recession hits.”
In other words, bearish sentiment is now accompanied with the mainstream news is calling for an imminent market crash. This is after flooding the market with non-stop narratives about a soft landing.non-stop narratives about a soft landing.
However, unlike the consensus, we believe this final swing higher in the markets has one more run in it before the secular bear market that started in 2022 commences again.
Five Stocks (Not Seven) Can Lead to New Highs
Nasdaq had the best first 6 months in the index’s history, and this rally was propped up by seven stocks known as the Magnificent 7: Apple, Amazon, Meta, Tesla, Nvidia, Microsoft and Alphabet. Meanwhile, the rest of the market is struggling. Many argue otherwise, but the picture below is worth a thousand words in terms of illustrating the narrow leadership of this market.
What is most concerning is that the equal weighted S&P 500 (RSP), which gives the same weighting to all 500 stocks in the index, is actually negative for the year. This matters because in a healthy economy, all sectors tend to participate, while mid-caps tend to outperform large caps. So, when the equal weighted S&P 500 is outperforming on a relative basis, it tends to be a good sign for the foundation of a new bull market.
The Equal Weighted S&P 500, like many others indexes, has put in a large top, and will likely not see a new all-time high for a long time. Note in the below chart that RSP could not sustain above its February highs, and has now broken through the major trendline in a 5-wave pattern.
If the market is going to continue the bear market that started in 2022 to new lows, it will have to take the form of a 5-wave pattern pointing down. These patterns are fractal, which means that a small one builds into a larger one until we reach our target. So, the fact that the current drop in RSP is taking the shape of a 5-wave pattern is quite concerning, and also confirms that we are likely still in a larger bear market.
However, markets do not drop in straight lines. The current 5-wave pattern is only the first wave (of 5) that should take us much lower. What follows this pattern is always a 3 wave retrace that makes a lower high. So, even though sentiment is prepping for a crash, we still have one more bounce before that happens.
Even with this weakness we are seeing throughout the market, the magnificent 7 stocks account for ~28% of the S&P 500’s total weighting, and nearly ~42% of the NASDAQ-100. It is feasible that even with the broad level of weakness we are seeing, a handful of these stocks can push the bigger markets higher, and even potentially make another high in the NASDAQ-100.
The Macro Backdrop
In late August, we stated that..
“According to the economic trends we are seeing, there is simply no evidence of a recession brewing in Q3 of this year, and this is important for investors to realize this when looking for some type of top.”there is simply no evidence of a recession brewing in Q3 of this year, and this is important for investors to realize this when looking for some type of top.”
This remains true today, as the resilience of the US economy is still chugging along.
Not only has retail sales accelerated for the 6th month in a row, but industrial production gave us the strongest 3-month annualized reading since May of 2022. Most importantly, employment is still quite strong. Once we see a sharp rise in the 4 week average for initial jobless claims, we can start to looking for an imminent recession. Until then, we simply see no sign that the economy is heading into a recession right now.
Furthermore, we warned our readers to be cautious of claiming victory over inflation in June of 2023.
“Peak inflation is behind us, but the real battle will be getting these numbers back to the 2% target. In fact, going back in history, there is no instance where core PCE inflation backs off from an inflation impulse without a recession.”Peak inflation is behind us, but the real battle will be getting these numbers back to the 2% target. In fact, going back in history, there is no instance where core PCE inflation backs off from an inflation impulse without a recession.”
