Updated August 29, 2023
Raymond Micaletti, Ph.D.
Both the broad market and the Nasdaq 100 ended their losing streaks last week with bounces of 0.7% and 1.6%, respectively. It wasn’t a straightforward affair, however, as both needed strong Friday afternoon rallies to do so.
Meanwhile, the dollar kept its 6-week winning streak alive, interest rates surpassed their October highs (and then backed off), and gold gained 1.3% (ending a 4-week slide).
The main events last week were Nvidia (NVDA) earnings on Wednesday and the Fed’s Jackson Hole symposium on Friday.
With respect to the former, NVDA reported spectacular sales and earnings, well above previous guidance. (One wag on Twitter chimed in: “For AI geniuses you guys sure could improve your revenue forecasting skills.”) The stock jumped 9% after-hours Wednesday (from 470 to 515), but by Friday’s bell was 2.5% lower than its Wednesday close. (Is the AI narrative’s effect on the market waning?)
As for Jerome Powell’s Jackson Hole speech, some commentators thought it was “hawkish.” But in our view, Powell didn’t say anything different from what he has been saying the past 18 months. The market was a bit helter-skelter during the speech, but quickly shrugged it off and finished more than a percent above its morning low.
Last week’s bounce raises the question as to whether the recent correction is over. From its July 27 high to its August 18 low, the S&P 500 futures lost 6%, while the Nasdaq futures had a max drawdown of 9% from its July 19 high.
Recall the study from mid-June that looked at instances in which the Nasdaq 100 was more than 20% above its 200-day moving average and found that such instances (with only one exception out of more than a dozen) led to further strong gains over the next 12 months (with a median gain of 25%).
If we are still in an environment characterized by that type of market strength, a 9% pullback in the Nasdaq (and 6% in the S&P) might be all the correction we’re going to get. If so, we would look for a strong bounce this week.
Conversely, if the market continues to sell off, that would be a red flag that the market regime may have shifted from bullish to bearish. If that were to occur, we would expect such action to be accompanied by unfavorable macroeconomic data (e.g., weak jobs, hot inflation) over the next month.
What does investor positioning have to say on the matter?
Dollar relative sentiment was essentially unchanged last week and remains bearish for the dollar (and bullish for risk assets).
Aggregate equity positioning amongst different investor classes also was largely unchanged and remains bearish. Positioning in other asset classes (commodities, currencies, fixed income), however, remains solidly bullish for equities.
Our composite measure of equity relative sentiment (which includes both positioning and survey data) held steady at 87% last week, a markedly bullish reading.
One thing to note is that positive equity-bond correlations have reasserted themselves. In such an environment, it’s bullish for equities when institutions prefer 30-year bonds to 10-year bonds, and that’s exactly the positioning we’re seeing in bonds at the moment. (The 30-year bond yield hit 4.47% last week before retrenching and closing at 4.29%. It did, however, leave a gap between 4.37% and 4.40%, which we would expect the market to fill at some point.)
The Smart Money remains bearish gold and silver, but have been aggressively covering short positions the last several weeks. Short-covering in gold is in the 97th percentile over the past four weeks while short-covering in silver is in the 93rd percentile over the past five weeks. If those trends continue, we would expect relative sentiment in gold and silver to turn bullish in the near future.
The Smart Money continues to be bullish on crude oil–a growth-related asset–which tends to have bullish repercussions for equities.
Thus, in general, investors are positioned for growth to continue and financial conditions to ease–both of which suggest the market’s bullish regime may persist.
The Bull Case
The bull case is largely unchanged from last week:
Momentum: We are still downwind from several momentum triggers and breadth thrusts from earlier in the year–the windows over which they tend to act would take us into Q1/Q2 2024
Relative sentiment: Composite relative sentiment held steady at a strongly bullish 87% last week. While it appears as though it will attenuate in the coming weeks, we expect it to remain above 50% for the foreseeable future.
Normal pullback: The current selloff may be viewed as a normal pullback after a huge rally into a seasonally weak period of the year (and thus there is no cause for panic just yet).
September during bullish years? Much has been made of September being the worst month of the year for equities on average. But when the first seven months of the year gain more than 15% (as is the case this year), September tends to be higher 67% of the time, with an average gain of 1.7% (courtesy of ISG via The Market Ear).
The Bear Case
The bear case remains largely unchanged as well:
Valuations: Long-term bond yields are more attractive than expected U.S. equity returns. Expected 10-year annualized (nominal) U.S. equity returns are in the ballpark of 2.5%, whereas the 10-year U.S. Treasury yield closed at 4.24% on Friday. Thus, investors are likely to realize 1.75% more per annum over the next decade on a compounded basis by owning the 10-year bond as opposed to U.S. equities.
Real rates: Real 10-year interest rates continue to hover near 2% (last: 1.92%), a level not conducive to multiple expansion in an environment where earnings seem to be growing slowly, if at all.
Short gamma: Both options dealers and CTAs will have to sell equities if equities continue to fall (reinforcing any move lower). If equities rise, options dealers will have to buy (i.e., the effect for dealers goes both ways).
AI narrative waning? Given NVDA’s action this week, selling off on blowout revenue and earnings, it raises the possibility that the AI narrative got ahead of itself and may no longer have the driving effect it had earlier this year. If so, any continued move higher in real rates may hamper tech stocks.
Given this year’s robust momentum and bullish tilt to relative sentiment, we have been of the belief that the recent dip would be bought and we would make a renewed attempt at new all-time highs.
Last week, we thought the probability of new all-time highs was diminished slightly–because of aggressive institutional selling–but not eliminated and that the likelihood of higher prices still held a modest edge.
We maintain that stance this week. The confluence of bearish dollar relative sentiment, strongly bullish equity relative sentiment, smart money buying things that do well with falling real rates (crude, gold, silver), and institutions preferring 30-year bonds to 10-year bonds in an environment with positive equity-bond correlations, all point to a favorable backdrop for equities.
If the selloff has not yet run its course, the nearest-most levels we would watch would be 14400 on the Nasdaq 100 futures and 4300-ish on the S&P 500 futures–both are the 61.8% retracement levels from the 2022 lows to the 2021 highs (and both are about 4% lower, respectively).
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