Updated January 17, 2023
Raymond Micaletti, Ph.D.
Some weeks it’s difficult to find something new to write about—the market goes sideways, the economic reports are benign, and the fundamentals, technicals, and sentiment are unchanged.
Last week was not one of those weeks. In fact, what happened last week may have lasting repercussions for all of 2023.
So…what happened last week? Jerome Powell didn’t talk equities down? Inflation came in as expected? Several Fed speakers advocated for 25 basis point rate hikes at future meetings?
Yes, yes, and yes.
But all those events paled in comparison to the real story—which is that we witnessed the relatively rare occurrence of a Breakaway Momentum breadth thrust.
A Breakaway Momentum breadth thrust occurs when the 10-day total of advancing issues on the New York Stock Exchange is at least 1.97 times the 10-day total of declining issues. Only 25 such signals have triggered in the past 80 years (approximately one every three years).
In 24 of the 25 occurrences, the U.S. equity market was higher 12 months later—and in the one losing instance, the market was up 17% in the first six months after the signal (then got caught up in the 1987 stock market crash). The average 12-month gain after a Breakaway Momentum signal (including the one losing instance) is 21%—substantially higher than a typical 12-month market return.
Breakaway Momentum’s predictive power is tied to the fact that in order for it to trigger there has to be unusual demand for equities by institutions. As institutions deploy a lot of resources to ascertain the likely path of corporate and economic fundamentals, when they act in concert like this (buying equities) over a multi-week period, it is highly suggestive of a better intermediate-term economic future, regardless of how bleak things may look at present.
Thus, if Breakaway Momentum had been the only bullish signal from last week, it would have been more than enough to revisit any bearish market theses one may have held. But as it turns out, it wasn’t the only bullish signal. In fact, there were several confirmatory conditions that also triggered last week. When taken together, it is our belief that the odds of a market “melt-up” have increased dramatically.
Those confirmatory conditions include:
The equity market was significantly overbought and up against resistance—both the 200-day moving average and the downtrend line from the all-time highs (a line that had stopped four previous advances in 2022)—yet the market still traded like a ball underwater, every intraday selloff was reversed.
Our composite measure of equity relative sentiment made a big jump from 64% to 89% last week, and this week it appears as though it could increase to 97%—an almost unheard of level of bullishness for this indicator.
From the Commitments of Traders Report (which shows the positioning of institutions, speculators, and retail traders in the futures and options markets), we see that institutions bought equities hand-over-fist last week (and institutions tend to get the direction of equities right over the intermediate term).
Speculators sold dollars again last week relative to retail traders. Dollar relative sentiment remains decidedly bearish and the dollar has fallen nearly 10% since that bearishness commenced (October 21, 2022). Continued dollar bearishness should help real rates decline, which in turn should support long-duration equities (like technology stocks).
Cryptocurrencies have rallied strongly the past two weeks—suggesting a newfound appetite for risk (incidentally, institutions are net long Ether futures—which may mean this crypto rally has legs).
Trend-following funds are seeing their trend indicators trigger, which means they have to buy the market as it continues to rise—adding additional upward pressure on equities.
The U.S. government is up against its debt ceiling. In order to pay whatever bills it can, the U.S. Treasury will spend approximately $360 billion into the economy in the next few weeks—an act that will loosen financial conditions (and counteract four months of quantitative tightening)
Retail investors have sold all the stocks they bought during the pandemic and then some. Now ask yourself: If retail traders are selling in a panic and institutions are persistently buying, which way would you bet equities are going to go over the next 3, 6, or 12 months?
The TD Ameritrade “Investor Movement Index,” which measures retail investor trading activity, is at its lowest level since the bottom of the COVID panic in March 2020.
The gap between the bearish and bullish sentiment of individual investors is one of the largest ever and at levels typically associated with market bottoms.
According to The Market Ear: “Despite this week’s rally, the all important Goldman [Sachs] sentiment signal registers one of its most negative signals over the past few months [-1.7]. Readings below -1 are normally associated with subsequent rallying in equities.”
Credit spreads continued to narrow last week—not what one would expect if the economic environment were deteriorating. (Note: The Atlanta Fed GDP forecast for Q4 is 4.1%.)
Last week we mentioned that retail had dumped tech stocks en masse and that such behavior might be indicative of a tech bottom (and an upcoming tailwind for the market). This past week the Nasdaq was up 4.5%. Amazon was up 14%. Nvidia was up 13%.
TSLA, which was up 8% last week, appears to be in a “falling wedge” technical pattern. Such patterns tend to resolve bullishly.
The February revision to the CPI calculation will give more weight to items whose prices are falling and less weight to items whose prices are rising—suggesting inflation may fall faster than expected.
The macroeconomic data is pointing to a soft landing—something institutions have been positioned for for several months now (as we have mentioned—incredulously—week after week). To wit, a -0.1% CPI print and only 205k new unemployment claims. As Bank of America strategist, Michael Hartnett, says, “[it doesn’t] get more Goldilocks than that.”
Lastly, we would mention that the responses to this tweet—which stated that the S&P 500 was up 4% for the year and asked whether the bull market was back—were mostly of the “hell no!” variety. That is, after a year of every incipient rally being beaten down, retail investors simply can’t conceive of anything different.
To be sure, there are no guarantees in financial markets. Not every Breakaway Momentum signal has been a winner (24 out of 25). The market doesn’t go up every time institutions are relatively bullish (“only” about 90% of the time over the duration of their bullishness). Earnings could still disappoint. U.S. equity valuations are not attractive. The Fed could begin actively talking down equities again. We haven’t cleared the downtrend resistance yet.
In other words, the recent run-up could be merely a Larry Bird-level head fake.
But rarely does one find such a confluence of bullish factors across different metrics and different markets. Consequently, it is our belief that the odds strongly favor continued appreciation in equities. There will be dips along the way, but given how fervently retail has sold and how surgically institutions have bought, we likely won’t top until retail has bought back in and institutions have sold their stocks to retail. That could be months from now.
If the odds play out as expected, U.S. equities should do well, but non-U.S. equities (particularly emerging markets) may fare even better given better valuations and a falling U.S. dollar.
Moreover, the sectors that outperformed in 2022—particularly energy—might take a breather and pass the leadership torch to those sectors that lagged (e.g., Consumer Discretionary, Technology), especially if real interest rates continue to fall.
We’ll admit it’s hard to believe we could be on the precipice of a major bull run in equities after the incessant talk of a baked-in-the-cake recession for 2023 and the reasonable assumption that earnings will decline. But it would be folly to ignore a Breakaway Momentum signal corroborated by institutional buying and retail panic-selling.
That’s a softball right down the middle of the plate. You may swing and miss, but you certainly have to swing.
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