The U.S. stock market’s January rally was the real deal. That isn’t a popular view, but I like that I am in good company.
Ed Yardeni, the strategist and economic data whisperer at Yardeni Research, puts the odds of a “soft landing” for the U.S. economy at 60%. Soft landing means the Fed manages to tame inflation without creating a recession.
An even more bullish take comes from money manager Vance Howard at Howard Capital Management: “The trend is up. Very much so,” he says.
Howard says the rally off the October lows through early February is the start of a new uptrend. He thinks the pullback since then is buyable, and the weakness is an opportunity to add to positions.
“This is just a consolidation in my opinion. This is a buyable pullback,” he says. “To be successful at this you have to do what is uncomfortable. There is a lot of negative news out there, but that doesn’t mean you can’t enter into a new bull market. You have to be really careful about not coming back into the market because you are afraid.”
Why should you care what Howard thinks? He uses a proprietary technical analysis system which supports a respectable medium-term record.
What to consider buying? Howard leans towards cyclical sectors. These are the areas that do well when sentiment improves on the economy and stock market. Sectors he favors currently include technology, biotech, health care and emerging-market debt.
You can get exposure to these areas via these exchange traded funds (ETFs): Invesco QQQ Trust for tech; Vanguard Mega Cap Growth ; iShares Biotechnology ; iShares US Healthcare and Invesco Emerging Markets Sovereign Debt Income oriented investors should consider iShares Select Dividend
As for individual stocks, Howard singles out Boise Cascade which sells wood used in construction. He also likes Crown Castle the cell tower real estate investment trust, PayPal Holdings in payment services, Salesforce in sales and customer relationship support software, and NVIDIA the high-end chip designer.
Here are my top five reasons for buying into the rally off the October 12, 2022 low, when I was also bullish.
1. Technical indicators are strong
The rally since October 12 has seen increasing stock participation, a.k.a. market breadth. The Invesco S&P 500 Equal Weight ETF is up almost 20% since then, compared to a gain of around 16% for the S&P 500 Greater participation is a bullish sign of a healthy market. Here is another good technical signal: The S&P 500 is holding above its 200-day moving average.
Also consider bullish insights from Howard’s trend indicator, which he calls the HCM-BuyLine. It tracks how the market acts in relation to its moving averages. Howard tracks the overall market, not just the S&P 500, Nasdaq or Dow Jones Industrial Average The HCM-BuyLine has turned positive on a short-, intermediate-, and long-term basis. His system tells him the bullish call has a 73% chance of being accurate. Howard has reduced his cash position to below 15%, from above 50% for much of last year.
Howard is worth listening to because he has a solid record. He was cautious for most of 2022 before recently turning bullish. His medium-term record is notable, too. Howard’s HCM Tactical Growth Fund outperforms its Morningstar large-growth stock category and Morningstar U.S. large- mid-cap broad growth index by three and two percentage points annualized, respectively, over the past three years, according to investment researcher Morningstar. Meanwhile, Howard’s HCM Dividend Sector Plus Fund beats its Morningstar category and index by five percentage points annualized over the past three years, and three percentage points over the past five years.
2. The stock market predicts economic growth
As a forward indicator, the stock market is good at predicting where the economy is going. That’s why it’s one of the 10 leading economic indicators tracked by the Conference Board. Right now, the stock market is predicting growth. We know this because of the strength in “cyclical” sectors, which do well as economies grow.
In January, the S&P 500’s most cyclical sectors led the charge, Yardeni points out. Communication services stocks were up 14.8%; consumer discretionary advanced 14.5%; information technology was up 9.8%; real estate advanced 9.2%, and materials were up 7.3%, compared to a 6% gain for the S&P 500.
Indeed, the U.S. economy is hanging in there, despite relentless Federal Reserve rate hiking. The Atlanta Fed GDPNow forecaster predicts 2.4% first-quarter U.S. growth. Since the U.S. economy is so dependent on the consumer, the key factor to watch is employment, which is strong. U.S unemployment is at 3.4%, which is below pre-pandemic levels despite the Fed rate hikes.
Skeptical strategists point out that employment is typically strong just before a recession, and in fact that contributes to economic contractions. The logic here is that when the economy is at or near full employment, there is no one left to hire to keep the growth growing.
But that might not be the case this time around, because U.S. labor force participation is relatively low — at 88.3% for 25- to 54-year-olds compared to 89.3% before the pandemic, and a long-term average of 93.3%. In short, potential labor shortages could be favorably resolved by more people returning to work as stimulus money runs out and Covid fears recede, says Jim Paulsen, an economist and market strategist who recently retired from Leuthold Group.
Goldman Sachs economist Jan Hatzius just cut his odds of a recession to 25% from 35%, compared to a consensus 65%. He cites continued labor market strength and signs of improved business confidence, in surveys.
You make money in the market by being right on an out-of-consensus view. Betting on a soft-landing scenario is definitely out of consensus now, despite the recent increase in investor sentiment.
3. Analyst earnings estimates are improving
The percentage of S&P 500 companies with positive changes in estimated forward sales and earnings rebounded to 66.1% and 56.5% in late January, up from 50.6% and 44.4% in late December, Yardeni points out. Analysts are bumping up their 2024 estimates relative to 2023. This matters, because the stock market looks ahead, discounting the future out six months and more.
4. The bond market predicts a ‘no landing’ economy
Economists like to examine the bond market for clues on the economy. What they see now is bullish. The bond market predicts inflation will fall a lot, but we won’t see a recession. The inflation forecast comes from the decline in the 10-year U.S. Treasury yield. It is currently 3.9% versus 4.25% last October. For a read on growth vs. recession, look at the spread between the yield on junk bonds, and “safe” government debt. When a recession is in the cards, investors sell junk bonds on fears of defaults, driving up junk bond yields relative to safer government debt. But that is not happening. The spread is tame and narrowing.
5. Low-quality stocks are leading the way
This sounds bad. But this is actually normal after market lows, and it can be a sign that a rally will continue, says Lori Calvasina, the head of U.S. equity strategy at RBC Capital Markets. By “low quality,” she means stocks of companies that are losing money, have low return on equity, a lot of debt, and smaller market caps. The low-quality leadership tells us the stock market thinks October 2022 was the low despite all the economic challenges, Calvasina says.
Nevertheless, one thing concerns me a little bit. Investor sentiment has improved noticeably. This is a little troubling for a contrarian investor like me. I like to bet against the crowd, and investors aren’t nearly as negative on U.S. stocks as they were at the low on October 12 last year, when all the bearishness was an excellent contrarian buy signal.
For example, one reliable sentiment indicator to track, the Investors Intelligence bull-bear ratio, has rebounded to 1.68, from below one for much of last year. That’s a big jump, but this level is actually still bullish. For context, this ratio is a buy signal when it is below two, and a strong buy below one, according to how I use it. And while American Association of Individual Investors (AAII) surveys show the average investor has turned a lot more bullish, their confidence level is nowhere near saying it is a time to sell stocks.
Michael Brush is a columnist for MarketWatch. At the time of publication, he owned PYPL and NVDA. Brush has suggested IBB, CCI, PYPL, CRM and NVD in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks
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