The predominant “theme” used to justify the relief demonstrations has changed throughout the year, but in all three cases, there was no justification for it in the first place. As I wrote in a recent SA article, I hope a sizable easing rally this time around, but there is no justification for bottoming at these levels, as was the case in the two previous easing rallies that started in March and June of this year.
In March of this year, the prevailing “theme” was “transient inflation, as shown in the S&P 500 (SPX) chart above. By the end of the month, there was a big bull trap.”
Then in June the “topic” was “recession concerns.” In mid-August, another bull trap was set.
The “theme” of this aid rally is a “pivot.” Some even argued that a Bank of Canada hike yesterday of 50 basis points instead of 75 was a “pivot.” But “pivot” means drastic policy change, not dynamic adjustments.
As part of the wishful thinking that is always a major factor in investment decisions, investors always invent a “theme” to justify seeking a risk premium. This is how the markets have always worked, and this behavior is not going to change in the short term.
We will see some data from the current easing rally that shows that it is too early to call it a bottom yet.
1. Value continues to outperform and high beta continues to underperform.
The table below shows the performance of 11 total return indices since the close on October 13 and also year to date.
The only two total return indices that have rallied close to their 200-day moving average are the Dow Jones Industrial Average and the S&P 500. The former also has the highest return of 9.06% in this relief rally. If this bounce was on a bottom, as its construction implies, the S&P 500 High beta should have gained more than value. At the same time, the NASDAQ-100 has gained just 5.8% and despite the relief rally, the tech sector remains relatively weak. The same is true for S&P 500 growth. In other words, investors are trying to recoup losses but are cautious about risks because there is so much uncertainty.
2. There is no rotation of sectors
The table below shows the performance of 11 sector ETFs since the close on October 13 and also year to date.
We are not seeing strong performance in consumer discretionary (XLY), communications (XLC), and consumer staples (XLP), which are sectors that historically outperform during recessions. Instead, these have lagged during this relief rally and surprisingly the best performing sector is Energy (XLE) with a return of 10.6% and the only one trading above the 200 moving average days.
For a fund, we should expect significant sector rotation and more sector ETFs moving above their 200-day moving average. If that happens, we may change our view on this relief rally signaling a bottom.
3. Asset performance is dismal and the bond market is not signaling a pivot
The table below shows the performance of asset ETFs since the close on October 13 and also year-to-date.
The bond market has been careful to call this relief rally a bottom. Bond ETFs (AGG) and (TLT) have been down since Oct. 13, with most of the action in developed and large-cap markets. Commodities (DBC) are consolidating and slightly below the 200-day moving average, indicating high uncertainty about future inflation. We need to see significant gains in bonds and big losses in commodities to justify the “pivot” theme. If that happens, then the odds of bottoming out can increase significantly. However, the data shows that this is more of an “extension” or “pause” than a “turn” in anticipation of new data.
Also, keep in mind that most of the equity market’s gains have been driven by weakness in the US dollar and commodities after a significant uptrend. Crowding in the managed futures space due to new ETF products can cause distortions and false technical and even macro views. Many investors have traded managed futures yields in the last couple of months, with the volume of some ETFs increasing exponentially. Some of the weakness seen in commodities may not be related to fundamentals but to a build-up effect. We need more data to conclude.
The third relief market of the year is underway and there has been a rush to call it a bottom due to a possible Fed “pivot”.
The data to this point does not support the expectation of a bottom in equity markets.
- Investors have been careful to avoid the riskier stocks.
- There is not enough sector rotation.
- The action in financial assets points to more uncertainty.
Despite the lack of data to support a bottom, this relief rally could continue because markets are driven by behavioral patterns and reflexivity. A 7.5% rise in the S&P 500 towards the 200-day moving average before the midterms cannot be ruled out. However, if fundamentals fail to improve, another bull trap could lead to new lows.