ACTV - A New Bull Market Is Born

2023-03-30 09:15:01 ET

Summary

• We had some company-specific news yesterday that was less bad than expected.
• That sparked a rebound in technology stocks and the retail sector.
• In today's pessimistic environment, less bad can be really good.
• The Nasdaq 100 is now in a bull market, and the S&P 500 is next on deck.

Stocks rose sharply across the board yesterday, led by the technology sector, which gave birth to a new bull market for the Nasdaq 100. The S&P 500 managed to retake the 4,000 level with a stunning breadth figure, as 92% of the stocks in the index rose yesterday. That was a new high for 2023 that should come as no surprise to regular readers of this morning brief. I reported that three different market breadth buy signals were triggered at the same time on January 12, which have historically led to a very high probability of positive forward 12-month returns for the index. Yesterday's performance reinforces that fact. I think the birth of a new bull market for the S&P 500 is now on deck.

The fuel for yesterday's rally came in the form of news that was less bad than expected for corporate profits, which in today's pessimistic environment can be really good. Micron Technology ( MU ) fell well short of earnings expectations for its latest fiscal quarter, but its outlook was encouraging, as inventory levels improved and management sees demand recovering during the second half of this year. As a result, chip stocks posted solid gains. Lululemon Athletica ( LULU ) reported results well ahead of estimates for its most recent quarter and provided upbeat guidance for the year, which is consistent with the uptick in consumer confidence. That gave a lift to apparel and footwear names.

I have encouraged investors to focus on rates of change rather than absolute numbers, because markets are always looking forward, while absolute numbers are reflections of the past. I see broad-based improvement in the high-frequency economic indicators from the standpoint of rates of change, which are being led by inflation. I think the bearish consensus on Wall Street has blinded itself to these developments because it is obsessed with the certainty of a recession this year. Therefore, it is unwilling to consider or account for alternative outcomes.

There will undoubtedly be another recession, as that is one of the natural stages of the business cycle, but it may not be until 2025. According to corporate America, which has its finger on the pulse of the economy, a recession has become less likely in the near term over the past six months. The number of companies citing "recession" on earnings conference calls peaked following the second quarter of last year at 241. That number fell after the third quarter to 185, and it declined again to 148 at the end of Q4. There is nothing good about 148 companies mentioning recession on earnings conference calls, but if it less bad than the previous two quarters, that is a positive from the purview of financial markets. I expect there will be even fewer during the upcoming earnings season.

Sector leadership on a year-to-date basis is clearly not consistent with what we see in advance of a recession, as the technology and consumer cyclical sectors are typically the worst performers and not the best. Healthcare and consumer defensives would be outperforming, but they are lagging overall market performance.

As the focus shifts to first-quarter earnings results, investors will be looking to see if the trough in corporate profits is behind us. According to FactSet, the bottom-up consensus estimate is for the S&P 500 to earn $51.01, which would be a 5.6% decline on a year-over-year basis. Revenues are still expected to grow modestly, which is in line with expectations for economic growth of 3.2% from the Atlanta Fed. The issue for companies is profit margins, which have been squeezed due to inflation. If you think we realize a recession during the second half of this year coupled with a still elevated rate of price increases, then profit estimates for the remainder of the year are way too high. If you see the economy sustaining below trend growth, as the rate of inflation continues to fall, which is my base case, then we should resume sequential growth in corporate profits, as seen below. I think that is why the stock market is climbing the wall of worry this year. Again, this would be a positive rate of change that is viewed as less bad than expected, which can fuel a continuation of the uptrend in risk asset prices.

For further details see: