Here are the five components we watch to stay bullish, in order, from top to bottom.

1) S&P 500 Index

As legendary technical analysis Paul Montgomery put it, “The most bullish thing the market can do is go up.” The top series provides the most important tell of all. Higher highs and higher lows are an uptrend, and the SPX has managed to do just that even without the support of mega-cap technology names.

2) S&P 500 Cumulative Advance-Decline Line

This is an equal-weighted series calculated as a running total of daily advance-decline values for the SPX. This is taken directly from the main breadth chart that I look at every single day. This line trending higher means that the components of the S&P 500 index are going higher – simple as that.

3) Small Caps vs. Large Caps

The ratio of the Russell 2000 ETF (IWM) versus the S&P 500 has been in a steady uptrend really since early October. Now it’s worth noting that most measures of small versus large also have a sector bias of sorts, as small-cap indexes tend to have a heavier weight in sectors like financials and industrials and less in technology. But still, this is a classic measure of risk-on versus risk-off, and it is definitely signaling risk-on.

4) Equal-Weighted SPX vs. Cap-Weighted SPX

This is similar to small cap versus large cap, but as the smallest S&P 500 names are in the $7 billion market cap range, this is more mid cap versus large cap. As with the previous ratio, it also signals that the smaller companies are outperforming the larger and is another bullish tell.

5) S&P 500 New Highs and New Lows 

Finally, we are looking at how many S&P 500 members are making a new 52-week high or low every day. You may not know that the 52-week lows are on the chart, because there really have not been any since March of last year! We’re seeing a consistent number of new highs each week, including about 15% of the S&P 500 members making a new 52-week high on Thursday and Friday. Bullish.

From top to bottom, this chart provides five separate reads on the S&P 500 index. All five are making new highs or confirming the bullish trend.

So, what would need to change for the outlook to be less bullish? Quite simply, these four ratios would need to turn lower and the new highs would need to evaporate. That would indicate an exhaustion of buyers, an increase in profit taking, and a pullback in price. Until that happens, these indicators suggest that the path of least resistance is higher.

 

The Fed, US Debt and Inflation

 

Inflation in February was benign. But starting with March, because of the COVID effect, the year-over-year comparisons will begin to show higher inflation. If you go back two years inflation will still look benign, but that is not what the BLS or the media will do. They will focus only on one-year change. And for March through June/July, the comparisons will probably show inflation rates well above 2%. Before the end of summer, combined with the recent stimulus package, it could actually approach 3%.

I believe this will be transitory, but the bond markets will see those numbers and want to push interest rates higher. The Fed will tolerate higher interest rates on the 10-year bond up to a point. They have said they would be willing to accept 3% inflation for a time, but they also want to keep interest rates down. Without actually implementing Yield Curve Control, per se, they can simply modify their bond buying to include longer maturities, and/or increase the volume of US government bonds they buy.

The previous administration was certainly willing to run up the deficit. The current administration is going to do so on steroids with infrastructure and other programs, on top of the just-passed COVID relief. The Federal Reserve’s balance sheet is around $7.5 trillion now, and rising some $120 billion per month.

 

 

The fiscal 2021 US deficit will certainly be more than $4 trillion and approaching $5 trillion, and the Treasury has more debt that has to be rolled over. The US government simply can’t afford higher interest rates. Financing costs would overwhelm the budget. Further, we are beginning to see Treasury auctions coming in “weak,” meaning investors demand higher yields.

The Federal Reserve is going to become the buyer of last resort, exactly like the central banks in Japan, the ECB, and to some extent the UK are. I expect the consequences will be much the same: lower GDP growth.

I’m asked all the time, how long can this go on? Probably longer than we can imagine. It will continue until it doesn’t. The Federal Reserve will continue to hold rates down, punishing savers and retirees. Their policies will aggravate wealth and income differences but no one will deal with the actual causes.

In summary, nothing is really going to change in terms of Federal Reserve policy. It will keep using broken data to justify its loose monetary policies, the monster deficits will require them to purchase even more Treasury bonds and, given their presuppositions, they really have no choice.

They will continue on that course until there is a crisis, and then they will double down. There is absolutely no way to know when that will happen. Japan and Europe have gone on for a long time. There is no reason to think the US can’t. Powell and whoever succeeds him will echo Mario Draghi’s “Whatever it takes” line.

I don’t want you to fight the Fed, but at the same time you don’t have to play the game. You have alternatives. Think in terms of an two-sided equity strategies, and more active management. Friends don’t let friends buy passive index funds. Not in these times.

 

Savings Rate VS Economic Growth

 

When consumers are confident in the economy and their paychecks, they spend more and save less.  The opposite is also true. Less spending, more savings. And the savings are finding their way into the market. With $1.9 trillion coming our way, the bet is on spending—but my gut tells me the savings rate will remain high.

Historically, a high savings rate correlates with slower economic performance. That makes sense, since personal consumption drives 70% of the economy. Since 1959, when the savings rate was more than one standard deviation above trend (think much higher than normal), U.S. economic has performed worst. The difference is material (source: Ned Davis Research):

  • Savings rate high: economic growth 0.31% per year
  • Savings rate neutral: economic growth 2.34% per year
  • Savings rate low: economic growth 3.51% per year

In general, that means companies in aggregate will earn less, and if earnings remain low, the current overvaluation of equities—absent a meaningful correction—will remain high.

 

US Economy

 

  • The amount of government stimulus this year is expected to exceed the 2020 level.
  • As a result of the COVID relief package (and the vaccine progress), economists have been upgrading their forecasts for GDP growth and consumer spending.
  • The GDP path is now expected to overtake the pre-COVID trajectory in early 2022 or even late this year.
  • What happens after the stimulus juice runs out? There will be a large “fiscal cliff” in 2022, according to Alpine Macro.

 

 

  • The inventory-to-sales ratio tumbled in recent months amid supplier bottlenecks and rising demand.
  • The decline has been especially sharp in durable goods.
  • For example, the inventory-to-sales ratio for lumber and other construction materials is now the lowest in over a decade.
  • That’s why lumber prices have soared.
  • The Fed’s measure of inflation expectations has rebounded sharply, according to Goldman.
  • CEO confidence hit the highest level since 1983.
  • The NFIB small business index ticked higher but was below forecasts.
  • The NFIB job openings index spiked, suggesting that we will see more vacancies at the national level.
  • Job postings on Indeed keep climbing.
  • More firms are boosting prices
  • It’s a clear indication of rising consumer inflation ahead.
  • Herd immunity by summer?
  • Producer prices are rebounding, which is now a global trend.
  • The CPI report was a bit softer than expected as the core inflation continues to drift lower, below 2%.
  • A substantial portion of the drag on core inflation in February came from three sectors: airline fares, used cars, and hotels.
  • Higher jet fuel costs will force airlines to boost prices this spring.
  • The Dow hit a new record in response to the tepid inflation data.
  • Rent CPI continues to trend lower.

 

US Jobs

 

The US jobs data classifies workers as “long-term unemployed” when they have been jobless more than six months. Getting in that category is harder than it looks. You have to have been available to work, actively seeking work and still unemployed without a single day of even part-time income the entire time. Despite that high hurdle, the number of long-term unemployed (as a percentage of total unemployed) is rising quickly and may soon surpass its Great Recession peak.

 

 

Worse, history shows that long-term unemployment, once it peaks, tends to drop more slowly than it rose. Getting back to where it was before the pandemic could easily take several years. It might happen faster if the post-virus recovery is as strong as some expect. That remains to be seen.

The official unemployment numbers exclude adults who can’t or don’t want to work. That includes retirees, fully disabled people, prisoners, etc. Add them all up and we find that about 57% of the adult population is employed. That’s down from about 61% before the pandemic. Regional variation is high within these numbers, though. This BLS map shows employment-population ratio by state. Nebraska is highest at 66.7%. West Virginia is lowest at 50.3%.

 

 

The ratio is clearly highest in the Great Plains and Rocky Mountain states and tends to be lower in the South and Southwest. But in all 50 states, the ratio fell last year. An economic recovery should make it rise everywhere, too.

 

Thought of the Week

 

“Sometimes our light goes out, but is blown again into instant flame by an encounter with another human being.”
― Albert Schweitzer

 

Picture of the Week

 

 

 

All content is the opinion of Brian J. Decker