No one rings a bell at the top or the bottom of a market or economic cycle. We have countless indicators, data points, models, and opinions that tell us when and where the exact top and bottom will occur, but none are perfect. It is clearly more of an art than a science. This is why I think it is important to never be all in or all out of the market. Instead, it makes more sense to increase or decrease exposure from a targeted percentage, and everyone has a different target based on their respective objectives and tolerance for risk. I look to vary my exposure based on the rates of change I see in all of the measurements of economic and market health that we have at our disposal.
While it is important to consider absolute numbers, I think the rates of change in those numbers are a lot more important. An absolute number can be misleading, especially when it is a lagging indicator. For example, it sounds like a horrible time to invest new money when the unemployment rate is 10%, but when the rate was falling from a peak of 10%, as it did in October 2009, it was an excellent time to put new money to work in risk assets. The economic data was far from good for some time after that, but the rates of change were positive, which is why risk asset prices rose.
Along the same lines, the rate of inflation is as lagging an indicator as the unemployment rate. No one knew for sure that the Consumer Price Index had peaked in June of last year at 9.1%, but the market’s response was extremely timely. One month before the Bureau of Labor Statistics reported that number in mid-July, the more domestically-focused Russell 2000 index of small cap stocks made its bear-market low nearly perfectly timed with the peak in the rate of inflation in mid-June. It rose more than 20% off that low and remains approximately 16% above that low, while the 50-day moving average is on the verge of a bullish cross with the 200-day moving average. This is a very positive development for the broad stock market.
This index is telling me that the macroeconomic landscape is growing less bad from what were horrible conditions. It does not mean things are great, but they don’t have to be great for the markets to perform.
The bear camp will point to the underperformance of the S&P 500, as it struggles with its 200-day moving average and the 4,000 level, but I think investors fail to appreciate the tremendous influence a half a dozen megacap technology-related names still have on this index. Remove those names and the index looks even stronger than the Russell 2000.
The equal-weighted version of the S&P 500 (RSP) has risen well above its 200-day moving average to challenge its November highs with the added benefit of a bullish cross, which occurs when the 50 day-moving average rises above the 200-day. This reverses the bearish cross that occurred last March. This tells me the average stock in the S&P 500 is performing much better than the index.
I think these bullish market developments are telling us that we will continue to see the rate of inflation decelerate at an increasingly rapid pace, while growth in the economy is sustained. That would produce a soft landing and avert the recession that bears are banking on for new lows in the major market indexes. Granted, there are still several troubling economic indicators that point to difficult times ahead, especially for the housing and manufacturing sectors, but the strength in consumer spending looks to be powerful enough to keep the overall economy on a growth path, which should support another year of very modest profit growth.