This morning the headline CPI was released at 0.1% for the month of May, and 4% year-over-year. Inflation is coming down as fast as it went up. The pace of increase in year-over-year inflation has now declined for eleven straight months. But because monthly ‘core’ inflation (ex-food and energy) has been higher than the headline number the last few months, some investors now expect a 25 bp rate hike at the July meeting.
Investors expect a one-third chance for a 25 bp interest rate hike tomorrow at the Fed meeting and a two-thirds chance for a pause. A pause doesn’t mean they are through raising rates for the cycle, but may allow stock prices to rise further until at least the July Fed meeting.
FROM BEAR MARKET TO NEW BULL MARKET
The S&P 500 managed to reach the 20% threshold on a closing basis to confirm a new bull market last Thursday when it closed 20.04% above its October 12, 2022 closing low. Some investors say it is not a true bull market yet because old highs have not been taken out but they are missing the point. Twenty percent is 20%. This quiet 20% run was led by technical indicators but it is a new bull market none the less.
This seems to be a good time to review the three pillars of a bull market to see how strong the rally has been and to gauge further upside potential. New bull markets don’t necessarily come with self-sustaining momentum. We will start with the technical indicators pillar and move on to fundamentals and valuation.
TECHNICAL INDICATORS: We won’t go into detail here since we just covered this in the June commentary, but we will add one more technical statistic: cash. Large institutional asset managers have about 6% in cash which is near the average peak level. Spending cash on stocks down to the average cash level of 4% could push this market up further in the short term. The other technical indicators we covered last time are still flashing green. There is a whopping $5.5 trillion in money market funds.
FUNDAMENTALS: The key question is; has the Fed gone too far likely pushing us into recession? Many investors are betting on a soft landing now but the threat of recession remains. The odds for a U.S. recession have dropped to 50/50 in our view – a coin flip. Has the market discounted a recession? We don’t think so. A recession later this year could halt further gains in the broader market. Tomorrow’s release of the FOMC decision on interest rates and Chair Powell’s comments on the economy will be key.
VALUATION: This bull market is starting at a high valuation level which is also a reason to question its staying power. The S&P 500 is now trading at 18.8x forward 12 month EPS and 17.9x 2024 calendar year earnings. The 2024 P/E is based on 12% EPS growth, an optimistic figure. A stock market that rallies sharply from this point will start to look like 2021, and we know what came next.
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We are not trying to throw cold water on the new bull market, but rather acknowledge headwinds. Analysis of the three pillars is usually a mixed bag, even in a bull market, and this time is no different.
We are satisfied that we have been preparing for this bull market for the last six months (we also covered this in the June commentary). Technology stocks continue to move up and cyclicals have started to rally, mainly financials, consumer discretionary, and industrial stocks. It would be healthy for the rally to broaden out.