The market rally continued to broaden out in July away from the mega cap stocks. The advance/decline line indicator continues to move higher, which means more stocks are participating in the upward market movement.
Market volatility has also declined dramatically over the past couple of months. In fact, the S&P 500 has not seen a 1% or more down day in over two months! Additionally, the S&P 500 closed higher for the fifth consecutive month, which has only happened 30 times since 1949.
The question on everyone’s mind is: What does the rest of the year look like?
See what the experts say below.
Analysts have become markedly more positive over the last couple months. For example, until recently, Morgan Stanley had a year-end S&P target around 3,200. Analysts believe that one of the main reasons we saw the market take off this year was that the investment community was so far off-sides with their market outlook. If everyone thinks the market is going to tank, then they will be invested in defensive sectors or cash. If the market then starts moving higher, all of those investors are now selling defensive sectors and deploying their funds in tech and other aggressive sectors, which pushes them up even higher. However, the inverse is also true. If investors become too optimistic on the market, they may be off-sides again and rush to sell the aggressive sectors in favor of defensive sectors or cash.
We follow multiple “investor sentiment” indicators and it does not appear that this is the current situation, but it is something we monitor. If you are interested, check out the AAII Investor Sentiment Survey. This is one of the main data points that we use to gauge market sentiment.
Just remember- if everyone is on one side, that can fuel a rally towards the opposite side!
Outlook
Two key things have continued to work in the market’s favor.
Corporate Earnings: we are at the tail end of earnings season for the quarter and once again, they came in better than expected. It is crucial for companies to continue to report good earnings in order for this market to keep moving higher. The economy seems to be on strong footing and GDP results have also been better than expected.
Inflation: Our second key item that needs to continue on its path is inflation. Inflation has been steadily coming down this year, which will hopefully cause the Federal Reserve to stop raising interest rates. However, falling inflation actually has a negative effect on corporate earnings. The extent of this negative effect will be a critical factor for the rest of this year and into 2024. CPI has been steadily declining all year, and it is likely that the Federal Reserve will stop raising rates if CPI continues on its current path. In our view, the main risk factor for inflation is energy prices. Oil prices have been trending downward until recently. If oil prices continue to rise, that could prevent CPI from going lower and reaching the Federal Reserve’s 2% long term goal.
Update
The day after I wrote this, while doing the final edits, the market decided to break the 1% streak and had a rough day. The pullback was spurred by the Fitch ratings agency downgrading the US debt. Realistically, the downgrade is not likely to have a major impact on the market in the long term. Nevertheless, it was enough to jumpstart a pullback that the market has been anticipating for some time. A pullback like this is not at all unexpected, and a part of a healthy market. However, there is a big difference between healthy pullbacks and the start of a more major correction. How do we tell the difference?
The 5% Canary
The 5% Canary Theory can help determine the potential extent of a market pullback. Below are two links. One to a video explaining the study, and one to the actual study itself.
Video: https://youtu.be/ZofcuE2dtUs
Study: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4417394
The commentary in this article reflects the personal opinions, viewpoints and analyses of the Element Squared Private Wealth employees providing such comments and should not be regarded as a description of advisory services provided by Element Squared Private Wealth or performance returns of any Element Squared Private Wealth client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Element Squared Private Wealth manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
Sources:
● https://www.cnbc.com/
● https://www.aaii.com/sentimentsurvey
● https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4417394
● https://youtu.be/ZofcuE2dtUs
