“The two most powerful warriors are patience and time.” – Leo Tolstoy
After a solid start to the year the stock market hit the wall in the month of May. With the exception of the S&P500, all the major market indexes we follow posted negative returns for the month. The relative strength of the S&P500 was the result of a few of the index’s top holdings having extraordinary positive gains for the month. The Aggregate Bond index was down a bit more than 1% and the CRB Commodity Index fell more than 5%. The US Dollar Index was up 2%.
All data as of 05/31/2023, Source: Wells Fargo Investment Institute. An index is not managed and not available for direct investment. Past performance is not a guarantee of future results. [Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.]
What an interesting time it is for investors. After what many would consider a brutal 2022, returns have been very mixed so far in 2023. The S&P 500 ended the month with a year-to-date return of 8.86% as of 05/31/2023 while the Aggregate Bond Index has increase by 2.46%. One index that we follow but don’t track here is the technology-heavy NASDAQ, which is up 23.59% in 2023. From this big picture perspective, we believe, everything looks good.
Dig a little further – go beyond what the major stock and bond index and the headlines – and you will see that investors live in a much more complex world. The returns on the indexes we track for you each month are widely divergent from each other this year. A number of them enter June negative for the year.
Which leads us to this simple question: Are we in a bull market or a bear market?
Let’s dig in …
Are we in a bull market for stocks?
A bull market is a period of time in financial markets when the price of an asset or security rises continuously. It usually happens when the economy is growing, unemployment is low, and consumers are buying. A bear market, which is a period of falling stock prices, is the opposite of a bull market.
From a technical analysis perspective, there are a few things we, at Magellan Financial, look for when we are assessing the broad stock market. We look at big market indexes and we try to keep our analysis simple. The three things we are looking at are:
Are prices above or below the 200 Day Moving Average (200DMA): The 200-day moving average is a technical indicator that measures the average price of a stock over a certain period of time. It helps to smooth out the price fluctuations and show the trend direction and strength of the stock. In our analysis, if price is above the 200-day moving average, in our opinion is bullish, below is bearish.
Higher highs and Higher lows: This refers to a pattern of price movements that indicate an uptrend in the stock market. An uptrend occurs when prices are making higher highs and higher lows, meaning that the stock price is rising over time. This pattern is identified by drawing an up trendline that connects at least two of the ascending lows and shows support levels below the stock price. The opposite price pattern (lower highs and lower lows) would be bearish.
Market breadth: Market breadth indicators analyze the number of stocks advancing relative to those that are declining in a given index or on a stock exchange, such as the New York Stock Exchange (NYSE). Positive market breadth occurs when more stocks are advancing than are declining, suggesting that the bulls are in control of the market’s momentum and helps confirm a price rise in the index. Negative market breadth has more declining stocks than those advancing and suggests lower prices in the future.
So where are we today? Taking a look at the market with these criteria in mind, we see a bull market for the S&P500. The price is substantially above the 200DMA and we have a series of higher highs and higher lows. Very positive, but all is not well.
The problem we see has to do with the market breadth, as measured by the NYSE Advanced Decline Line. Since peaking in early February, the trend has been lower, suggesting that there is underlying weakness in the bull market. Put another way, the market trend higher is happening as a result of fewer and fewer stocks moving higher in price.
What About the Broader Market?
We talk about the stock market, but really what we are discussing is a market of stocks. A stock market index measures the performance of a grouping of individual, commonly themed stocks. Stock market indexes act as benchmarks for individual assets or investment funds’ performance — or even that of the stock market overall. The overall price of an index is influenced by several factors, including the number of stock shares outstanding for each company and the company’s share price. In other words, the index tracks the market capitalization of the companies within the index.
As a result, one index – like the S&P500 – doesn’t tell the whole story, and can, at times, be rather deceiving. Chart #2 is the equal weighted S&P500 that tells a very different story than the cap weighted version (Chart #1). Both indexes peaked in early February, bottomed in March, and recovered through about mid-April. It was at this point that the two indexes diverged with the equal weighted index showing substantial weakness as the cap weighted index continued back to the February highs.
Chart #2: www.stockcharts.com Data 09/13/22 – 05/31/23 as of 06/01/23. An index is not managed and not available for direct investment. Past performance is not a guarantee of future results.
Such a divergence occurs when a small number of the largest companies are outperforming and/or a large number of stocks are underperforming. The weakening advance-decline line in Chart #1 suggests this is what has happened.
To broaden it out further, there is considerable weakness that goes beyond just the large cap space. Chart #3 presents the Dow Industrial Average ($INDU), the Small Cap S&P600 Index ($SML) and the Mid-Cap S&P600 Index ($MID). What we take note of is the similar pattern of weakness since mid-April seen in the Equal Weighted S&P500 (Chart #2).
Chart #3: www.stockcharts.com Data 09/13/22 – 05/31/23 as of 06/01/23. An index is not managed and not available for direct investment. Past performance is not a guarantee of future results.
To ask the question again: Are we in a bull market or a bear market? In our opinion, we see in the market right now a stealth bear market that is hiding under the surface of a handful of large cap technology companies that have dominated the S&P500 Index returns.
Market psychology, the economy, and the stock market
Keynesian economist Paul Samuelson is reported to have joked that economists have predicted 9 of the past 5 recessions. We mention this because for at least the past 18 months there have been calls by both economists and market observers that a recession is imminent. When it doesn’t happen, the analyst has some excuse about this or that for the delay, but fear not, the recession is still approaching. The cycle then repeats itself.
Will there be another economic recession? At some point, yes, we believe there will be. Will it happen in 2023? Maybe, but we do not believe the economic data supports the recession argument at the present time.
In our opinion there are some major misunderstandings about what is really happening in the economy. These misunderstandings are why the calls for recession continue, and have caused the stealth bear market.
Impact of Inflation: In 2022, the average inflation rate in the United States was 8.0%, which led to aggressive interest rate hikes from the Federal Reserve Bank (The Fed). The reason it does this is to combat rising inflation by making borrowing more expensive for consumers and businesses. Past cycles of inflation and rising interest rates have led to job losses. Currently, the official unemployment rate is 3.4% and job openings, down from their highs, remain elevated.
Chart #4: www.fred.stlouisfed.org/series/TDSP# Data December 2000 – April 2023 as of 06/01/2023.
Consumers are running out of money: This may be true for some, but overall, people keep on spending. In fact, over the past 20 years, consumer spending has generally been on a steady rise with two exceptions: The Great Recession (2008-2009) and the Covid pandemic and its aftermath.
Chart #5: https://fred.stlouisfed.org/series/PCEC96# Data January 2002 – April 2023 as of 06/01/2023.
Household Debt is choking the consumer: This is a line that sounds plausible and is in line with the idea the consumer is running out of money, or at least spending on the credit card. The overspending argument isn’t backed up by the data. According to data from the St. Louis Fed, household debt service as a percentage of disposable personal income remains at historical lows.
Chart #6: www.fred.stlouisfed.org/series/TDSP# Data 1Q 1980 – 4Q 2022 as of 06/01/2023.
Market psychology is often used by the financial media and analysts to explain market movement that may not be explained by other metrics, such as fundamentals. We view it as a powerful force and may or may not be justified by any particular fundamentals or events- perception vs. reality. Greed, fear, expectations, and euphoria are all factors that contribute to markets’ overall market psychology.
Right now, we see a market that is experiencing some fear and some greed. The fear of economic recession and higher than desired inflation is holding back the broader market of stocks. Greed, on the other hand, is masking the true market trends by sending specific stocks and sub-sectors higher.
For us, markets like these tend to be the most frustrating. Emotions appear to be winning over fundamentals. Up is down. Down is up.
We continue to believe that it is important to understand that this too shall pass. If you are young and your investment plan is to be heavy in the stock market, continue forward. For the retiree who is taking income, stick with your investment strategy. Patience and time are your winning formula.
For More Information About our Complimentary Portfolio Review Service, Contact Our Team Of Financial Advisors Today!
1 What Is A Bull Market? – Forbes Advisor
2 Stock Market Indexes: Definition, How They Work, Role in Investment (businessinsider.com)
3 Does the S&P 500 Index Include Dividends? (investopedia.com)
4 The Stock Market Has Predicted Nine Of The Past Five Recessions (forbes.com)
5 Current US Inflation Rates: 2000-2023 (usinflationcalculator.com)
6 Market Psychology: What is it, Predictions, and FAQ (investopedia.com)
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Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.All investing involves risks including the possible loss of principal invested. Past performance is not a guarantee of future results.
Index returns are not fund returns. An index is unmanaged and not available for investment.
Dow Jones Industrial Average: The Dow Jones Industrial Average is a price-weighted index of 30 “blue-chip” industrial U.S. stocks.
S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value.
S&P Midcap 400 Index: The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between the S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
S&P Small-Cap 600 Index: The S&P SmallCap 600 Index consists of 600 domestic stocks chosen for market size, liquidity (bid-asked spread, ownership, share turnover and number of no trade days) and industry group representation. It is a market value-weighted index (stock price times the number of shares outstanding), with each stock’s weight in the index proportionate to its market value.
MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.
MSCI World Index: The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.
MSCI EAFE® Index: The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
The CRB (Commodity Research Bureau) Index measures the overall direction of commodity sectors. The CRB was designed to isolate and reveal the directional movement of prices in overall commodities trades.
Bloomberg Barclays U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based measure of the investment grade, US dollar-denominated, fixed-rate taxable bond market.
NASDAQ Composite Index: The NASDAQ Composite Index measures the market value of all domestic and foreign common stocks, representing a wide array of more than 5,000 companies, listed on the NASDAQ Stock Market.
Russell 2000® Index: The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents.
U.S. Dollar Index (USDX) measures the value of the U.S. dollar relative to majority of its most significant trading partners. The index is similar to other trade-weighted indexes, which also use the exchange rates from the same major currencies.
Technical analysis is only one form of analysis. Investors should also consider the merits of Fundamental and Quantitative analysis when making investment decision. Technical analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the future.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility.
Investments in fixed-income securities are subject to market, interest rate, credit and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the bond’s price. Credit risk is the risk that the issuer will default on payments of interest and/or principal. The risk is heightened in lower rate bonds. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
Investing in commodities is not suitable for all investors. The commodities markets are considered speculative, carry substantial risks, and have experienced periods of extreme volatility. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. The prices of various commodities may fluctuate based on numerous factors including changes in supply and demand relationships, weather and acts of nature, agricultural conditions, international trade conditions, fiscal monetary and exchange control programs, domestic and foreign political and economic events and policies, and changes in interest rates or sectors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks, including futures roll yield risk.
Wells Fargo Investment Institute, Inc. is a registered investment advisor and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.
Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SIPC, a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company. Any other referenced entity is a separate entity from WFAFN.