Market Update

The S&P 500 lost 0.1% last week to finish at 4,133.52. The Nasdaq fell 0.4%. The S&P 500 is still well ahead on the year, but the rally hasn’t lifted most stocks. Bloomberg reported Friday morning that 10 stocks accounted for 6.5% of the 8.5% gain year-to-date. Those 10 stocks are the mega-cap tech stocks that did so well during the bull market run from 2017 through 2021. The strong start to the year has pushed the S&P to 18.3 times 12-month forward earnings. The index began the year trading at 16.7 times earnings. The long-run average is 15.5 times.

Longer term the S&P has fallen 1% over the last two years, according to Deutsche Bank’s Jim Reid. He points out that the poor performance coincides with inflation rising above 3%. The fear is that higher inflation will continue to lead to poor stock performance. Reid points to the period from 1968 to 1982 as precedent. The S&P 500 went nowhere over that period.

The S&P has risen 0.6% so far in April, on track for its smallest monthly change since May 2022, according to Barron’s. It would be only the fourth time in five years that the index moved less than 1% in a month. The VIX finished the week at 16.77. It hit 16.17 during the week, its lowest reading since 2021. The VIX measures the expected volatility of S&P 500 options over the next 30 days. Volatility is a major input to option pricing. Options buyers aren't willing to pay much to hedge their stock positions. Stock investors are complacent.

The VIX has fallen for five weeks in a row. It dropped 34% over that period. The VIX is trading near its lowest level in 17 months. There have been 10 similar declines since the March 2020 low. A spike in volatility has usually followed, according to Frank Cappelleri of CappThesis. The VVIX index (the VIX of the VIX) has stopped falling. The VVIX leads the VIX. That the VVIX is no longer falling indicates that the decline in the VIX is probably over. Cappelleri points out that a volatility spike usually coincides with a stock market decline.

The stock market is showing no signs of an imminent decline. The bond market is signaling recession. “The MOVE index is quite high (recession territory) and is consistent with a volatile economic climate and financial shocks whipsawing Treasury yields,” writes Stan Shipley, an economist at Evercore ISI. (The MOVE index stands for Merrill Lynch Option Volatility Estimate. It is the bond market counterpart to the VIX.) “The MOVE, as a measure of rate volatility, is screaming cognitive dissonance,” writes Harley Bassman, the inventor of the Treasury market gauge. “Stocks and credit are smoking cigars on the top deck while the rates market is running for the lifeboats,” he wrote recently.

The bond market is usually right when stocks and bonds disagree on the outlook. The stock market looks as if it will test 4,200. It might push as high as 4,325 in the short term. The bond market is suggesting that the stock market will test the October low. It should be an interesting quarter or two.

Economic Indicators

The economy continues to show signs of weakening. The U.S. leading economic indicators index fell for the twelfth month in a row. It dropped by a greater-than-expected 1.2%. It fell 0.5% the prior month. The index is down 4.5% over the last six months. It fell faster over the last six months than the prior six months. The LEI is at its lowest level since March 2020. Weakness among the index’s components is widespread according to the Conference Board. The Conference Board is forecasting a recession by the middle of the year.

Housing starts dropped to 1.42 million from 1.43 million. Building permits fell to 1.41 million from 1.55 million the prior month. Building permits are a leading indicator. Meanwhile, jobless claims continued to rise last week. Jobless claims rose to 245,000 from 240,000 the prior week. Continuing jobless claims are rising as well. Continuing claims were 1.87 million last week, up from 1.80 million.

The Atlanta Fed GDPNow tool is forecasting first quarter GDP of 2.5%. The Fed is forecasting a recession later this year. The Fed and the Conference Board are in agreement. Earnings estimates have fallen but are still too high if there is a recession.

A Market of Stocks

I had two people ask me last week if it was a good time to invest in the stock market. They are concerned about the economy, the banking system, and the stock market. They know I think a 15% to 20% pullback this year is likely. They were surprised when I told them that it’s always a good time to buy good companies that are on sale.

We can’t predict what the stock market will do in the coming weeks and months, not with any certainty. I track interest rates and earnings because they drive the stock market in the long run. The business cycle is real. Different sectors and industries prosper during different times in the business cycle.

Understanding where we are in the business cycle helps me find good companies on sale. It always helps to have a treasure map when you’re looking for treasure. And there is always buried treasure in the stock market. Sometimes there isn’t much. Bull markets and high valuations make the search harder. Other times treasure is laying around easy to find. Bear markets make treasure hunting easier.

Norwood Economics currently owns several stocks trading with single-digit price-to-earnings ratios. All our stocks are inexpensive compared to the market and their own trading history. We are researching other single-digit P/E stocks. We are also hoping to buy more of what we already own at lower prices.

Buy good companies on sale whenever you find them. Ignore what you think the market might do. Buying a good company at the right price allows you to earn an acceptable risk-adjusted return. It may take a few years, but the returns will come.

Regards,

Christopher R Norwood, CFA

Chief Market Strategist