The Bear Thread

Week before Thanksgiving DJIA Up 20 of 31, But Down 6 of last 7

DJIA has a fair track record over the last 31 years, rising 20 times the week before Thanksgiving with an average gain of 0.44% in all years. But the other major U.S. stock market benchmarks are not as strong and there has been more weakness the past seven years. Since 2017, DJIA has advanced just once during the week before Thanksgiving.

Over the last 31 years, S&P 500 and NASDAQ have the same record, up 18 times, with similar average gains of 0.20% and 0.23% respectively. Russell 2000 has been the weakest, up 16 times with an average gain of 0.08%. Last year, the week before Thanksgiving, enjoyed solid across-the-board gains as the market recovered from a correction.

Should weakness materialize next week, it may be a solid set up for the Thanksgiving trade of buying into weakness the week before Thanksgiving and selling into strength around the holiday and/or during typical November end-of-month strength.

 

Health Care Weightloss
Tue, Nov 19, 2024

We discussed the hard fall in Health Care sector stocks in today's Chart of the Day. While the drop has resulted in extreme underperformance versus the S&P 500, it has also resulted in the sector's weight in the S&P 500 falling dramatically. At the end of 2022, the sector's weight rose almost to 16%. At that time, it was the second-largest sector behind Tech, and relative to its history, it was one of the largest weights on record. The past couple of years have seen a dramatic weight loss that is now teetering on moving to a single-digit weighting. At 10.36%, the Health Care sector currently has its lowest weight since September 2000. Additionally, the 1.67 percentage point loss in weight over the past three months is one of the biggest declines on record.



Back at the recent highs in late 2022, Health Care was the second largest sector in the S&P 500. Today, it is only the fourth largest sector which is the lowest ranking it has had in more than a decade (2012). Of course, that smaller weight means that the Health Care sector won't have the same pull on the broader market that has been typical over the past couple of decades.

 

Chinese Stocks in Free Fall
Fri, Nov 22, 2024

In the US, equities have staged a solid rally this month with most of the move occurring after the election. Elsewhere in the world, equities haven't exactly shared in the gains. Chinese stocks, using the iShares MSCI China ETF (MCHI) as a proxy, surged throughout September and into early October as stimulus measures were announced. After a massive 42.7% gain from the end of August through the closing high on October 7th, MCHI reversed lower and was down 14.5% by Election Day. Headed into the election, MCHI actually stabilized somewhat, but post election it has taken another leg lower as it is now down 9% since then and 22.2% since the October high. As shown below, the ETF is also now in no-man's-land trading smack in the middle of its 200 and 50-DMAs with gaps to fill from the September post-stimulus run up.



Although MCHI is pulling back, it is at least still higher than it was prior to stimulus announcements back in September. The same cannot be said for some of the country's most prominent stocks. As shown below, Baidu (BIDU) and Alibaba (BABA) have now both round-tripped over the past couple of months. That also leaves them at interesting standpoints from a technical perspective. Starting with BIDU, the stock has been in a steady downtrend throughout the past year and this recent turn lower leaves it testing support at 52-week lows. For BABA, the long term trend is a bit more friendly with a series of higher lows throughout the year. However, BABA has also been on a ruthless stretch of declines including a daily loss in six of the last seven sessions. Whereas BIDU is testing support at 52-week lows, BABA is testing support at its 200-DMA.

 

First Trading Day of December Trending Bearish

In the now available, Stock Trader’s Almanac 2025, on page 90, it is shown that the first trading days of every month since September 1997 for DJIA have produced just over 35% of the total gain. Greatest gains were produced by the first day of February followed by March and July. However December’s first trading day has not been as productive for DJIA or S&P 500. In the following table, the performance of the first trading day of December over the last 23 years is presented.

Aside from disastrous 2008, first trading day of December losses have been relatively mild for DJIA. The second worst loss, 1.34%, was 2021. Although the table has numerous years with 1% or greater gains, consistency is lacking. Since 2006, December’s first trading day has been trending weaker, down ten of the last eighteen for NASDAQ, down eleven of the last eighteen for DJIA, and twelve of eighteen for S&P 500.

On the heels of above average gains this November, it would not be surprising to see the market pause in early December to consolidate gains.

 

South Korea ETF (EWY) Reaching New Lows
Tue, Dec 3, 2024

Although US equities are mostly flat today, South Korean equities have been much more eventful. News broke today that the country's President Yoon Suk Yeol declared martial law which was then contested by the National Assembly shortly thereafter. The catalyst for the declaration was claims to address what he described as communist/North Korean sympathetic parties conducting anti-state activities including budget disputes and impeachments. While the event is still unfolding, in response to the political tensions, the MSCI South Korea ETF (EWY) is down 2.35% as of this writing. That makes for the fifth straight day of declines, resulting in the ETF trading at its lowest level in over a year.



In the table below, we show the 22 country ETFs tracked in our Global Macro Dashboard (which was most recently updated last week). As shown, South Korea (EWY) is by far the worst performer today and it is also now the only one trading at a 52-week low too. In total, EWY is now down over 15% year to date with only Mexico (EWW) and Brazil (EWZ) falling more. Of those, EWZ is also the only country ETF that is now more oversold than South Korea. On the flip side, other Asian country ETFs like Japan (EWJ) and Singapore (EWS) have been moving higher into overbought territory.

 

Overbought Markets Pullback During Typical Early December Weakness

• Choppy First Half Before Yearend Santa Claus Rally
• Small Caps Surge in Election Years
• “January Effect” Small Cap Outperformance Starting Mid-December

Trading in December is holiday-inspired and fueled by a buying bias throughout the month. However, the first part of the month tends to be weaker as tax-loss selling and yearend portfolio restructuring begins. December’s first trading day leans bearish for S&P 500 and Russell 1000 over the last 21 years. A modest rally through the sixth or seventh trading day also has fizzled going into mid-month. It is around this point that holiday cheer tends to kick in (and tax-loss selling pressure fades) propelling the indexes higher with a pause near month-end. Election year Decembers follow a similar path, but with noticeably larger historical gains in second half of the month by Russell 2000.

Small caps tend to start to outperform larger caps near the middle of the month (early January Effect) and our “Free Lunch” strategy is served from the offerings of stocks making new 52-week lows on Quad-Witching Friday. An email Issue will be sent prior to the market’s open on December 23 containing “Free Lunch” stock selections. The “Santa Claus Rally” begins on the open on December 24 and lasts until the second trading day of 2025. Average S&P 500 gains over this seven trading-day period since 1969 are a respectable 1.3%.

This is our first indicator for the market in the New Year. Years when the Santa Claus Rally (SCR) has failed to materialize are often flat or down. Six of the last seven times our SCR (the last five trading days of the year and the first two trading days of the New Year) has not occurred were followed by three flat years (1994, 2004 and 2015) and two nasty bear markets (2000 and 2008) and a mild bear that ended in February 2016. Santa’s no show earlier this year was likely due to temporary inflation and interest rate concerns that quickly faded. As Yale Hirsch’s now famous line states, “If Santa Claus should fail to call, bears may come to Broad and Wall.”

 

Biggest Winners and Losers Since the Election
Wed, Dec 4, 2024

It's been nearly a month now since the Presidential election, and from the close on 11/5 through yesterday (11/3), 354 (71%) stocks in the S&P 500 have experienced gains and the average performance of all 500 stocks in the index has been a gain of 3.89%. Of the ones that have rallied since the election, 13 have posted gains of at least 20%, and we have listed each one below with one-year price charts below that. Of the 13 biggest winners, most of them were already big winners leading up to the election, and all but four are currently up over 40% YTD. Looking at the charts, it's also worth noting that the only four that experienced reversals in their trends around the election were EPAM Systems (EPAM), Super Micro Computer (SMCI), Tesla (TSLA), and Warner Brothers Discovery (WBD). In most cases, the reason for these reversals had little to do with the election and were more company-specific events. EPAM and WBD both reported earnings two days after the election, and SMCI had news related to hiring a new auditor. Tesla (TSLA) is the only stock that really saw a notable shift in its trend due to the election, and given CEO Elon Musk's role as the right-hand man to President-Elect Trump, that move is understandable.





Turning to the losers, only 12 stocks in the S&P 500 were down 10% or more between 11/5 and the close yesterday (12/3). Unlike the list of biggest winners, though, some of these names, especially in the Health Care sector, were in steady uptrends ahead of the election but have seen those rallies reverse. Shares of Leidos (LDOS) were also at 52-week highs just after the election but have plunged since, as Vivek Ramaswamy has discussed the large amounts of bloat in funding for federal contractors. In several cases, though, the declines have been company-specific.





Finally, within the "Trillion-Dollar Club", most have seen gains but to varying degrees. Leading the way higher, TSLA has rallied nearly 40% (Elon's bet really paid off!), and next on the list is Apple (AAPL) with a gain of 8.6%. There's been a lot of talk about Mark Zuckerberg not being welcomed at Mar-a-Lago, but it hasn't impacted the stock of Meta Platforms (META) as it has rallied 7.2%. Behind META, the other members of the "Trillion-Dollar Club" that have outperformed the S&P 500 are Amazon.com (AMZN), Berkshire Hathaway (BRK/B), and Microsoft (MSFT), which have rallied 7.0%, 5.7%, and 4.8%, respectively. That leaves Alphabet (GOOGL) and Nvidia (NVDA) as the only two members of that club that have underperformed the S&P 500 since the election.

As with anything, it's tempting to look at these recent performance numbers and extrapolate the out or under-performance throughout the entire Trump Administration, but remember that it hasn't even been a month yet, so expect a lot of changes along the way.

 

A Fed Policy Error Is a Big Risk for 2025


Federal Reserve Chair, Jerome Powell, was quite upbeat about recent economic data during a moderated conversation with the New York Times Dealbook. He noted that the since the Fed’s September meeting, growth has improved, while downside risks to the labor market have declined. At the same time inflation has come in a little higher. As a result, he believes the Fed can “afford to be a little cautious” on moving policy rates to neutral (the rate at which policy is neither stimulative nor restrictive). Other Fed members are also singing from the same hymnal, signaling a more gradual pace of normalization.

In my opinion, it’s very likely the Fed will cut rates by 0.25%-points at their December meeting (Dec 17th – 18th), taking the Fed funds rate to the 4.25 – 4.50 percent range. Fed funds futures are currently pricing in a 74% probability of a cut in December, and it’s notable that Powell didn’t say anything to push back on this. But the question is what happens in 2025.

2025 Cuts Are an Open Question
The Fed has two mandates — stable inflation and maximum employment. So when thinking about the path of rates, it’s best to think about what could happen in these two areas, especially relative to the Fed’s own projections (as outlined in their Summary of Economic Projections (SEP), which includes the “dot plot” for the fed funds rate).

Here’s what they projected in their September SEP:

• The unemployment rate at 4.4% for 2024 and 2025
• Core PCE (Personal Consumption Expenditures Index) inflation at 2.6% in 2024 and 2.2% in 2025
• Given the above two, they estimated the fed funds rate to be 4.4% for 2024 and 3.4% at the end of 2025

However, the data is upending the Fed’s projections. The unemployment rate is currently at 4.1%, below their 2024 projection of 4.4%. So, labor market risks are less of a worry now from their perspective. On the other hand, core PCE is on track to hit 2.8% in 2024, above the Fed’s projection of 2.6%.

The December rate cut seems very likely at this point, pulling the fed funds rate to 4.4%, which would be in line with their September projection for 2024. But this is in the face of both unemployment and inflation going in opposite directions from their forecast (unemployment below, and inflation above). That means they’re likely to shift their 2025 rate projection when they update the dot plot in December. The problem is that as we go into 2025, it’s very possible that the data continues to upend their projections. Unemployment could very well remain low (below 4.4%), assuming no labor market surprise. And inflation could stay “hot.”

Buckle Up, the Inflation Data Is a Mess
Headline PCE inflation currently shows no signs of concern, running at an annualized pace of 2.2% over the last three months and 2.3% year over year. As long as energy and food prices remain muted, headline inflation should be contained. Again, barring any surprises.

The Fed targets headline inflation, but they focus on core inflation as a gauge of underlying inflation and a rough forecast of where headline inflation may go. The problem is that the core PCE data are a mess, and for the matter core CPI too (Consumer Price Index). Core PCE is up 2.8% over the last three months (annualized) and year over year. But that 0.80%-point overshoot versus the Fed’s target of 2% is not really capturing underlying real-time inflation. Instead, about 0.63%-points of that overshoot is coming from two sources, housing and financial services.

We’ve discussed a lot about how housing inflation is really capturing lagged dynamics of what happened in 2021 and early 2022, as opposed to what’s happening real time. The good news is that we’re seeing housing disinflation, and there should be more in the pipeline for 2025. The bad news is that it’s happening slowly. Housing inflation (which makes up 17% of the core PCE basket) is up 5% year over year, down from 6.3% at the end of 2023 and 7.7% at the end of 2022. But we still have some ways to go to hit the pre-pandemic pace of about 3.4%.

Financial services make up just under 10% of the core PCE basket. And right now, it’s elevated because of surging stock prices, which is driving portfolio management services inflation higher. Also, the spread between what banks pay all of us on deposit accounts versus the fed funds rate is large right now, and this shows up as “inflation” in the government data. It does become less of a problem as the Fed lowers rates, but for now it’s contributing more than it did pre-pandemic. The PCE index for financial services is up 7.3% year over year, the fastest pace since March 2022. Contrast that to a 1.3% pace in December 2019.



It would be one thing if housing and financial services inflation were reflecting a real-time inflation dynamic. But that’s clearly not the case. As I noted above, housing inflation is severely lagging private market data, and financial services is imputed from market prices. I don’t think any of us will complain about surging stock prices and would not root for the opposite (never mind the bears).

The problem is that neither of these dynamics is likely to fully abate in the first part of 2025. Housing inflation may remain elevated for a while longer, even as it continues to pull lower ever so slowly. The Q4 surge in stock prices could likely keep financial services elevated as well. On top of that, seasonal adjustments since the pandemic have been messy and residual seasonality could likely result in elevated inflation data in Q1 (we saw this at the beginning of this year). Moreover, we could very well see less disinflation in commodities outside food and energy (like used cars, apparel furnishings, and appliances).

All this means core inflation could stay elevated through the first quarter of 2025, and perhaps through the first half, clocking in well above the Fed’s 2025 core PCE projection of 2.2%. That could very well keep the Fed on pause in early 2025. Of course, this assumes we don’t get a big downside surprise on the labor market side, but that’s not something we want to root for (bad news will be bad news in our book).

Forward Looking Measures of Inflation Don’t Show a Problem
In contrast to the backward-looking data, forward looking measures show that inflation has mostly normalized.

One, wage growth has eased a lot. The Employment Cost Index (ECI), which is the gold standard of wage growth measures, was up 3.1% (annualized) in Q3 2024. That’s still solid, but consistent with 2% inflation. The pre-pandemic pace was 2.9% for comparison. In fact, Powell himself noted recently that the labor market is no longer a source of inflationary pressure. (My question is, then why not normalize rates sooner rather than later?)



Two, consumer expectations of inflation have also normalized. The New York Fed’s consumer survey showed that 1-year ahead inflation expectations are at 2.9% and 3-year ahead at 2.5%. These are consistent with what we saw pre-pandemic, when overall inflation was muted. Moreover, consumers tend to project current inflation into the future. The fact that current expectations match what we saw in the 2017-2019 period suggests inflation has normalized.



Three, business expectations of inflation have mostly normalized. The Atlanta Fed’s survey of businesses found that 1-year ahead inflation expectations are at 2.2%, not far above the 2017 – 2019 average of 2%.



Keep in mind that inflation (at least measured by core PCE) was running below the Fed’s target of 2% before the pandemic. The fact that all the three measures I discussed above are close to pre-pandemic levels suggest underlying inflation is close to 2%.



Ultimately, if the Fed does pause for an extended period of time, that’s going to be on the back of spurious, backward-looking inflation data, rather than what’s happening in reality, let alone forward-looking measures like wage growth and inflation expectations. Meanwhile, policy would implicitly be getting tighter, as policy rates stay elevated and underlying inflation remains muted. That’s a big risk for cyclical sectors of the economy, like housing and even manufacturing and business investment.

I still think we could see 2-3 rate cuts in 2025 (each worth 0.25% points), but we may have to sit on our hands a bit before that comes to pass. Even if we don’t see that many rate cuts in 2025 (or none), it’s likely not going to pull the economy into a recession next year, in my opinion. But it’s not a good scenario for growth prospects, let alone an equity market that may be banking on rate normalization.