I earlier claimed that market breadth would only push higher with the participation of small cap stocks. Well the big moment of truth already arrived as the iShares Russell 2000 ETF (IWM) punched through its bear market line for the third time in 11 months. With the S&P 500 (SPY) and the NASDAQ (COMPQ) relentlessly pushing higher, IWM’s breakout adds yet more pressure to the bears. This milestone expands market breadth and further emboldens bulls and buyers. This move adds to the sense that the economic outlook is not nearly as awful as assumed for the last 12-18 months.
Note that even after IWM confirms its breakout with a follow-through buying and a higher close, it will immediately face resistance from the highs of the year set in February. Right after that hurdle, IWM will face resistance from the highs of last August. In other words, while IWM has almost traded straight up since nearly testing support at its 50-day moving average (DMA) (the red line above), I suspect trading in the next week or two going into and following the Fed meeting will be chopping and include false alarms both bearish and bullish. Still, the upshot remains that IWM’s achievements point to more overall upside potential in the stock market. The classic extended overbought rally is back on the table.
The Lingering Bear Case
In a timely move, CNBC’s Fast Money brought some bearish commentators on stage to pressure them over their stubborn bearishness. I give these three guys – Danny Moses, Guy Adami, and Dan Nathan – some kudos even as they needed to band together to face the music. Each one stayed on message from what I have heard for a long time on their podcast “On the Tape.” I stopped listening several weeks ago because the dogmatic rage against the machine became far too repetitive. So hearing this reprise was a nice confirmation that I need not rush back to the podcast for an update on the bearish case.
Adding in commentary from Cameron Dawson of New Edge Wealth, here is the collective bearish case from the show:
- Valuations are stretched thin.
- Rate hikes have to make a negative impact at some point.
- S&P 500 companies are suffering on-going earnings declines.
- Positioning is almost over-extended into tech and growth. When positioning hits maximum overweight, valuation will start to matter to (presumably) exhausted buyers.
- High valuations are pulling forward a lot of excitement over something that “might or might not happen” (a reference to the AI trade). It feels like a feeding frenzy (in other words, a mania doomed to collapse).
If this list looks uncompelling to you, it is because you have listened to these or similar/related arguments ad nauseum (over and over) for 12-18 months. The bear case was of course quite compelling last year. This year, the bear case has had few moments to shine.
I do not find it constructive to stubbornly lean against the market’s momentum. Instead, I keep my eye on my favorite technical indicator, the percentage of stocks trading above their 50DMAs (AT50), to confirm a market extreme. Regular readers know the trading rules surrounding this signal after an overbought period gets underway: a convincing fall below the overbought threshold flags the likely end of the up cycle. Small caps are now adding fresh upward pressure to keep market breadth overbought.
Counterpoint from Toggle.ai
The bearish reference to a “feeding frenzy” points to the excitement about AI-related stocks. In its daily email to subscribers on July 18th, Toggle.ai examined the case for a bubble in AI. They came up with a conclusion that initially surprised me but upon examination makes sense:
“Basically, the existing cloud infrastructure can’t yet support a rich ecosystem of commercially viable AI companies, and hence supply of AI investments relative to demand feels like it’s fueling a bubble. The “bubble” we are seeing is just a paucity of available outlets to invest in. Beyond NVDA, MSFT, GOOGL, and AMZN, plays on AI are hard to find.
When it comes to AI bubbles, let alone AI’s tangible commercial impact, we are barely starting.”
If correct, Toggle.ai’s thesis suggests that a flood of artificial intelligence (AI) IPOs should provide the tell-tale signal of the beginning of the end of the “feeding frenzy.” Still, that moment seems a long ways off. Companies just got started in the mad scramble to either figure out an AI strategy or to accelerate existing plans. The companies that enable these AI-capabilities will also scramble to come up with the needed capacities. Just like any shortage situation, the potential AI pressure could push valuations ever higher before a sustained top occurs.
Either way, the pressure remains on the bears absent a new catalyst changes the narrative.
Be careful out there!
Full disclosure: no positions
Addendum:
Also adding pressure to the bears: improving economic outlooks from earnings. From Bank of America’s CEO yesterday:
Bank of America (BAC) CEO Brian Moynihan is dialing back his expectation for a mild recession this year, mostly thanks to the resilience of the US consumer.
“People are working, and they are getting paid more, and they are spending,” the longtime leader of BofA told Yahoo Finance Live on Tuesday. “It’s going to be hard to have a tough US economy because of the amount that is driven by that [spending].”
Moynihan pointed out that his research team sees a “light” recession in the first half of 2024. And given that it will be “light,” the economy won’t feel like it’s in a recession.
“In a broad context across 60 million customers, across $4 trillion of spending, it’s a pretty resilient group,” Moynihan added.
https://finance.yahoo.com/news/bank-of-america-ceo-the-consumer-is-resilient-and-here-is-why-193850783.html
1) I have to concur with Moynihan. My wording: if it looks like a good economy, walks like a good economy, and quacks like a good economy, it’s probably a good economy, so stop wringing your hands and start picking stocks.
2) AI “feeding frenzy”: buy stocks in the companies selling the cooking implements. NVDA is making most of that money, and its stock is deservedly soaring. But cloud vendors like DLR (a data center REIT) have been doing well and have quite a bit of headroom. (I’m not long DLR but I used to be). If you believe in AI long term, Micron (MU) sells memory and storage to data centers and EV manufacturers. It has medium-term headwinds at the moment that are keeping its valuation reasonable.
Reminds me of an article I wrote on buying the picks and shovels in the AI space… 🙂
https://drduru.com/onetwentytwo/2023/05/25/running-with-picks-and-shovels-in-generative-ai-race/