The stock market remains on its low-volume upward trajectory…as investors continue to somehow think that “bad news is good news” for the stock market. Despite the lower LEI data, another number showing that jobless claims are rising, and an absolutely horrible Philly Fed Business Outlook, the stock market rallied nicely once again yesterday. Of course, the reasoning behind this “bad news is good news” reaction is that if the economy is slowing more significantly that it already had been, it will mean that the Fed will throttle back on their tightening program.
The problem with this reasoning is that the stock market is not cheap. With the S&P trading at 17.5x earnings and 2.5x sales, the stock market has not priced-in a recession. (It has only priced-in the end of an historically massive liquidity program.) The easing-back of a tightening program is not the same as a QE program…and the stock market cannot rally back to the kind of extreme valuation levels that have coincided with these QE programs over the past dozen years. So, unless we’re going to see a big improvement in sales and earnings over the next 18 months…which is highly unlikely given that the economy is deteriorating significantly…the upside in the stock market will be somewhat limited.
That said, even though the upside should be limited, it does not mean that it’s zero. The S&P 500 has reached 4,000, so it has broken above the key resistance levels we’ve been talking about recently. That is bullish for the near-term. Of course, even short-term rallies don’t move in a straight line. Since this week’s strong rally, we might see investors and traders take some chips off the table in front of the weekend. Let’s face it, even the biggest bulls on the Street would have to admit that there are many landmines out there…and one of them could be set-off at any time. Therefore, it wouldn’t be a big surprise if some of them wanted to lower their exposure going into the weekend. Thus, a pullback today would not be a big surprise…BUT it would not necessarily signal that next week will be a tough one for the stock market either. In other words, we certainly could see some upside movement before this bear market rally tops out.
We got some very negative news out of Europe last night…with a much lower-than-expected Eurozone PMI. It fell below the magic 50 level (it was 49.6 vs. a 51.0 estimate and a prior number of 52.0). A number below 50 signals that their economic growth is not just slowing, but it’s actually contracting. This has interest rates in Europe plummeting. The 10-year yield in Germany has fallen to its lowest level since May. This development in the European bond market has caused long-term rates here in the U.S. to fall as well.
This decline in the yield on the 10yr yield note has taken it down to the “neck-line” of a “head & shoulders” pattern. Therefore, a meaningful break below this level should signal that long-term interest rates are headed lower. This might sound like a reason for us to turn bullish…as lower interest rates are usually bullish for the stock market. The problem with this rule is that the exact opposite is true when those lower long-term rates are associated with a recession. Every time THAT has happened over the past 40 years, interest rates and stock prices have FALLEN in tandem with one another…….In other words, if history is any guide, the drop in long-term rates we’re seeing now is actually a bearish development, NOT a bullish one.
Matthew J. Maley
Chief Market Strategist
Miller Tabak + Co., LLC
Founder, The Maley Report
275 Grove St. Suite 2-400
Newton, MA 02466
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