Coiled Spring Capital Macro Report 12/15/24

We believe it’s time to celebrate. As we enter the final two weeks of the year, the stock market (SPX) has delivered an impressive ~27% return year-to-date, capping off an almost 50% gain over the past two years. That’s certainly something for investors to applaud. Despite relentless handwringing and the constant drumbeat of negativity from the perpetually bearish crowd, staying the course and following the trend has proven immensely rewarding. Bull markets present the best opportunities for investors, and since its birth in October 2022, this one has been thriving—with the SPX surging an incredible ~70% since then.

Some may argue that we are nearing the peak of the current bull market, but statistically, that’s unlikely to be the case. The chart below, sourced from Carson Research, illustrates the probable trajectory of the stock market over the intermediate term.

Here’s another perspective: bull markets tend to endure far longer than most anticipate, making it premature to assume this one will end next year. Currently, we’re 27 months into this cycle, compared to the historical average of 67 months before a bull market concludes.

Yes, valuations are elevated (22x FTM P/E for the SPX), but when has valuation reliably signaled the end of a bull market? As technicians by trade, we find that notion amusing. However, we do acknowledge that elevated valuations can lead to more challenging returns as markets frontload good news, driving prices higher in advance.

As the scatter chart below demonstrates, the relationship between forward P/E ratios and subsequent market returns is anything but consistent. The data is scattered, showing little to no reliable correlation. As Liz Ann Sonders from Schwab aptly states, "The correlation between the S&P 500's forward P/E and subsequent one-year performance — going back to the 1950s — is -0.11, which means there is virtually no relationship." In other words, high valuations alone are not a definitive predictor of market performance.

We approach valuation through the lens of its rate of change. When the rate of change is improving, stocks tend to find support—even in what appears to be a historically expensive market. The bar chart below, highlighting the SPX forward twelve-month (FTM) earnings estimates, underscores this point. It illustrates a clear year-over-year improvement in earnings estimates, reinforcing the idea that an upward trajectory in fundamentals can justify higher valuations.

This does not mean markets are guaranteed to keep climbing. If the P/E multiple contracts for any reason, gains in the SPX may face resistance. Predicting what multiple investors will assign to future earnings is a highly complex and imprecise task, influenced by a myriad of factors. That’s why we focus on simplifying the analysis, grounding our assumptions in the macro inputs driving prices.

The dominant macro factor over the past two years has been interest rates. However, post-election, the narrative has shifted toward the incoming administration’s pro-growth policies. This optimism, rooted in expectations of pro-business and pro-capitalism initiatives, has reignited investor enthusiasm and bolstered valuation multiples, even as the rate trajectory has reversed course since the first rate cut in September.

At this juncture, we see little to derail this momentum outside of a surprisingly hawkish tone from Powell at this week’s FOMC meeting. However, it’s unlikely Powell would risk unsettling markets just before the holidays. He’s acutely aware of the market’s reaction to his late 2018 comments, which triggered a “taper tantrum” and sent the SPX plunging over 20%. With a new administration set to take office in early January, Powell likely aims to avoid starting his tenure with a similar market shock. Of course, this is speculative—but a reasonable assumption given the circumstances.

As we transition into Q1, the landscape may shift. Last week’s inflation reports showed some re-acceleration, fueling arguments for a “hawkish pause” at this week’s meeting. This uncertainty is clearly weighing on the broader market, as reflected in the equal-weight SPX (RSP ETF), which has dropped 10 consecutive days. Testing the bottom of its regression channel and aligning with the 50-day moving average, this marks one of the most challenging stretches for the index since 2018, according to BTIG.

We’ve consistently advocated for a sell-on-strength strategy throughout December, and this approach has proven to be highly effective. While the headline indexes may not fully reflect it, the correction beneath the surface has been notably harsh for investors who are overexposed. The pain has been particularly acute in certain sectors. Below is a snapshot of sector performance since the beginning of December, illustrating the challenges faced by the broader market.

Much of the index’s strength has been concentrated in the Mag 7—a move we anticipated in our 12/1 report when we suggested this group was poised for higher prices.

Now that the market has undergone a stealth correction beneath the surface, is it time to step in and be opportunistic?

For many investors, the final three weeks of the year can make or break their annual performance. If you’ve struggled to keep pace with the indexes, CSC Idea-Tier is here to help you close the gap. Designed to target gains in leading stocks driving the market, it’s your opportunity to finish the year strong.

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