Coiled Spring Capital Macro Report 9/22/24

For all the criticism aimed at Powell and the Fed over the past few years—first for missing the inflationary surge their loose policies helped create, then for potentially holding rates too high for too long—perhaps it's time to reconsider. How many pundits, after endlessly promoting their market predictions and stock picks, ever step back and apologize when they get it wrong? Very few, we'd say. We live in an era of bold proclamations and sensational predictions, but rarely do they come to fruition. Maybe it's time to change the narrative. Perhaps the FOMC was right all along.

Despite unprecedented money printing following the Covid crash and a spike to 9% inflation, the Fed responded decisively, and the U.S. economy has yet to experience a significant downturn. In fact, they may have pulled off what many thought was impossible: a soft landing. The economy continues to grow, unemployment remains low, and the stock market is hitting new all-time highs. Credit is due where it's deserved. Steering the massive U.S. economy is no easy feat, and while no one can be right all the time, the Fed’s handling of this situation warrants a round of applause.

Our 9/15 report suggested the FOMC would be the catalyst to send the market to new ATH’s:

Last week, the Fed officially ended the fastest rate hike cycle in history, surprising the world with a supersized 50 bps rate cut. The reception by the stock market was originally cheered, but the enthusiasm was worn off by the end of the day. The reversal brought all the bears out of hibernation, who had continuously pounced on every stock market failure since the bull market began in Oct ‘22, only to be shoved back into their cave in short order. Their misfortune continued the next day as the enthusiastic unwind was violently reversed.

We wrote about this very phenomenon in our 9/18 mid-week report. We explicitly said not to draw too many conclusions from a notoriously over-hedged Fed Day.

Here is the excerpt from the report:

“Fed days are notoriously tough to navigate because of the massive hedging and derivative exposure surrounding these events….It's hard to glean the true direction of the market from this kind of activity, as the real moves often come a day or two later.”

We couldn’t have scripted it any better as the SPX gapped up on Thursday to forge a new ATH, trapping overzealous bears again.

As technical analysts, we believe that daily charts can be noisy, and long-term charts can better assess the true direction of the dominant trend. Our interpretation of the post-Fed reaction was simply a “sell the news reaction” after the SPX was up seven days in a row.

From the 9/18 report:

In the report, we laid out various scenarios for possible follow-through weakness in the indexes, none of which transpired. This moves the goalposts to assess future market trajectory, which we will discuss later in the report.

We also wrote this in that report:

“…unless September’s lows are breached, we view any weakness as a corrective move to shake off the pre-FOMC enthusiasm.”

So, where does that leave us? Bears will continue pointing to a Fed that is aggressively cutting rates, which historically has preceded downturns. This is only true if we are headed into a recession. Here is a chart from Fundstrat showing SPX returns in a scenario for “no recession.” Three months after the first rate cut, the SPX is up every single instance. This implies that we have not seen the ATH’s for the year.

Would the number of stocks outperforming the SPX look like this if we were headed into a downturn? We’d say the opposite.

Last week's new ATH on the S&P 500 was accompanied by an expansion in the number of stocks making new highs. The 10-day average of new highs is now at its highest level in 3+ years, according to @WillieDelwiche. This sort of breadth advance is bullish and argues for higher prices.

According to Ned Davis Research, when over half the world’s central banks are cutting interest rates, it’s bullish for stocks globally.

We are also entering unchartered waters, where the Fed is cutting rates into an earnings expansion scenario. Typically, they are cutting rates to stave off an economic slowdown, which favors defensive sectors (consumer staples, healthcare, utilities).

But since the Fed is now cutting rates into an economy that is slowing but still growing, we think that playbook might suffer.

We’ve been advocating for a rotation into other sectors of the market—small caps, cyclicals, and select lagging tech stocks. Last week, hedge funds significantly increased their exposure to US technology, media, and telecom stocks, marking the fastest buying pace in four months, according to Goldman Sachs. While it’s too early to call the full impact, we anticipate a shift out of defensive sectors as investors become more aggressive, particularly as we move past the phase of negative seasonality.

According to Ned Davis, this week, we are entering the difficult part of the pre-election seasonality window. It is also the end of Q3, and we should expect increased volatility this week as quarter-end rebalancing will be in full swing.

Markets do not move in a straight line, and a bullish end-of-the-year setup may still produce better entry points.

Let’s review the charts.

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