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In the heart of every market lies a fierce clash between bulls and bears, where optimism battles pessimism and greed contends with fear. Buyers and sellers engage, and their sheer will is one of the most important factors driving the markets. The market itself is a complex ecosystem with many players, but at the end of the day, it’s fear versus greed that is a fundamental aspect of market dynamics. For every transaction, there is a buyer and a seller. The bulls are greedy and optimistic about the future growth outlook. The only reason they are buyers is that they expect to sell at a higher price. In contrast, the bears are a dour bunch. They’d rather sell now and get back in at a cheaper price.
This battle reflects the constant struggle between optimism and pessimism. As investors, we all know it well. Driving these emotional swings are market fundamentals, economic indicators, and geopolitical events, just to name a few. It’s an essential aspect of price discovery, but drives volatility and creates opportunities for investors. At any point in time, there will always be conflicting signals, either pushing markets higher or pulling them lower. Table 1 below summarizes just a few of these conflicting forces.
The dynamics of these forces, and which one is perceived as stronger, often create contrarian opportunities for investors. When market sentiment becomes excessively bullish or bearish, it may present opportunities to take the opposite stance and capitalize on potential market reversals. Embracing and effectively navigating conflicting signals can enhance investors’ ability to achieve their financial goals in an ever-changing market environment. Unfortunately, reading the tea leaves is often more of an art than a science.
The S&P 500 recently cracked through to a fresh record high. It took a total of 513 trading days to make the round trip – 195 days for the market to fall -25.4% and bottom on Oct. 12, 2022, and 318 days to claw its way back to the previous high-water mark struck just over two years ago. It then went on to set several higher highs in January. Despite the conflicting forces, the market has continued to run like a juggernaut.
The historical precedents are promising. Forward returns are pretty decent on average after striking an all-time high, especially following such a long period between highs. Usually, once a new level has been hit, markets tend to cling to it. For those with cash on the sidelines waiting for a decent pullback, patience has not been a very profitable virtue.
The S&P/TSX Composite Index continues to lag but is a mere 4% away from its previous high set in early 2022. The Nasdaq, which continues to get most of the attention, rightfully so, thanks to its 53% rise from the depths of the 2022 selloff, is just 3% from its highs. Large-cap is winning over small once again; the Russell 2000 is still 20% below its 2021 peak. It would seem that there is a party in the market, but not everyone is invited.
Even the most ardent optimists have reason to be twitchy. Year-to-date attribution for the S&P 500 is quite thin and top-heavy. Most, if not all, of the heavy lifting is thanks to big names such as Nvidia, Microsoft, and Meta. The “Magnificent 7” is getting culled, with members getting kicked out of the saloon. Tesla is down 26% year to date, Apple is negative, and so is Alphabet following earnings.
The narrow breadth of a top-heavy market is not necessarily a problem. It is certainly not a brand-new phenomenon. But it does pose several challenges. We’re seeing concentration risk in action, and investors should be keenly aware of how quickly the positive tone can unravel.
At the close of 2023, bond yields eased, and equities had a broad-based rally. The overwhelming narrative is that peak rates are in the rearview mirror, and markets were looking forward to a cut. It still seems like markets got a little ahead of themselves with this excitement. We’re in the plateau period of a rate hiking cycle. The plateau can continue for some time and is usually when previous hikes catch up to the economy and wallets of consumers.
Currently, there is a 66% chance of a rate cut in May and an 87% chance in June. The market is in the process of severely dialling back and delaying the cut timeline. It’s changing by the day. At the beginning of the year, the market was pricing in an 84% chance of the first cut happening in March. The odds of a cut in March have been all but eliminated by the market. It was trending in that direction, but Powell’s post-FOMC conference all but eliminated that chance. The first cut will likely be in June. The chart below shows the doves taking hold of the market from October to December but losing control at the turn of the year, with rate-cut expectations being pushed further ahead.
Investors and analysts have been obsessed with guessing when and how many times the Federal Reserve would finally cut interest rates. All the guesses and market odds were largely wrong – and will probably continue to be. That doesn’t change the fact that these expectations have great power and have the ability to move the market.
Why cut when the economy seems to be doing better than expected, even with rates at current levels? For one, inflation does not seem to be a primary concern anymore; inflation swaps have fallen to nearly 2%. Inflation expectations are markedly lower than they were over the past few years. If the Fed were to keep rates where they are, in “real” terms it effectively means policy has continued to tighten the past few months. This isn’t necessary, as inflation is moving in the right direction. Politics, of course, also enter the conversation, with it being an election year in the U.S. Not to say anything about the Fed’s credibility, but we’re sure this enters the thought process.
In their own words, rates are “sufficiently restrictive,” and a few rate cuts don’t mean they are afraid of a recession; it’s simply a return to what they view as a normal policy rate or R-star. They will, of course, carefully assess incoming data, the evolving outlook, and the balance of risks.
Expectations for the Bank of Canada are similar. They will remain quite restrictive for much of this year. Following the Fed is likely, but perhaps a few months delayed if inflation pressures ease as expected. Should the economy continue to slow, the cuts would be pushed ahead. Cuts, in this instance, would not be good if it were due to signs of economic distress.
From our perspective, the greatest peril right now is the assumption of a seamless transition or perfect landing factoring into market valuations. The markets have sailed full speed ahead; however, they might not have charted the waters for anything but smooth sailing. The data decidedly remain mixed; there are green shoots and darkening clouds. Markets remain focused on the positive for now. Even the credit market has seen spreads setting new lows at the end of January. The bond market is near sanguine, with the lowest credit spreads since the last time the S&P 500 made new highs.
However, our base case still points to a probable recession in 2024. If we put our Bayesian thinking caps on, the probability of this outcome is fluid and shifts as new information becomes available. The Teflon consumer has, for now, resisted any lingering residue from higher rates to sap demand. The economy can change quickly, as we’ve seen many times in the past.
Next time: We delve into the current earnings season to assess trends and what they mean for investors.
Craig Basinger is the Chief Market Strategist at Purpose Investments Inc. and portfolio manager of several Purpose funds, including Purpose Tactical Thematic Fund. Derek Benedet, Portfolio Manager at Purpose Investments, and Brett Gustafson, Analyst at Purpose Investments, contributed to this article.
Notes and disclaimer
Content copyright © 2024 by Purpose Investments Inc. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the “Market Ethos” page of the Purpose Investments’ website. Used with permission.
Charts are sourced from Bloomberg unless otherwise noted.
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