Five reasons why market lows are behind us
Cash mountain signals turning point
Over the past few weeks, we’ve experienced a tactical risk-off rotation in the form of bonds outperforming stocks, and the defensive sectors of the stock market outperforming their cyclical counterparts.1 While those trends may foreshadow another pullback at the S&P 500 Index level – akin to what we saw in December of 2022 or February of 2023 – I believe the primary uptrend (as defined by a series of higher highs and higher lows) should remain intact.
For U.S. stocks to test and fail their October 2022 lows, I think five big concepts, or peaks, would have to reverse course and reach new highs, which I don’t see happening any time soon.
What does a stock market recovery depend on?
In my view, it relies on five peaks, four of which are clearly visible. Moreover, a monetary policy pivot may be on the horizon.
1. Peak fear – My technical checklist of market-bottom indicators suggests investor risk aversion peaked at the end of last year. Peak fear has usually coincided with major troughs in the U.S. stock market.
2. Peak inflation – Headline consumer price inflation peaked in June 2022.2 Pandemic-related supply chain disruptions seem to be easing, with positive knock-on effects for inflation and stocks. I suspect policymakers and investors will be caught off guard by how quickly the disinflationary impulse asserts itself.
3. Peak bond yields – The 10-year Treasury bond yield peaked in October 2022.3 Peak inflation points to lower bond yields for now. Indeed, cooler inflation enhances fixed coupon payments, thereby increasing the value or attractiveness of outstanding debt issues (i.e., higher bond prices and lower bond yields).
4. Peak US dollar – The U.S. dollar index (DXY) peaked in September 2022.4 Generally, strong U.S. currency cycles end when Fed tightening cycles end. U.S. policymakers seem closer to the end than the beginning of monetary tightening.
5. Peak Federal Reserve (Fed) – Since October 2022, we’ve enjoyed a broad easing of financial conditions, helped by falling government bond yields, a depreciating U.S. currency, tighter corporate bond spreads above their Treasury counterparts, and rising stock prices. Together, those trends imply the Fed may soon pause its interest rate hikes.
Unfortunately, cycles don’t die of old age…the Fed kills them with rate hikes! True, recent bank failures are the types of major credit events that end old market cycles. From a different perspective, however, financial crises can also begin new market cycles.
Is the herd right or wrong?
It’s wrong. Ironically, mountains of cash have generally accumulated near big turning points in U.S. stocks.
In my experience, investors can be their own worst enemies, especially when it comes to making asset allocation decisions. Unlike shoppers at department stores, the investment community tends to run away from the stock exchanges when there’s a significant markdown in prices.
Coming full circle, this is just another way of illustrating my first point about peak fear. I know it feels awful, but some of the best days in the stock market occur in the worst of times. As I’m fond of saying, chaos can create opportunities for patient, long-term investors…if they just stay the course.
1. Source: Bloomberg, L.P., April 27, 2023. Bonds represented by the Bloomberg US Treasury 7-10 Year Index, which measures the performance of public obligations of the US Treasury with a maturity between 7 years and 10 years. Stocks represented by the S&P 500 Total Return Index, which measures the performance of 500 of the largest companies in the US. US defensive sectors include the S&P 500 consumer staples, health care, telecommunication services, and utilities indices. US cyclical sectors include the S&P 500 consumer discretionary, energy, financials, industrials, information technology, and materials indices.
2. Source: US Bureau of Labor Statistics as of April 30, 2023.
3. Source: Bloomberg, L.P.
4. Source: Bloomberg, L.P.
Talley Léger is Senior Investment Strategist, Invesco Thought Leadership Team, at Invesco Canada. Mr. Léger is involved with macro research, cross-market strategy, and equity strategy.
Subscribe to Invesco Canada Markets and Economic Insights newsletter.
Content copyright © 2023 by Invesco Canada Ltd. Reprinted with permission.
The opinions referenced above are those of the author as of May 12, 2023. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
The information provided is general in nature and may not be relied upon nor considered to be the rendering of tax, legal, accounting or professional advice. Readers should consult with their own accountants, lawyers and/or other professionals for advice on their specific circumstances before taking any action. The information contained herein is from sources believed to be reliable, but accuracy cannot be guaranteed.
Some references are U.S. centric and may not apply to Canada.
Commissions, management fees and expenses may all be associated with investments in mutual funds and exchange-traded funds (ETFs). Trailing commissions may be associated with investments in mutual funds. For mutual funds the indicated rates of return are the historical annual compounded total returns, including changes in share/unit value and reinvestment of all distributions, and do not take into account sales, redemption, distribution or optional charges, or income taxes payable by any investor, which would have reduced returns. For ETFs unless otherwise indicated, rates of return for periods greater than one year are historical annual compound total returns including changes in unit value and reinvestment of all distributions, and do not take into account any brokerage commissions or income taxes payable by any unitholder that would have reduced returns. Mutual funds and ETFs are not guaranteed, their values change frequently and past performance may not be repeated. There are risks involved with investing in ETFs and mutual funds. Please read the prospectus before investing. Copies are available from Invesco Canada Ltd. at invesco.ca
These are the personal views of the author as at the date indicated, and not necessarily the views of Invesco Canada. The views expressed above are based on current market conditions and are subject to change without notice; they are not intended to convey specific investment advice. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions considered to be reasonable, there can be no assurance that actual results will not differ materially from such expectations.
Products discussed on the Invesco Canada blog page are available to Canadian investors only.
†Invesco Fixed Income (IFI) is a unit comprising Invesco Senior Secured Management, Inc. of New York, U.S, Invesco Advisers, Inc. of Atlanta, U.S.; Invesco Asset Management Ltd. of London, U.K.; and Invesco Canada Ltd. of Toronto, Canada.