Market Update

The S&P 500 rose 1.6% last week. The index broke through resistance at 4,200 in late trading Thursday. The S&P gapped up at the open Friday morning. Traders were likely hoping resistance would become support. Alas, that didn’t happen as the up-open met selling. The index slipped back below 4,200 after holding above that level for the first 90 minutes of trading.

The 4,200 level represents major resistance. The January rally couldn’t surpass it. The market pulled back over the following six weeks, falling to 3,800 by mid-March. A sustained break above 4,200 opens the door to 4,325, the August 2022 high. The S&P fell from 4,325 to the bear market low of 3,491.58 in October. It’s been in an uptrend ever since. A clean break above 4,200 would confirm the uptrend. The S&P is already trading above its rising 200-day moving average. It is starting to look like the bear market is over.

But it isn’t looking like much of a bull market. The five largest stocks in the S&P 500 have returned an average of 50% in 2023, according to Barron’s. Those same stocks account for almost 80% of the S&P 500’s 8% 2023 gain. Also, the S&P 500 would be down 2% on the year through May 12^th if a handful of AI stocks were excluded, according to Societe Generale data. Instead, it is up 8%. The median stock in the index has gained less than 2%. Less than half of the S&P 500 stocks are trading above their 200-day moving average. It is the narrowest of rallies. And the top five stocks are expensive, trading at an average of 31 times estimated 2024 earnings. The S&P 500 is trading at 17.4x 2024 earnings by comparison.

The narrowness of the current rally is exceptional. It has led to some excesses. Apple’s market capitalization alone is more than the entire Russell 2000 small-cap index. Apple, Microsoft, Alphabet, Amazon, and Nvidia have a combined market cap of $8.7 trillion. That is almost 25% of the S&P 500 market cap. It is 3.2 times the $2.7 trillion Russell 2000 capitalization. The five biggest S&P stocks haven’t been this much larger than the Russell 2,000 since the peak of the dot-com boom in 1999-2000, according to Barron’s.

So, what does it all mean? One logical interpretation is that investors believe the economy will struggle to grow. A lack of confidence in the economy has them hiding in a handful of stocks. The University of Michigan Sentiment Survey hit a 40-year low last June. It is up 27% from that level, but still at levels associated with recessions.

The lack of confidence in the economy has investors worried. Yet they are also afraid of missing out on a rally. So, they are crowding into the few companies deemed “safe” and avoiding everything else. It is those handfuls of “safe” companies that are holding the stock market up.

It seems unlikely that these expensive few stocks can get much more expensive. The soldiers will need to follow the generals higher soon or the market rally will fall. At least that is how it has usually turned out in the past. Broad-based earnings growth is needed for the rally to continue. A broadening of the rally would indicate that investors are anticipating broad-based earnings growth. A continuation of the narrowest of rallies would indicate they are not.

A Few Observations

The following commentary appeared in Barron’s this week. “It’s hard for the market to truly sell off if no one actually owns stock.” The columnist then wrote that U.S. stock exposure in mutual funds is two standard deviations below average. Of course, the columnist’s comment is nonsense. Mutual funds may have less exposure than normal to stocks, but someone holds those shares. Someone buys when someone sells. The total number of shares held doesn’t change unless a company buys and retires stock or issues more stock. If mutual funds are underweight, then pension plans or some other investor is overweight.

Excess Savings

The Fed estimates that households still hold a half-trillion dollars in excess savings courtesy of the Covid relief packages. The half trillion represents more than 2% of GDP. It is a big enough number to keep consumer spending growing through year-end.

Economic Indicators

The U.S. leading economic indicators (LEI) weakened again last week. The LEI was down for the 13 months in a row. The index fell 0.6% after falling 1.2% in March. The LEI is down 4.4% over the last six months, a steeper rate of decline than the prior six-month period when it fell 3.8%. Weaknesses among underlying components were widespread, according to the Conference Board. Only stock prices and manufacturers’ new orders for both capital and consumer goods improved in April. The Conference Board is forecasting a recession. It will start in Q2 and lead to a mild recession by mid-2023.

U.S. retail sales rose 0.4% in April after falling 0.7% in March. Industrial production rose by 0.5% after showing no growth in March. Capacity Utilization was 79.7% up from 79.4%. Housing starts were up in April. Starts totaled 1.40 million, increasing from 1.37 million the prior month.

Existing home sales fell to 4.28 million in April from 4.43 million the prior month. Building permits fell to 1.42 million from 1.44 million. Building permits are a leading indicator. Jobless claims fell to 242,000 last week from 264,000 the prior week.

It's possible that the stock market has already discounted a mild recession. It’s possible that the stock market is beginning to price in stronger earnings growth for 2024. It’s also possible the U.S. will experience more than a mild recession. The swing factor could turn out to be how much credit tightening occurs in 2023. The U.S. banking system is stressed as deposits leave for higher-yielding investments. Banks will tighten lending standards as the cost of their deposits rise. Tightening lending standards will reduce demand.

Estate Planning Complexities

More 401(k) educational sessions last week and more questions. None about estate planning though. People don’t think about estate planning much, especially not compared to investing. It is a serious oversight on their part. Dying without a Will can cause confusion and heartache for loved ones. Living without a Durable Power of Attorney (DPOA) can cause confusion and heartache while you are alive. So too, not having a living will or letter of intent. We see the fallout at Norwood Economics all too often.

A Will can provide clear instructions on who gets what. Clear instructions can prevent fighting among loved ones. A DPOA gives someone you trust the ability to make decisions for you. A healthcare representative appointment allows someone to make medical decisions for you. Trusts are useful in some circumstances. They may make sense for a blended family for instance. Cinderella would have benefited if her dad had created a trust for her.

Many people do no estate planning. Others do it once but never update their documents. Still, others put little thought into picking their representatives. The eldest child isn't always the best choice. Appointing all your children as executors of your Will or attorneys' in fact can lead to fighting, well-intentioned or not. Failing to appoint a guardian for your children can lead to a court battle between in-laws. There is an endless stream of problems that can result from a lack of or bad estate planning.

Why don't more people do more estate planning?

It is avoidance. People don’t like to think about their final days. They don’t want to plan for the end because it is the end. They would much rather discuss the stock market, economy, or who will win the Super Bowl.

And that’s how unintended transfers of wealth happen. An ex-spouse receiving $1.35 million because beneficiaries weren’t changed. Adult daughters and a fourth husband (of six years) squaring off after mom dies. A cancer victim unable to dictate how they want to live during their remaining days. Sisters fighting over whether to sell or keep the family farm. A man inadvertently leaving over $4 million to the state because he lacked a Will and any living relatives.

The stories go on and on. Heartache, anger, greed, concern, and love causing real damage because of a lack of estate planning. Everyone needs at least basic estate planning. Otherwise, they risk fights among loved ones. They risk their own wishes going unfulfilled. They risk losing control of their lives in their last years. Don’t let any of that happen to you. Be prepared by preparing.

Regards,

Christopher R Norwood, CFA

Chief Market Strategist