Market Update September 2021 – Anticipation of Participation
Are equity markets climbing a wall of worry? Or are investor actions due to optimism, despite the many items about which they could be worried? The two scenarios of worry and optimism don’t usually fit together but they have been fast friends during this era. Can the markets continue their march upward?
With the S&P 500 Index establishing another new high during August, it continues to distance itself from the initial COVID-related market disruption in early 2020. This era certainly fits the “climbing the wall of worry” paradigm. With a global pandemic, social unrest, political divisiveness and so-on, it would be hard to call this era anything but a time of “worry”. In the midst of this environment, it would be expected that the general opinion would eventually shift to either “relief” as concerns recede or towards greater ‘worry” of a market reversal instigated by a resurgence of the issues at hand. And, not surprisingly, the capital markets now look to be at an inflection point between these two paradigms.
The current “math” for this tension is simple to list but difficult to predict. The most recent culprit adding to the uncertainty camp has been this month’s employment reports. For the most part, these gauges underwhelmed investors by falling well short of expected levels. But this is also emblematic of the difficulties of assessing current economic conditions and data. Did these datapoints fall short because of a lack of hiring? Businesses not hiring would be a sign of caution. Or, was it due to a lack of applicants? This might signal further economic strength with fewer individuals out of work and looking for jobs. The anecdotal evidence supports the lack of applicant’s paradigm. (This may represent the side effects of the necessity for a quick response by fiscal and monetary authorities at the outset of the pandemic. This urgency resulted in officials erring on the side of caution as evidenced by certain programs supporting those out of work, about which many opinions exist. We may see additional job seekers re-enter as these programs expire. Regardless, it is the current state that investors must consider).
In the midst of these considerations, the hard truth may be that its neither the worries nor the optimism. Rather, market action since March 2020 may be most impacted by an effective balance between monetary policy (the Fed) and fiscal policy (government), coupled with generally improving COVID conditions despite flare-ups at times due to a variant or regional factors. (As an aside, we’d like to acknowledge that while the general virus data for the US implies improvement in 2021, it in no way diminishes the difficulty of the path and serious challenges for many of those individuals battling the virus at this time.)
So what does it mean? Since the initial outbreak of COVID, there has been a general trend of reduced disruptions due to the virus, enabling global economies to rebound from the hard shock in mid-2020. Against this background, the recovery has been supported by significant fiscal stimulus measures intended to help individuals and business to bridge the gap of the recovery. And accommodating monetary policy has certainly helped to support this recovery by keeping costs low and ensuring adequate liquidity.
But injecting cash into the economic system, managing interest rates and providing liquidity cannot persist forever. The wall of worry represents sentiment, but at some juncture, the actions of the Fed and government will be unwound. And we will find out if the current market’s climb of the wall of worry connects to a bridge that safely takes us over the currents of unwinding stimulus programs.
CHART OF INTEREST – Anticipation of Participation
Following a long period of market gains, it is not unusual for investors to become concerned over a bull market’s longevity. And as we enter September, a month that has disappointed in the past, concerns are rising. But more important than a single month is the health of the longer-term trend initially established following the strong rebound from the March 2020 low.
While many may have concerns of a resurgence of the COVID virus, the market recovery in 2020 began even while the virus was still relatively uncontrolled. The initial catalyst of the recovery came not from good news on the COVID front, but from the actions taken by fiscal and monetary officials to calm markets while the world adjusted to the pandemic environment. Now, with the S&P 500 more than 30% above its pre-pandemic high, have markets moved ahead of themselves? With recent talk of monetary officials plans to dial back their support (i.e., “tapering”), can the market and economy stay healthy?
While no two market eras are the same, historical similarities can be helpful and may provide insight on current conditions. The early-2013 market reveals some striking similarities with today’s conditions. Following the global market disruption in 2010 and 2011, the Fed intervened by initiating additional monetary stimulus programs intended to help ensure the proper functioning of markets. As the orderly advance reached late 2013, the Fed then signaled that they would begin to “taper” these programs. While first a concern, these actions did not deter the market and it marched higher through 2014. Today, we see similar conditions following a low volatility advance, along with anticipated Fed “tapering”.
The chart below compares these two eras, along with an internal measure of the market participation, the Bloomberg US Composite of 52 week New Highs and Lows (Bloomberg HiLo Index). This index provides a picture of market internals, i.e., “participation”. When the diffusion index is positive, more new 52-week highs have been made than 52-week lows and when the index is negative, more new 52-week lows have been made than 52-week highs. It stands to reason that markets are more likely to advance when new highs outpace new lows and vice-versa.
Looking at this chart, we see a very similar condition today as that in 2013. With the specter of Fed tapering, the market, represented by the S&P 500 Index, did not role over, but rather, markets maintained their health and continued the orderly advance (top clip). And internally, as evidenced by the Bloomberg HiLo Index (lower clip), the market internals remained healthy as the index’s 14 day moving average remained above the zero line never moving into negative territory. Looking at today’s market, recent volatility remains well within the current trend’s channel and the Bloomberg HiLo Index continues to reflect more new highs than lows.
While the ratio has declined, it remains positive and supportive as in 2013. While one gauge alone will not tell the full picture, this measure of breadth is one piece to watch for evidence confirming the current trends.
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