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- The S&P 500 posted a clean breakout last week to new records after surviving a July momentum stock bust and basically churning in a 3% range for nearly three months.
- The liquidation of the hedge fund Situational Awareness after its leveraged AI-hardware positions unwound was exactly the sort of offering to the market gods that frequently puts in a market low.
- Still, there needs to be recognition that the highs achieved by those momentum stocks in the second quarter came from massive leverage and crowding that won’t quickly return, not from pure fundamental improvement.
- Sources of mine such as the ‘mystery broker’ David Snyder and Tim Hayes of Ned Davis Research warn that stocks are showing some market topping behaviors.
Market Memo
The predominant condition of the stock market across all relevant time periods is “up.”
The S&P 500 index has posted a positive return in more than 70% of all calendar years and better than 60% of all months, building on a 54% daily win rate. It’s far more common for stocks to be up 20% or more in a year than for them to decline by any amount at all.
The S&P has hit an all-time high on 7% of all days since 1952, including three times last week, culminating in Friday’s rally above 7750 on a soggy jobs report that dampened concerns that the Federal Reserve would soon need to lift interest rates.
This history is well understood, right? The fact that the stock market favors the bulls more often than bears is the very premise of the investment industry. It’s further been established that investors who check and tinker with their portfolios less frequently outperform over time.
So why do those of us who cover markets and those who participate in equities spend so much time scrutinizing the market’s vital signs, scanning for potentially unhealthy irregularities and metabolic disturbances?
For one thing, the exceptions to the prevailing rule of rising markets tend to hurt, and the idea of sidestepping them is, for many, irresistible. The market’s message is often beguiling and inscrutable, with frequent overshoots and crowd-humiliating turnabouts that would be so satisfying to see coming in advance.
As my friend Ed Borgato, a veteran fund manager and longtime Berkshire Hathaway follower, once wrote, “Getting on the right side of a trend and then just doing nothing is a hard trick for the educated/ambitious minds most attracted to this game.”
But there’s a more practical reality at play, too. Risks are ever-present and the stakes – retirement, quality of life – are consequential.
Investors recognize that the good returns enjoyed by equity owners are – or should be – compensation for shouldering a genuine hazard of interim loss. As the poet-philosopher of New Jersey sang a half-century ago, “To get to Candy’s room, you’ve got to walk the darkness of Candy’s hall.”
For all the reassuring statistics about stocks’ long-term win rate – which gets to 100% over any past 20-year span – most investors should probably expect to experience a “lost decade” of lousy performance over the course of a lifetime.
Even the more routine setbacks, such as the nine-month cyclical bear market of 2022, take an investor back in time. And what causes more regret and rumination than lost time?
S&P 500’s clean breakout
At the October 2022 low in the S&P 500, the index sat where it had two years earlier. This means a skeptic who fought the crowd by sitting out the exuberant, bear-gutting rally of late-2020 to late-2021 was redeemed and granted an allotment of bragging rights (which expired almost immediately).
Then came ChatGPT, a false recession alarm, a peak in inflation, the anointing of the Mag 7 and, eventually, last week’s three fresh all-time highs.
The S&P 500’s clean breakout to new records after churning in a 3% range for nearly three months could hardly have been scripted any better. A July crash in momentum stocks and pressure on the mega-cap tech platforms paying for the AI buildout was offset almost to the penny by strength elsewhere, the majority of stocks gaining on the index leaders.
The energy for the index’s final thrust out of the trading range was provided by the negative, confused market response to Federal Reserve Chairman Kevin Warsh’s intentionally cagey July press conference. The market likes nothing better than a scare-and-relief sequence to get itself unstuck.
The bears had an opening to inflict more aggregate damage, to seize on the erratic flows of an over-intense “dispersion trade,” and couldn’t.
From a high altitude, it’s fair to observe that it’s hard for stocks to get into deep, lasting trouble at a time when 2026 corporate earnings are tracking to rise an astounding 30% over last year, when nominal GDP growth exceeds 6%, some $750 billion is spilling into the economy via partly debt-financed AI capex and corporate-bond spreads are benign.
We can pick apart each of those attributes, of course. There is at least a fair risk that companies are “over-earning,” pulling forward demand and gorging on fleeting pricing advantages.
Trader sentiment has reheated quickly, too, based on measures from Market Vane and Bank of America and in the options market. This doesn’t cost the bull market the benefit of the doubt, but the wall of worry has worn down a good deal.
And a huge chunk of the S&P 500’s 47% second-quarter earnings growth – nearly 20 percentage points of it – came from unrealized gains totaling $140 billion from investments by Alphabet and Amazon in Anthropic and SpaceX. The market will neither extrapolate nor put a multiple on such extraordinary third-party investment windfalls.
Market gods satisfied?
Is there still unfinished business in rationalizing the excesses of the semiconductor surge, which formed the core of the momentum-stock frenzy?
The liquidation of the hedge fund Situational Awareness after its leveraged AI-hardware positions unwound was exactly the sort of offering to the market gods that frequently puts in a market low.
So many observers chalk the 25% semiconductor retreat and more severe downturn in the memory-chip leaders as mere “positioning” adjustments after a strong run. Yet along with this should come the recognition that the highs achieved by those momentum stocks in the second quarter came from massive leverage and crowding that won’t quickly return, not from pure fundamental improvement.
Jeff DeGraaf of Renaissance Macro Research, who was early in calling the momentum trade a bubble in the spring, points out that $100 placed in the long-short tech momentum strategy at the June peak is now worth $61. The average path of such busts would take that to $41 in a year, after some short-term recovery.
It’s so adorable that the momentum trade sprang largely from a “scarcity of memory,” because eager dip buyers tend to forget how payback often works.
Market Temperature Gauge
This indicator from John Kolovos of Macro Risk Advisors “blends numerous data points that capture both what investors are saying and what they are actually doing.”
After July’s momentum wreck, bullish market sentiment retreated from extreme levels, setting the table for last week’s upturn.
Market on Close
Structural Weakness?: I mentioned above that history says to expect a “lost decade” of meager stock returns at some point across an investing lifetime. David Snyder, founder of Journey 1 Advisors and formerly known only as my Mystery Broker source, does not need to be reminded.
Having entered the business in the 1970s and shepherded clients through the post-2000 tech-wreck and then the global financial crisis, he has lately been fixated on the prospect that the secular bull market that began in 2009 is in its waning phase.
Since the reveal of his identity on CNBC last December, Dave now posts his market views actively on X and LinkedIn, including this take from late July. He is slated to come on Closing Bell Overtime this week to elucidate his outlook.
Ned Davis Research chief global strategist Tim Hayes also maintains a Secular Bear Watch model meant to foretell equity ice ages. His conclusion in an update last week: “The report is not indicating that a secular bear has started…But there are a few consistencies to be aware of, along with historical extremes warning that the market is overbought, overowned and overvalued. That also described market conditions before previous secular tops.”
Tasty Waves: On Thursday, we mark the anniversary of my favorite historical moment of cultural convergence.
On Friday, Aug. 13, 1982, two epochal events occurred. The greatest bull market in history began. And “Fast Times at Ridgemont High” opened in theaters.
Together, I insist, they marked the start of the 1980s as we’ve come to think of them. (Credit to fund manager and newsletter writer Eddy Elfenbein for first alerting me to the coincidence years ago.)
The Reagan bull market got going as inflation, finally, entered a persistent decline and Salomon Brothers market-whisperer economist Henry Kaufman declared that Treasury yields had peaked. Eighteen years of superb equity returns, enlivened capital markets, valuation expansion and democratization of equity ownership followed – interrupted by the savage crash of 1987, which bruised an investment generation’s psyche more than it impaired their portfolios.
“Fast Times” was where a Generation X youth ethos and mall culture were introduced and a fresh mode of filmmaking, interlaced with current pop music and featuring upstart stars, emerged.
There are almost no adult characters in the film. GenX was the last generation that was truly impatient to grow up, even if it was to reject the template of adulthood that Boomers seemed to have rigged for themselves.
Both phenomena took hold with little notice.
The Dow Jones Industrial Average gained a tidy 1.4% that Friday in August 1982, though it was coming off a bear-market low of 776, a level first reached 18 years earlier, after more than a decade of false starts. “Fast Times” opened in a mere handful of theaters on the West Coast, the studio doubting it would find an enthusiastic audience, before going wide and becoming a massive hit on home video.
When the major inflection points come, you won’t see them clearly in the moment.
Around the Street
– An important read on younger people’s active stock-trading habits, and how dissatisfied they are with the results. Fits well with the breakdown in Robinhood’s earnings presentation showing its clients collectively woefully underperformed the S&P 500 in the year ended June 30. (Bloomberg via Yahoo Finance)
– Fund manager Eric Peters of One River Asset Management has for nearly two decades sent a Sunday “weekend notes” dispatch with market observations often focused on broad macro dynamics, investor psychology and the market’s penchant for periodic ruptures.
– The chaos afflicting the restaurant-reservation ecosystem – with multiple middlemen services, third-party players stepping in front of the public and distrust with publicly displayed information – evokes the cacophonous equity-trading landscape of 10 to 20 years ago, as electronic venues fragmented the flow among willing buyers and sellers. (Wall Street Journal)
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