In August we mused about a historic bullish market script that would likely see markets close the year on a positive note with the view that the August lows would get retested with either a higher low or marginal new low during the traditional weak period of September/October.
Markets indeed made a new marginal low in early October of -3% vs the August lows as rising yields and dollar offered justified concerns and expanding volatility. Yet with a larger rally emerging from the early October lows market appeared to follow indeed the historic script.
Then the unexpected attack by Hamas on Israel threw the bullish script off track and crash calls became the theme of the day contributing greatly to fear and risk off behavior. Asset managers radically reduced exposure culminating in a 10% correction since the July highs for a move of 4.5% below the August lows with a seeming breakdown on indices, such as $SPX losing its daily 200MA, and the weekly 50 and 100 MAs.
In short: The bull case seemed off base or at least severely stress tested by a new geopolitical event. But while participants appeared in panic mode positives kept lurking underneath the market as well as the prospect for a historic runway for markets that is indeed bullish at least in the short term.
Before we discuss the historic market runway let’s followup on the positives highlighted on October 25th. We outlined a number of key charts that suggested a coming shift in market trend.
Arguably suffering the most in 2023 from the high yield regime have been financials and by extension small caps and banks. And when the weakest show sudden positive on the charts it makes sense to pay attention:
Today the banking index made another new low whilst maintaining the positive divergence and against market weakness showing relative strength with a daily wick into close. Context above.$BKX pic.twitter.com/Q0B7B5WEaE
— Sven Henrich (@NorthmanTrader) October 25, 2023
And since this divergence we’ve seen massive follow through:
Related to banks one of these key charts was that of high yield credit. While plenty of calls for an imminent credit event persisted the chart suggested a coming positive move in form of a positive divergence and bullish falling wedge:
A week later here we are rendering immediate credit event worries invalid:
Both these moves were presaged by rumblings in yield land on October 20th as $TLT was showing signs of capitulation amid a positive divergence:
— Sven Henrich (@NorthmanTrader) October 20, 2023
Here’s the chart updated now seeing sizable follow through on the positive divergence and offering the prospect that yields have possibly peaked in this cycle:
The sudden reversal in yields an important milestone in market cycles and it couldn’t have come at a better or worst time depending on your positioning.
Asset managers had sold out hard:
Yikes. Asset managers have puked out of positions for the lowest asset exposure of 2023.
Nobody is positioned for a rally. pic.twitter.com/qpRXazzMbd
— Sven Henrich (@NorthmanTrader) October 26, 2023
And market fear was rampant:
I’ll see y’all at Extreme Greed.
Have a good weekend everyone. pic.twitter.com/5I2EeZW1Qv
— Sven Henrich (@NorthmanTrader) October 27, 2023
In short: The perfect ingredients for a counter rally as the Line in the Sand appeared broken:
But would it be a “sustained” break for the breakdown brought $SPX to a historic point of confluence support as I outlined this weekend in Coiled Spring:
This support has clearly held and served as a rallying point as yields reversed:
Reversing the technical break from last week with ferocity:
A move so swift it appears to have been missed by said asset managers:
— Sven Henrich (@NorthmanTrader) November 3, 2023
All of which offers the prospect that last week’s down move was a bear trap:
Leaving the discussed historic path to new highs, which was challenged last week with the break of the uptrend, still intact as the break has been reversed this week:
As markets, while now short term overbought, still structurally vastly oversold and asset positioning remaining extremely low. This is in the face of a historic market runway that appears very much ignored at the moment.
What is the historic market runway? Initial relief from a peak in yields in major cycles:
What tends to happen when the 1 year yield has peaked in a cycle?
Recessions with severe consequences can follow, but even if a recession comes markets often have a runway to run first before that happens. Could be months, could be years.$SPX
Monthly chart: pic.twitter.com/mTn702G9eS
— Sven Henrich (@NorthmanTrader) November 2, 2023
But the yield curve is re-inverting does this not mean bad news for markets? I was asked about this yesterday, my response:
Makes new all time highs first or trades to near the highs during the re-inversion process before a recession unfolds.
That’s at least what the last 50 years of history shows. https://t.co/AsGv6vjYpG pic.twitter.com/HBD6hvBDI0
— Sven Henrich (@NorthmanTrader) November 2, 2023
That’s the history. I don’t know when a recession unfolds and the market landscape is littered with corpses calling for a recession this year.
A recession may indeed unfold and we will know when the labor market cracks. After all signs of a slowing in the labor market is now becoming more apparent with today’s jobs report.
But timing is everything and as long as the market has a sense that yields have peaked we may well see the historic market runway take off.
That doesn’t mean the risks have dissipated and there won’t be pullbacks, but on balance bears have once again failed to make their case as critical support once again held and volatility was again reverted below the bull/bear divide trend line by the end of October:
This despite a new war with broader geo-political risk served on a platter.
And this actually raises a much broader question about recession risk, history and all the bad news that has permeated the landscape.
Thousands are dying in the new Israel/ Hamas war, hundreds of thousands in fact have died in the Ukraine war, it’s terrible. But what does history show? Tens of millions died in the worst war ever, World War II, and it did impact markets dramatically in the beginning, but while millions died and with the war far from over markets bottomed in 1942 years before the war ended:
Why? Massive government spending to fund the war, industrial production, you name it:
This chart above not updated for the 7%/8% deficit vs GDP the US government is currently running which is, outside of the Covid crash and the GFC, the largest deficit since WWII. It really makes you wonder about the sheer size of the fiscal impulse that’s running through the system and its implications.
Much has been made about a coming debt crisis as higher for longer and increasing interest payments on debt make the math seemingly unworkable. And I agree, it makes little sense hence my musings on the issue the other day:
Hear me out: The Fed is done & may actually have to cut rates sooner than anybody expects.
The US government’s torrid debt spree ($600B+) in just the past month alone has exacerbated the move in yields due to supply/demand imbalances.
As inflation has been coming… pic.twitter.com/niAsljRMa6
— Sven Henrich (@NorthmanTrader) October 19, 2023
But if you thought all the bad news that was running through the world in 1942-1945 was a reason to be short markets you got your head ripped off. And what happened with markets when fiscal impulse was running through the system as a result of the GFC and Covid? They rallied like bastards.
And so yea, all of a sudden I’m pondering something perhaps nobody has considered, maybe because nobody is mad like me 😂, but what if it’s not 2008, not 1987, not 1929, or any other scary analog, but what if it’s 1943:
80 years later a similar structure and some similar world events although fortunately at a much smaller scale, but still.
What triggered the recession in 1946 after the war when you would’ve thought all the good news of the war ending would produce nothing but happy markets? The end of the fiscal impulse. What then triggered the new bull market was the baby boom and many more consumers to come. We don’t have all this now, but what we have in the here and now is massive fiscal impulse with no end in sight it seems.
The very speculative implication: Perhaps recession risk will remain on the back burner leaving markets a much longer runway than any of us currently think. Let’s not forget there are big agendas at work and the powers that be are paying attention:
Narrator: They’re totally gaming it. https://t.co/FqamgGQ2bb
— Sven Henrich (@NorthmanTrader) November 1, 2023
After all next year is an election year and it’s no accident that Janet Yellen already has a Treasury buyback program planned for 2024 to “add liquidity” to the Treasury market. Already she’s on the record stating that “higher for longer is by no means a given.”
And if lower yields are on the agenda the market runway has a lot of room to run supported by given current positioning, oversold signals and structural pattern charts.
When do we know this bullish assessment is wrong? With an $SPX monthly close below the monthly 20MA and 40MA.
But even then bears don’t necessarily have proof for only a close below the yearly 5 EMA would point to structural bear market, something that bears failed to accomplish even last year:
On this premise there simply isn’t evidence of a structural bear market at the moment. Perhaps that will change by year end, but for now signals, positioning, history and price action suggests there is potential for the historic market runway to still unfold, but bulls too have a lot to prove as ultimately new highs above the July highs would be required to prove the case.
I’d say it’s fair to say that the case for a historic market runway to unfold would surprise most as AAII sentiment has collapsed since the July highs:
And market positioning is reflecting this. One week of rallying does not make for a confirmed low, but I think it’s fair to say the ferocity of the rally this week has caught many by surprise. But if you look at the history of the market runway perhaps it’s not a surprise, but rather a consequence. The next few weeks will tells us more.
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Categories: Market Analysis