Chart(s) of the Day: March 2, 2023
Are U.S. stocks heading higher or lower?
In today’s Chart(s) of the Day we take a quick look at some of the necessary ingredients for a intermediate term rally in the stock market.
First, let’s look under the hood of the market with another update on my custom, Aggregate Risk On vs Risk Off Index, see Figure 1.
The Risk On vs Risk Off Index is shown in Figure 1 with its 200 day moving average. The index broke below the 200 day in January 2022 before bottoming in the first week of July. Since that point it has been forming a series of higher lows before finally breaking out above resistance in early-February — setting a new, higher high and formally beginning a new uptrend. The index is also now trading above an upward sloping 200 day moving average — a sign of an uptrend.
This is bullish. It says money flows within the equity and fixed income markets have shifted from risk averse to risk seeking. This is the behavior you should expect in an environment supportive of risk asset prices.
If funds are flowing into risk assets — the next question you should ask is, “how long can this possibly last?”.
Figure 2 comes to us from Bank of America. It looks at a combination of growth expectations, cash allocation, and equity allocation to form a measure of investor sentiment. Currently, investors remain extremely pessimistic. Pessimism is fuel for rallies in risk asset prices IF investors are actually positioned as pessimistically as they’re thinking.
Figure 3 displays the results of Bank of America’s most recent fund managers survey (FMS). This survey is a way to measure what trades may be over- or under-crowded. Equities now hold the lowest spot on the list — suggesting that investors are positioned according to their sentiment. They’re pessimistic and they’re currently underweight equities.
Should economic data begin to be released that suggest an unexpected slowdown in the economy or weakening of the labor market, it could be perceived by investors as an improvement in future inflation expectations. If the bond market prices in a more dovish Fed the current underweight positioning by fund managers in equities could be reversed and provide fuel for an intermediate term increase in stock prices.
Figure 4 provides a forward view of the U.S. economic calendar for the next week.
All of this said, U.S. equity valuations remain high and while markets can rally in the short and intermediate term based on changes in sentiment and positioning, long-term equity returns are driven by valuations — the price you pay for assets. This was discussed in yesterday’s Chart of the Day.
Figure 5, from The Daily Shot, provides another way to view the current overvaluation of U.S. stocks.
So, while the ingredients are present for a short to intermediate term rally in risk assets — long-term market returns are likely to remain capped until U.S. stock market valuations have a chance to reset lower and provide investors with a significantly better price than is available today.
— Brant
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