Overview- The last 2 years have been full of surprises in all markets, and this year may well hold a few more. We wanted to highlight several market factors that help influence the composition and allocation in our portfolios. Below is a brief synopsis of the key factors we evaluate when assessing the health of the market. The chart package that follows illustrates each component.

Valuation- After moving higher last year the US equity market is not cheap, and it is most likely expensive. However, rich valuations are never a sell signal on their own. Markets can stay expensive for long periods of time, and less frequently, they can be attractively valued and get cheaper. Current rich valuations, an uncertain economic and geo-political backdrop, and attractive less risky alternatives like bonds, suggest that risk mitigation and diversified balanced portfolios are key for the next 5 years as the ride could be volatile.

Economy- After avoiding a certain recession, which was priced into US equity markets at the start of 2023, there are currently more signs of slight weakness than strong growth in the global economy. This backdrop is being interpreted by market consensus as a soft landing. Time will tell, but this is more of a hope or guess, not what the weight of the evidence says. However, this backdrop is supported by historic data which generally supports the notion that the market does not need a strong economy to rally. In fact, the market almost always leads what the economy is doing. The economy is no more than confirmation of a likely already existing trend in the market. What this means is that we want to see signs of evolving strength to confirm the existing trend. Until we see that, we view the economy as a modest negative.

Inflation/Rates- Inflation is trending in the right direction – this is a clear positive as inflation has come down below the danger zone of 4%, and rates have finally started to fall. While inflation dropped below 4% in June, it wasn’t until early December that rates broke below the former uptrend and are now in a downtrend. These are unabashed positives for the market. More than anything, the market is a discounting mechanism that is greatly affected positively by lower interest rates and the equity market has reacted positively. This is another example of the market moving ahead of a decline in inflation and rates. It is a clear confirmation of an emerging intermediate rally.

TrendBy almost any measure, the market is showing clear signs of an uptrend. The market broke above its 200-day moving average in November. Since November, the market rally has been confirmed by other measures of trend strength. This is the clearest sign of an intermediate rally, and the factor we weigh the most in our thinking. The real question is whether the Magnificent 7 Growth/Technology leaders continue to hold sway or will the rally broaden into the lagging areas of the market. 

Sentiment – Markets do not move on the news of the day; they move on surprise events that are not already discounted into the current market narrative. There are many ways to measure if market participants are too bullish or too bearish. When the market is too bullish it is susceptible to a pullback; when participants are too bearish, it is susceptible to a rally. What we have seen since the spring of 2023 is far too much bearishness on the part of investors. Bearish sentiment was already priced into the market with the violent move down in 2022, and the unwillingness to invest at oversold conditions, paved the way for a rally in 2023. As we look at market metrics now, we do not yet see significant signs of overbought bullishness, which normally suggests the market could be topping. Given the current economic and geo-political backdrop, we do see signs of short-term overbought conditions on the rally since the start of the year. We now have an equity market that is in a confirmed uptrend that should likely continue in the intermediate term but could pause in the short term.

Conclusion- After the strength last year, and a good start to 2024, the weight of the evidence is mostly positive. We are nearly fully invested and will continue evaluating all market factors in real time to confirm the continuation of the uptrend while looking for signs of a change in market character, or leadership, which may suggest a break in the uptrend, or increase the prospect for a new downtrend. We will adjust the portfolio as market events play out.

The following charts highlight the factors discussed above.