The Market Mosaic 11.10.24
The next major bull market phase is underway.
Welcome back to The Market Mosaic, where I gauge the stock market’s next move by looking at macro, technicals, and market internals. I’ll also highlight trade ideas using this analysis.
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Now for this week’s issue…
Investors were on edge heading into a week full of catalysts. But the aftermath of the election and latest Federal Reserve meeting are delivering historic moves for the stock market.
With a gain of 2.5%, the S&P 500 posted its best post-election day return in history (chart below) following a general election that saw Republicans take control of the White House and Senate.
The gains also drove the S&P 500 to its best week of the year. But it’s the moves in other sectors of the stock market that are even more revealing on the market reaction regarding the outlook. Bank stocks surged 12% the day after the election, with the SPDR S&P Bank ETF (KBE) breaking out to new all time highs.
Small-cap stocks as measured by the Russell 2000 Index posted a single-day gain of nearly 6% following the elections, putting small-caps near record highs. High yield bonds that are sensitive to the economic outlook also jumped to fresh highs. The chart below shows fund flows in to ETFs tracking risk-on sectors, which saw the largest jump since 2016.
And it could just be the beginning of the next major bull trend for the stock market. The market reaction to the election is pointing to a strong outlook for the U.S. economy. At the same time, a global rate cutting cycle remains underway and is boosting the liquidity backdrop at a time when growth is already strong. The chart below shows the percentage of central banks cutting rates (blue line) at the highest level since 2021.
The positive reaction from cyclical sectors, an improving earnings outlook supported by economic growth, and easing cycles by major central banks around the world is fueling the next broad-based move higher in stocks.
But the gains could just be getting started. Here are the signals I’m watching that suggests the global capital markets could be in the early stages of the next major risk-on move.
Checklist For A Major Bull Trend
I’m monitoring key signals that the next major risk-on stage is underway across the capital markets. In order to see a broad melt up unfold, there are two criteria that must be met in my opinion.
First, the credit backdrop needs to be supportive for such a move. That means credit needs to be cheap and plentiful, while a positive rate of change in liquidity indicators provides an added boost.
Financial conditions are a way to measure the cost and availability of credit. Looser than average financial conditions are correlated to economic growth, which is also a positive for the corporate earnings outlook.
The Chicago Fed maintains a measure of financial conditions that looks at metrics spanning equity and debt markets. Financial conditions are already loose as the Fed cuts interest rates as you can see below. The zero line represents the average, with a reading below zero pointing to looser than average conditions.
Central banks play a direct role in tightening or loosening financial conditions via monetary policy. As noted above, more central banks are cutting rates than at any point in the last three years.
All this points to an ongoing upswing in the global liquidity cycle. The chart below shows a global liquidity indicator (black line) that continues to inflect higher after bottoming in 2022. Based on the cycle projection (red line), liquidity could keep improving over the next year.
My other criteria for a major risk-on move comes down to chart breakouts. A broad risk-on rally needs to be supported by significant chart breakouts from cyclical sectors or other areas of the market that are sensitive to an improving credit backdrop and demand for risk-on assets.
And not just any breakout will do. These need to be breakouts from major basing patterns spanning time and are ideally rallies out to fresh record highs.
I would argue the last major risk-on phase started after the S&P 500’s correction into October of last year. As the market gained traction a year ago, it was led higher by key breakouts in sectors like housing, semiconductors, industrials to fresh all-time highs.
This time around, leadership is emerging in new areas of the market. In addition to banks and small-caps noted above, Bitcoin is breaking out to fresh record highs following an eight month consolidation (chart below).
During Bitcoin’s basing period, the weekly MACD reset at the zero line while the RSI held support at the 40 level. Those are key momentum resets during a bullish trend, and are in the early stages of turning higher.
This round of significant chart breakouts across cyclical and risk-on sectors are being supported by the favorable credit and liquidity backdrop. That signals the next major phase of the bull market could be underway with more room to run.
Now What…
Breakouts in banks, small-caps, and Bitcoin all look to be in their early stages based on momentum indicators. Here’s another reason it could just be the beginning for small-caps.
The market reaction to the election is pointing to a strong outlook for the U.S. economy. That should boost small-caps relative to large-caps since they derive a larger portion of revenues from domestic sources (versus the S&P 500 of large-caps that get around 40% of revenues from international regions).
At the same time, a Fed rate-cutting cycle is historically more bullish for small-caps than any other market capitalization. The chart below shows how smalls perform relative to mid- and large-caps over various forward timeframes once the Fed starts cutting rates.
Surging performance in small-caps is also boosting breadth metrics. Breadth measures participation in the market’s trend, and ideally you see strong breadth when an uptrend is getting underway.
Looking at 52-week new highs versus new lows is one way to gauge participation. And on the day after the election, net new 52-week highs across the major exchanges rose to the highest level since 2021 (chart below).
It’s also worth noting that the stock market is entering a favorable seasonal period based on several measures. I noted here that the S&P 500 is entering the best three-month stretch historically, which runs November through January.
Bigger picture, we’re also nearing the most bullish year of the decade cycle. The chart below traces the average movement of the Dow Jones Industrial Average by years ending with the same digit going all the way back to 1897. In other words, how did the Dow perform on average in years ending with 1, 2, 3, and so on.
And historically speaking, years ending with “5” rank as the best across the decade. More recent decades with years ending in “5” like 2015 and 2005 experienced sideways volatile trading and don’t really stand out. But 1995, 1985, and 1975 all produced large gains for the Dow.
I’m watching for further confirmation of a bull phase in other segments sensitive to interest rates, credit conditions, and the growth outlook. That includes the SPDR S&P Retail ETF (XRT).
Retail stocks have been trading in a basing pattern since March shown with the shaded box in the weekly chart below. That’s resetting the MACD at the zero line while the RSI is holding over the 50 level. I’m watching for a move over $80, which could target the prior highs around the $90 area.
That’s all for this week. Inflation data will take center stage this week, with updated reports on the Consumer Price Index (CPI) and Producer Price Index (PPI) due. I’ll be watching how recent chart breakouts are evolving, and what it means for the next bull market phase.
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Disclaimer: these are not recommendations and just my thoughts and opinions…do your own due diligence! I may hold a position in the securities mentioned in this report.
AWESOME!
How will the outlook be for commodities like gold nd silver