Bear Sightings

In the last market update we discussed looking for signs of a bear market. Well, a few weeks ago we got our wish and the bears showed up. In the span of a little over a week the markets got slammed with a 6% drawdown. However, the bulls licked their wounds, regrouped and clawed back most of the losses since then. The bear raid did spook some investors though; volatility picked up significantly and the VIX (fear index) shot up. It’s still at slightly elevated levels even after coming down over the past several sessions. Adding anxiety, the financial sector has been stuck in a rut and trading at about the same level as it did in March. Banks peaked in mid-September and have been looking for direction ever since (but still just 2.5% off their highs). Investors want more assurances that inflation is under control and debt (both federal and private) is manageable. The Mag-7 stocks (where many investors are concentrated) peaked in late October and have also been looking for a decisive path forward. In healthy and robust bull markets you want to see your leaders lead (tech, in this case) and financials to remain healthy, so these are two areas we are watching closely.

Tech still looks strong and has been consistently leading the market higher this whole cycle (both in the shorter term and going all the way back to 2008). Apple is at new highs, Google is up over 60% this year, and Nvidia keeps posting record profits. However, there have been growing concerns over the use of debt by the major tech companies to fuel their AI chip purchases from the likes of Nvidia. Hundreds of billions of dollars are being spent to upgrade processing power in the war for the best AI. Nonetheless, credit spreads (a gauge of health and risk in the debt market) remain very tight. When creditworthiness deteriorates due to overleverage or underlying problems within a business sector, credit spreads do not remain tight, they widen. This has preceded every major financial crisis and is scrutinized by the Federal Reserve (and market participants). When things get bad enough the Fed must step in and “backstop” banks that hold large amounts of bad debt to stop a “run on the bank.” Thankfully, bank balance sheets look healthy and well capitalized despite the added leverage in the system by large borrowers like Amazon and Meta. Investors just want a little more reassurance that this business model and these profits will continue before pushing bank valuations higher.

The real bear sightings have taken place in the speculative tech sector. Companies that have rocketed higher this cycle and been the favorites of day traders, like Palantir and quantum stocks, are down well over 20% and many are down close to 60%. At the index level this doesn’t make much of a difference. Nonetheless, it does show that fear is creeping in from the margins and investors are cashing out of names that have done the best over the past few months. We would prefer to see risk appetite remain high so as to be more confident that investors are still bullish, but seeing the most important sectors holding up along with the major averages is still a very good sign.  Even with the recent drawdown, more stocks are going up than going down and the bull appetite remains robust. There may have been some bear sightings, but this is still a bull market.

Looking For the Bear

Stocks don’t go up in a straight line, but it sort of feels that way since the Tariff Tantrum sell-off in April. The rally that ensued has lifted the market over 40% from the lows of spring. Along the way there have been some pullbacks, but all were short-lived. Yet each time stocks retreated pundits began sounding alarm bells of a bear market. We too have been looking for the bear, but it is proving rather elusive. Every dip is being bought up and when cracks emerge, they seem to be quickly repaired. Across the market we are seeing bull market behavior. For example, few weeks ago there was a mini banking scare when a midsize auto parts maker filed for bankruptcy and billions of dollars in bonds held by banks vanished as the assets plummeted in value. There was fear of contagion and shares in regional banks across the market fell in price. Jamie Dimon, head of JP Morgan further stoked fears when he said there is rarely just one cockroach. Nevertheless, the buyers stepped back in, and bank shares found support. This is not seen in weak or bear markets. We are seeing similar behavior in the homebuilders. Stubbornly high interest rates have been wearing on the housing market for a few years now, but even in this rough market shares in homebuilding stocks are roughly flat on the year. There will always be reasons to be fearful, but when the market is digesting bad news and still holding ground or marching higher that is usually a very positive indicator.

Looking past headlines promising of dangers ahead can be difficult, but price is the only thing that pays an investor and so far, prices have been moving higher this year. Furthermore, we are now entering the most bullish time of the calendar after gritting through what is historically a rough month. Comparing price action with seasonal trends helps us gage the sentiment in the market. When prices are supposed to rise and they do rise that tells us something but when they are supposed to fall and they rise that tells us a lot more (and vice versa). Other evidence suggesting we are in rally mode is the continued strength in “risk-on” assets. We determine this by looking at specific industry group ratios. This helps us determine the risk appetite in the market. One good ratio is high-beta stock performance to low-volatility stock performance. These groups often perform differently during different points in the market cycle. Historically, when high-beta stocks (ones that moves in the same direction but to a greater extent than the overall market) outperform their low-beta (low-volatility) counterparts, that is telling us that investors are willing to take on more risk. In weaker stock market environments or market downturns you see investors pulling money from riskier stocks and putting them into “safer” low-volatility industries like consumer staples. With the logic being that no matter what the economy is doing, people are always going to be buying things like toilet paper, soap, and toothpaste.

We can also test this by looking at a company like Tesla, one of the top holdings in Invesco’s high-beta ETF. It is on the verge of completing a massive base and breaking out to new highs not seen in almost 5 years. With a trailing P/E of nearly 300 this is not a fundamental or earnings story. This is a story of investors jumping in to take on more risk with the hope of outsized gains in an advancing market. High-beta investing being fashionable is not a bearish indicator.

One day the bear will show up, but before it does so in full force it will likely start making its presence known underneath the surface. As of now evidence is still in favor of the bulls.

Small-Caps Secular Trend

Until the other day, it had been almost three years since small-cap stocks and the Russell 2000 index made new highs. Meanwhile, the largest companies comprising the S&P 500 index have already done it over a dozen times this year alone. But the trend is changing, and the data is backing it up. Small-cap indices are knocking on the door, ready to break out much higher. Last month we discussed how small-caps were leading the charge with the help of things like regional banks and industrials creating relative strength for the index when compared to large-cap indices. More factors are lining up, adding fuel to the trend. The Fed is cutting rates, giving a boost to smaller companies with thinner customer bases who typically are more reliant on credit than their cash-cow big brothers. So even small moves in interest rates affect them much more. Traders seem to be taking notice and momentum is picking up. We are already seeing speculative growth stocks go on a tear in things like uranium, Bitcoin miners, and quantum computing. Globally, small caps are already taking the reins in countries like China, Brazil, and others. Seasonality should also start to come into play for the year-end, as the fourth quarter tends to favor small-caps historically.

 After years of outperformance by the mega-cap leaders of the S&P 500 and Nasdaq, the Russell 2000 has some catching up to do, and that could bode well for the little guys. There’s an old adage on Wall Street, “the bigger the base, the higher in space.” With the small-cap index pushing up on new highs for the first time in almost 1000 days, this marks the longest drought for the index ever. And the relative underperformance has gone on even longer. This makes for a very long base that could serve as a launchpad. Even coming out of the 2008 financial crisis it only took 959 days to retrace the losses. Currently, we sit at a logical time in the cycle (middle of the bull market) and at a logical weighting (large caps are at their heaviest weighting in the indices in over 20 years) for the trend to shift. Long, secular trends like this are great to catch because they can carry on for years. It will take a while for money managers to unwind their heavy weightings in the large-cap space. After all, these are the biggest and best companies in the world, and they have dominated the market for years.

Large endowment funds and institutions move very slowly, and it may take many cycles of outperformance by the non-Mag-7s for money managers to meaningfully change their allocations. While it is important to pay homage to the ones that have produced the biggest gains, it’s also important to stay sharp and identify areas of potential outperformance. Pairing that with core holdings (often mega-cap) is an effective way to maximize growth and minimize taxes. Just like in sports, positioning matters. Putting yourself in position to make a play is more than half the battle. We are still in the early innings because the media outlets are not talking about it being “small-cap season.” That usually happens late in the trend. And as long as we continue to see record levels of “short interest” in small-caps while their indices charge to new highs it lets us know that we are in position to capture further gains. Anyone that is “shorting” a stock is just a guaranteed buyer in the future. Given the recent trends, the odds are they will be buyers at higher levels than today.

Small Caps and Banks

Investors have been piling into the mega-cap tech companies as they build out their AI infrastructure and rain in profits. The growth and influence of these huge companies over the last decade-plus has been astounding. The Mag 7 (NVDA, MSFT, AAPL, AMZN, META, GOOG, TSLA) now account for over 30% of the S&P 500 value. In the meantime, the smaller companies have been left for dead. Nobody has wanted to touch them since roughly the end of the Great Financial Crisis when investors started pulling money from small and mid-sized stocks in favor of the large-caps. At the time it made sense because there was systemic risk in the markets with some companies failing and filing for bankruptcy while others were getting bailed out – namely the big ones. Fast forward 15 years and now the large-cap weighting relative to small-caps is at the same level it peaked at in the Dot-com era. However, this does not mean we are headed for a crash, quite the opposite in fact. It looks more likely that we will have advancement and rotation in the market.

If there was ever a time for small companies to outperform it should be now. We are in the midst of a bull market, the short interest on small-caps (those betting against the stocks) is at record highs, and momentum is turning in their favor. Large and mega-cap companies are still advancing, but over the past few weeks they have done so at a slower pace relative to small and mid-cap stocks. In previous instances when investors were narrowly interested in a handful of stocks and positioning is this extreme, a reversion to the mean takes place. This unwind often comes fast and can catch investors off guard. Whether this results in a major shift or a short-term move remains to be seen, but a move of some kind is likely coming. It would actually be abnormal for small-caps to not assume a leadership role before this bull market is over. From studying previous cycles, we see that during almost every major bull-run small-caps lead at some point for a stretch of time.

Looking under the hood we are noticing several sectors with an abundance of small-cap companies posting strong returns lately. To just take one, let’s look at financials. Investors have been largely wary of buying stock in banks since the Financial Crisis of 2008. For one, they were at the heart of the problem with their disastrous loans, and secondly investing in a bank stock is just not as sexy as buying the company that runs all the computers or makes all the phones. But what many are missing, and the market may already be sniffing out, is that banks are among the most underrated AI trades in the market. And US banks aren’t the only ones leveling up in the AI space. The larger banks from around the world are transforming and benefiting as well. Slowly but surely the entire banking industry has reversed the negative trend that was in place for years and have now been outperforming the overall market for months. This is a sector that was dead money for well over a decade but now they are catching bids from investors who view them as innovators in a changing economic landscape. JP Morgan is rolling out its own Chat GPT tool, Bank of America’s AI assistant is handling billions of customer interactions, and Goldman Sachs is using AI to draft IPO documents. As these banks grow their top and bottom lines, they will likely go on buying sprees as well and gobble up financial technology (FinTech) companies and regional banks. This is pushing up valuations in the whole space. And almost all the players are small and medium sized businesses. Banks have enormous amounts of data, billions of customers, and currently a more relaxed regulatory environment. Conditions that are ripe for AI integrations. These factors could combine to make them hyperscale the way we have seen the tech giants do, by investing in data centers and other AI adjacent products, services and technologies.

If small-cap companies are going to take on a leadership role at some point in this bull market, then this could be a sector that plays a significant role.

Growth Getting Frothy

At the last Fed meeting they left interest rates unchanged for the 5th consecutive meeting weighing concerns over inflation versus weaker growth and damage to labor should rates move lower or higher. The fear is that if rates are lowered too much too soon then inflation will spike again, and as every consumer knows, prices are plenty high as it is. On the other hand, if rates are kept too high for too long it might damage the economy and increase unemployment. The stock market reaction to the Fed decision was not great but also not overly negative either. Regardless, the Fed announcement was quickly put in the rearview as investors salivated over the latest reports from Microsoft and Meta (Facebook). After reporting earnings, the two companies combined to add over half a trillion dollars in market value. That gain alone amounts to more value than 475 of the S&P 500 companies combined. Microsoft is now worth more than $4 trillion and META is on its way to $2 trillion. Along with Apple and Amazon, these companies make up about 20% of the S&P 500 and 40% of the Nasdaq 100. They are the drivers of the markets at the index level. But beyond that they are the drivers of innovation and at the forefront of the global economy. Their investment dollars matter, and their capital expenditures are watched closely. As the infrastructure for AI is built out, companies in the semiconductor and software space grow as a result of the demand from these market behemoths. Additionally, Apple and Amazon reports tell us about the demand for retail goods and the health of the consumer economy. Taken altogether the Magnificent 7 (NVDA, MSFT, AMZN, GOOG, META, APPL, TSLA) not only have significant impact on the major stock market averages like the S&P 500 and the Nasdaq, but they also impact companies across various industry groups sending shockwaves through the broader market. Cloud computing, AI companies, and even energy catch higher bids when the Mag 7 are growing.

The growth we have witnessed from these tech giants have been truly magnificent and we expect that trend to continue along with this bull market. Nevertheless, it would make logical sense for this to be a moment for some digestion of those gains. The ratio of Growth to Value in the market is at historic highs as returns in Growth companies have outpaced Value companies steadily since the Financial Crisis of 2008. This is coinciding with major averages like the S&P 500 looking a bit stretched with tech (Growth) doing most of the heavy lifting. If we do see some digestion and consolidation at this level, it will likely be while Value catches up. When we talk about Value we are talking about things like energy, utilities, consumer staples, and healthcare. It would make sense to see some rotation back into these more stable businesses because we are starting to see some froth in the market as evidenced by headlines like “Meme Stocks Are Back” (Fox Business). Overall, there are still record amounts of cash on the sideline ready to carry this bull market forward and giving us evidence that we are not at a market top quite yet. However, on the margins we are seeing speculative greed in weak companies with high short-interest (meaning institutions are betting against the company), like Kohls, Opendoor, and Krispy Kreme. Some of these names are doubling in a single trading day. Typically, by the time the headline hits the trend is getting close to being exhausted.

Another thing we are keeping an eye on is the dollar. Throughout this market-run since April the dollar has been dropping as is typical during periods of market strength. A weak dollar means more demand for our goods and services. However, over the past few weeks we have seen renewed strength for the greenback and that could potentially act as a headwind for stocks. But for the time being, earnings, technology, and sentiment are combining to keep trend in place and the bulls in command.

Charlie Dow and the Return to Normal

Charles Dow was a journalist in Springfield, Massachusetts who used to go door to door asking shopkeepers how business was going in order to report on the economy. Most of them told him that their business was none of his business.  He thought there must be a better way. So, he moved to New York and began using information from the stock exchanges. He published an afternoon letter (later to become the Wall Street Journal) that contained an average change in price of twelve stocks from various industries. The Dow Jones Industrial Average was born. Getting a gauge on how major transportation and industrial companies were doing provided great insight into the economy at large. The old transportation index (a segment of the Industrial Average) consisted of railroads and shippers and was closely monitored by economists, traders, and eventually the general public. The index still exists today but now includes things like airlines, trucking companies, and even Uber. The transportation index is less relevant now because of the rise of the digital economy. What many consider to be a better measure of today’s economy and the new “transportation index,” is the semiconductor sector. In today’s economy goods and services are delivered via routers, not railroads.

The semiconductor fund, SOXX was looking like it had peaked and was rolling over a few months back. Semis were major leaders during this entire bull market up until last summer when financials and other industries stepped up as money rotated. But just as we have seen many times throughout history, people get very bearish and bet that the short-term weakness in front of them is the sign of a new extended downtrend only to have the markets rip in their face and continue their longer-term uptrends. The SOXX is up over 40% from the April lows. Bellwether Nvidia is up over 60% in that time. Where Nvidia goes, so goes the rest of the semiconductors. Their earnings reports have become some of the most important dates on the economic calendar. Betting against them seems to be a fool’s errand given their track record over the last several years. After their latest earnings report the stock jumped 6%. That’s over a $200 billion increase in valuation in a matter of minutes. You can’t have computers and technology without chips and they are the biggest and best chipmaker. So, for economists and others interested in how tech stocks are doing or looking for insight into the health of the economy, their eyes will be on Nvidia and the SOXX.

Sector rotation continues to be the lifeblood of a bull market and further rotation back into semiconductors, and technology more generally, would be consistent with the next leg up of the current bull market. Seeing technology lead again also gets us back to more of a normal market feel. The tariff ordeal has pumped a ton of noise and fear into the markets over the last few months, but just recently we have started to see stocks trading on their own merits again and less on macroeconomic headlines. The fear gauge (VIX) is still elevated compared to pre-2025 norms, but that seems to be part of the new normal in today’s political climate. Risk is definitely still out there but it feels more defined and more manageable lately. In the absence of a recession (and in the the longer-term more generally), economies grow and stocks go up, usually on the back of technological advancements. Just as Charlie Dow did, we will continue to keep an eye on the components of major industrials that offer insight about that growth and those advancements for guidance.

Repricing and Rotation

April was wild. We end the month at about the same place we left off in March, but there were dizzying swings along the way. With the announcement of significant tariffs imposed on nearly all trading partners investors quickly did back of the napkin math to reprice what companies would be worth under the new order. Hit hardest were the ones who relied on cheap manufacturing abroad whose import costs would skyrocket. One example is RH (formerly Restoration Hardware). They use cheap Asian labor to make their furniture and ship to the US, charging a premium to domestic customers. During a conference call discussing earnings and tariff impacts the CEO was told by an aide the current stock price and shocked he breathed, “Oh sh**” into his open mic. RH went from about $450 to $123 in a matter of weeks and on that day in particular it was down close to 50%.  One journalist opined that they were burning the furniture to keep the lights on. While I don’t think it’s that bad, the point is taken. During any given bull market, there are periods when traders move from one sector to another. This is healthy and normal. What is not healthy is having whole industries upended due to external forces.

The worst of the tariff madness is seemingly behind us and the longer-term underlying trends appear to be evident again. Money was already flowing from US stocks to foreign ones. We have been noting it for the past few months. At first investors were using their gains from Big Tech as a piggy bank to fund investments abroad, but after the tariff announcements money rushed not only out of tech, but also out of importers broadly as described above. As a result, the world versus the US market returns are starting to look pretty lopsided. Year-to-date, Latin America and Germany are up over 20%, Spain and Hungary are over 30% and Poland is up nearly 50%. Momentum has moved abroad. For years now “momentum” investing was essentially a code word for US growth, or more specifically, Big Tech. Two of our major investing tenets are momentum and low volatility investing. When deployed together they produce outsized returns relative to the overall market. For the better part of two decades foreign stocks have gone sideways while US tech accelerated up and to the right with consistent momentum. However, over the last ten months the script has flipped - there is a rotation underway. It’s impossible to determine if it’s the result of repricing US equities relative to foreign ones now that their margins will be squeezed by tariffs, or if it’s just a sign of healthy market breadth expansion. Regardless, if it’s working, we should embrace it.

Twenty years ago, emerging markets and foreign markets more generally were priced at a premium relative to US markets. Meaning investors were willing to pay up for the potential of larger returns due to the faster pace of growth abroad. But after the 2008 financial crisis money flowed into the perceived safe haven of US stocks and the premium slowly evaporated and even turned negative. Back then, the emerging market P/E ratio was about 40x and the US was around 25. Today, investors are paying about 15 times earnings for European stocks, 11x for Chinese stocks, but about 27x for US stocks. The narrative is boring because it doesn’t come with fancy new phones or AI models, but maybe that’s a good thing and will prevent wild swings in capital. Repricing and rotation can move very slowly but last a long time.

Indices abroad are being driven higher largely by financial and industrial stocks. For the most part these companies have little to no software or AI hype. They are just real-word businesses like banks, manufacturers, industrial leaders, and utilities. Ultimately this is great news and not a sign of the end for US equities. Participation in market growth is broadening around the world for the first time since the Great Recession and that simply means there are more opportunities for us. The likes of Google, Apple, Nvidia, Amazon, Facebook, and Netflix are in little danger of being overtaken by these foreign companies, but making them have to compete for our investment dollars will ultimately drive them further to greatness.

Markets and Tariffs

It’s time to talk about tariffs and the market. The markets have been pushed into turmoil over the past several weeks over the executive decision to implement tariffs on nearly every country all at once. These are the highest tariffs since 1904. The stated goal is to reduce the trade deficit and increase domestic production. Trade imbalances exist all around us in various forms and they are not necessarily an evil. All of us, for example, run a trade deficit with our grocer. We buy more from the grocery store than the grocer buys from us. This does not make me want to put a tax between us to encourage me to grow more food in my backyard (I do love my chicken eggs though.) In the global economy trade deficits are offset by surpluses elsewhere, just as the grocer takes his surplus from us and runs a deficit with his wholesalers. The US has a deficit with China, but we have surpluses with the UK, Australia, the Netherlands, and many others. The fact that we have a net trade deficit with the world is driven by two major factors: our budget deficit and dollar strength. We have a mammoth $2 trillion budget deficit that drives excess demand for imports, and we have a strong dollar that makes American goods expensive abroad and foreign goods cheaper domestically. In short, tariffs are likely to do little to affect the stated goals. Even if we end up buying fewer goods from China and start producing more domestically, it will come at a cost. Americans, with their already stretched budgets, are not prepared for $6,000 iPhones and $70 undershirts. Thus, the market reaction.

Economists have spoken up and they say if tariffs persist, the US will enter a recession. First quarter GDP growth is projected to be near zero, and further weakness is expected in subsequent quarters. That being said, the market is amazing at sniffing out strength or weakness much sooner than it shows up in the economy. Stocks were showing some weakness, especially domestically heading into the tariff announcements and then really sold off when the announced numbers blew through everyone’s expectations. Going from roughly a 2% average tariff to 25% was simply outrageous. But the buyers have been ready to take back control. The first glimpse of this was the other week when a fake story broke that there was a pause on tariffs and markets shot up over 3% before ending the day down 4% after it was debunked. And then we had April 9th when a real 90-day pause was officially announced and markets rallied over 10%. As crazy as Washington seems (or maybe is), they don’t want to tank the US economy and are more susceptible to market judgments than they let on.

The underlying health of the US economy is still intact. If it wasn’t for this unforced error the markets would likely still be chugging along orderly. Be wary of pundits saying the recent market strength is nothing but a “dead cat bounce.” We are about halfway through tariff mania and the worst is likely behind us. That doesn’t mean we can’t see fear pop back up and huge sell-offs take place. People are ultimately unpredictable after all, but the path of least resistance is higher lows, not lower lows from here in the market. As negotiations take place and deals start to roll in, we will see people get more comfortable owning stocks again. Sentiment indicators are very low and that points to how people are positioned. The market itself however, is holding a key support level (the highs of the last cycle.) Just as we were calling for caution in the short-term if the Dow was below 42,000 (it’s 39,600 now), we are saying below 36,000 is the line in the sand. If that were to break, then look out below. The markets kissed that level last week but have rallied back. To get the bull market fully back on track we need to see a few more positive headlines that push stocks back above those January and November lows (42,000). Global stocks are already at the equivalent January and November levels and we are looking for the US to follow suit.

We remain cautious, but optimistic that destroying the underlying economy in the name of tariffs is both harder and less politically palatable than pundits think.

Volatility

The S&P 500 pulled back roughly another 4% in March, just as it did in February. It is sitting just above “correction” territory - the term we use for a 10% drawdown from the peak. Volatility returned in a big way in the first quarter as there were more up or down days of at least 1% than we experience in full years on average. The narrative driving this volatility is of course tariffs, but also concerning is persistent inflation and weakness in the labor market and slowing economic growth. With inflation already hovering around 2.9% (which is about 50% higher than the Fed target) the fear is that tariffs will throw gasoline on the problem and ignite another bout of soaring inflation like we saw a few years ago. If inflation spikes at the same time as the economy cools and unemployment increases, the Fed will be in a very difficult position since the cure for one illness is the cause of another.

When investors get nervous, they start to make mental notes of levels they are comfortable buying and selling at. It’s a psychological phenomenon and something that has been studied in behavioral economics. We have tools that give us approximations of where these levels are, and they can be helpful for investing and planning. One level (and we noted this here a few months ago) was 4,200 on the Dow. This was the pivot point of the July highs and the November lows. It also happened to be the exact level the Dow bounced off in January. Months ago, we said as long as the Dow is above this level there was very good reason to believe the bull market was still on. It all comes down to supply and demand. Very simply, the data has shown that the demand for stocks is greater than the supply above that level. As I write this, we are just above 4,200 after dipping below several times over the last 3 weeks. Does this mean sell everything and hoard cash? No. But it does mean proceed with caution in the near-term.

The backdrop of macroeconomic insecurity along with indices dipping below key levels of demand has us more discerning of when and where to deploy cash. This is true even with the long-term outlook unchanged. The US economy is still poised to grow at roughly 2% and stocks still offer a better risk-adjusted return over the medium and long-term to bonds and cash. However, we’d like to see volatility subside and risk appetite pick up before we really dive back in. The markets are searching for direction, and many investors are in a wait-and-see mode.

The reasons for worry and pessimism are always well documented in the media. But let’s also look at reasons to be optimistic. Credit it abundant and global growth is gaining steam. Credit spreads are tight, meaning that companies are well capitalized and banks are eager to lend. Markets get into big trouble when lending dries up and money movement freezes. Every economic crisis is really a credit crisis. Secondly, we are seeing actual and predicted growth picking up across the globe. Copper is flashing positive signals and is a major leading indicator of economic growth. It is a vital component in construction, defense industries, cars, wind turbines, power grids, and so on. Copper often sniffs-out growth before it shows up in economies and stocks - and it just hit a new 52-week high. It’s going largely unnoticed because the growth is not being driven by the usual suspects of the US or Europe. It’s the emerging and developing economies doing the heavy lifting, growing at 4.2%. This is more than double the pace of developed countries. The take-away is that if we were really headed for a prolonged economic slowdown, it would be unlikely that global industry would be ramping up and the credit and lending markets would be so healthy.

The US markets, and the tech industry specifically, were due for a period of digestion after the gains we have seen over the past several years. The volatility is warranted and so far we do not see this turning into a crisis. Drawdowns of this magnitude are seen routinely during bull markets.

Sentiment Craters

The S&P 500 is only about 4% off its all-time high and yet bearish sentiment is nearing historic levels. The stock market gains over the last four and a half months have been erased as investors reduce their exposure to many risk assets in the US and take money off the table. The Bull-Bear spread, as it’s called, has only been lower 10 times in the last 30 years. Historically, returns over the ensuing 6-12 months are quite robust, with an average gain of 22% after one year. Only once were they lower, and that was by a miniscule 0.35%. Sentiment readings at this level are what you would expect to see during major market bottoms, not near all-time highs.

It’s hard to pinpoint exactly why investors are so bearish when overall investment performance has been strong, but there are some sensible reasons to point to also. For one, portfolios really haven’t budged much in the last 6 months. Technology companies have been on a historic run over the past few years and now they make up a hefty weighting in the indices and in individual portfolios. So when they stall, the market typically stalls too. Nvidia, for example, shot up 300% from the start of last year into summer, but has since taken a well-deserved breather and is trading at essentially the same price, and it makes up nearly 8% of the Nasdaq 100 index. Their earnings are still growing at a phenomenal rate and even after their meteoric rise NVDA is trading at a cheaper earnings multiple than Apple, so another leg higher (especially after the recent sell-off) could be coming. Another reason for pessimism is all the tariff talks. Whether tariffs are good or bad for an economy is debatable. Regardless of the outcome, big policy changes like these take years to work their way through the system but businesses must adapt quickly. In the short term, major policy changes disrupt business plans and throw chaos into the markets. Imagine being a manufacturer and suddenly a key part doubles in price due to a new tax or is no longer allowed to be imported. Chaos. This could be why we are seeing such strength in markets abroad. Dollars are chasing relative certainty.

Outside of the US, global equities are on a tear. Asia, Europe, and Latin America are all outperforming US markets. This isn’t necessarily a bad thing for US equities. It just shows that breadth is still expanding and now it’s not just new US sectors participating in the bull market but global equities as well. We have discussed sector rotation and breadth expansion in the past here. Rotation is the lifeblood of a bull market and breadth expansion signifies its health. We are seeing more and more stocks participating in the 3yr old bull market. Simply because we are experiencing a bit of a stall and pull-back in US equities does not mean that the bull market is canceled here. We would need to see much more confirming evidence first. An expansion in the list of stocks making new lows versus new highs, for example. The number of stocks that have declined by 20% from their highs is creeping up (to levels not seen since November of 2023), but still nowhere near critical levels. As investors, we might be a little more cautious today than we were a few weeks or months ago, but we are still looking for more things to buy rather than to sell. And with breadth expanding it is presenting us with new opportunities to capture growth. Developed markets have done the best, markets like Germany and Italy. Some of these international indices are bumping up against all-time highs not seen since before the financial crisis of 2008. China and emerging markets have also been on the move, though are much further from their former highs. However, if this trend is going to continue and we are going to see more countries breaking out to new highs, then the dollar will likely have to weaken. Weak dollars make foreign investments more valuable here. A US investor will receive more dollars back if the investment they hold overseas has a strengthening local currency. But a weakening dollar is also a tailwind for US equities since so many of our companies derive much of their business from outside the US. So, if the dollar continues to weaken (as it has done steadily over the last few months) this would bode well for equities in general and might finally be the kicker that boots global stocks back into favor, even if sentiment here in the US remains in the doldrums.