Closing March with a Zweig
While the overall market continues to grind along without gaining much ground over the last 10 months, we continue to collect several bullish signals that should eventually lead to broad price gains for most of the market. We added another bullish signal on the last day of March when the market completed a Zweig Breadth Thrust (ZBT). Developed by famed analyst Martin Zweig, the Zweig Breadth Thrust is similar in nature to the Breakaway Momentum Indicator that the market achieved this past January. While both of these thrust indicators are based on the daily New York Stock Exchange Advance Decline data, the Zweig Breadth Thrust is historically much more difficult to achieve due to the NYSE data having to move from an oversold position to an overbought position in a short 10 day period.
The Zweig Breath Thrust was achieved on the 10th day, which was March 31st. This marked the first time this thrust was completed since January 2019, when the market rocketed out of the “Christmas Crash” of the previous December. Going back to 1945, this is the 27th time a Zweig Breadth Thrust has occurred. What is most important is the historical performance of the markets moving forward after the data this indicator triggered. Below is a chart showing the forward performance of the S&P 500 over a number of different time periods for each Zweig Breadth Thrust that has occurred since 1945:
When any breadth thrust occurs, it puts the market into a short-term overbought position, but the further you move out from the signal, the market almost always posts a positive return. In the case of the Zweig Thrust, per the 1-month data, the signal forward returns have been positive about 90% of the time. And the one-year forward returns have always been positive outside of the 1987 Crash. Digging deeper since we are in a preelection year market, this is the eighth time a Zweig Breadth Thrust has occurred in the year previous to our Presidential election. The common theme with these past signals is that the market has been historically stronger in the six months following the signal than in the other three years of the Presidential Cycle. Six months out, the forward returns are roughly inline for all markets.
With all of the bullish signals we have seen over the past few months, it has been frustrating that the market has not been able to break out of its trading range. Our belief is once the external factors, mainly the Federal Reserve, are no longer a market concern, these bullish signals will finally begin to follow their historical patterns and market prices will be able to break out.
What Monthly Bonds Auctions Are Telling Us Now
One area of the bond market that we continue to focus on is the results of the monthly government bond auctions. Each month the government holds seven separate auctions for each maturity of Treasury Bond they offer. The sheer size of these auctions is incredible, with the government offering out roughly $225 billion of new bonds each month. Many data points can be attained from these auctions, but the most important is the “when issued yield” for each bond offering. This yield will be attached to each bond when it is delivered and is an excellent gauge of demand from investors and institutions worldwide. Increases in month-over-month” when issued yields" for Treasury bonds traditionally signal expectations of higher future interest rates, and the inverse expectations occur when month-over-month yields fall. Most of the time, these changes in yields are based on the Fed’s future monetary policy, but other external events can cause changes; last month was one of these times.
In March, the Treasury held auctions for the 3-year, 10-year, and 30-year bonds during the first full week of the month. Each of these auctions produced much higher yields than their February auctions, with the 3-year Treasury showing a 13.88% month-over-month increase in yield. These increases had led us to believe that not only would the Fed continue with their rate hikes, but that they may have to increase the size of the hikes more than the market currently expected. Then everything changed on March 10th, when Silicon Valley Bank and Signature Bank failed, forcing the Fed, Treasury, and FDIC into protection mode to stave off potential bank runs. These bank failures, along with growing concerns of contagion within the global banking sector, produced two crucial responses from the Fed which greatly affected the yields on Treasury bonds later in the month of March:
The Bond Term Funding Program created a facility for banks to gain liquidity and balance sheet flexibility.
Although they raised rates by 0.25bps in March, the Feds post committee meeting comments dramatically shifted from their previous hard stance on rate increases.
Over the last week and a half, the Treasury auctioned off 2-year, 5-year, 7-year, and 20-year bonds. Since the 20-year auction was held on the same day as the Fed meeting, there was little change in the “when issued yield” from the February auction. The same cannot be said of the other three auctions that occurred the last week of March. These three auctions produced “when issued yields” more than 10% lower than their February auction results. Most importantly, we saw a more than -15% decline in the yield of the 2-year bond, an essential step in reversing the inverted yield curve hanging over the market.
It will be interesting to see if this yield shift will continue in the months ahead. The Fed has flipped its narrative a few times over the past year and caused the market to drop with inflation data being too moderate, production data collapsing, and the continued concern about the banking sector, we feel the Fed should no longer be feared, as they are about at the end of their cycle.
The real unknown is how the Bond Term Funding Program continues to impact the economy and the market. Technically this program is a form of quantitative easing, even if the Fed and Treasury do not want to admit it now. History tells us that when liquidity is being pumped into the market and economy, you should expect risk asset prices to rise and bond yields to fall, just like we saw the last few weeks of March.
A Positive from Mid-Term Year Lows
Another positive historical data point to be on the lookout for is the expected return of the Pre-Election year market when the market has a -20% or greater correction in the preceding Mid-Term year. The chart below from Strategas Securities shows that when there is a correction in the S&P 500 of 20% or more in a Mid-Term year, the S&P has rallied more than 30% one year from the market lows.
Last year the S&P 500’s lowest close was 3,585.62 on September 30th. Based on the historical observation below, at a minimum, we would expect the S&P 500 to rise by 30% from that price, which gives us a potential target for the S&P to hit at some point this year of 4,660.
Granted, we would like to have more data to qualify this study, and it’s another reason to expect better-than-anticipated results by the end of 2023.
The Return of April
Before 2022, April has almost always been the strongest month of the year for the market over the last five decades. Last year was a much different story. The -8.80% that the S&P returned last April was the second-worst monthly performance for 2022 and the worst April for the S&P in 52 years. The main issue for the weakness last April was centered on the release of the March 2022 CPI report, which showed the largest 12-month advance for inflation since 1981, at 8.5%.
Remember that in March of last year, the Fed just raised rates for the first time in over three years and completed their quantitative easing program three months early. The scorching CPI report for March 2022 was one of the first economic data points that showed how far behind the Fed was with its monetary policy. This sparked fears that the Fed would become more aggressive at their next meeting and possibly raise rates by 0.50bps, the most significant single Fed rate hike since 2000. As we know now, the Fed raised by 0.50bps at their May 2022 meeting, then by 0.75bps at each of their next four meetings, and finished 2022 with a 0.50bps increase in December.
As we move into April 2023, the market is still concerned about the Fed and Inflation, but much more is understood about each of these issues today than a year ago. And although we don’t want to be premature, we appear to be nearing or past the peak of both Fed hikes and inflation growth.
Of course, the market will always seek out something to worry about, so it will be interesting to see what will fill the void left as the risks associated with the Fed and inflation begin to subside. There is still that “R” word that everyone believes we are headed towards that appears to be the main risk ahead. But we caution that this is the most talked about potential recession ever, which has already provided a significant discount to asset prices over the last year.
For April 2023, we expect a return to normality and the market's historical performance. While most of our market indicators are bullish, two significant timing indicators, based on the 30-Day Fed Futures Contract and 3-Month SOFR Futures, line up for a nice rally during the next few weeks. There may be some chop to start the month, especially given the overbought condition of the gains of March's last two weeks. But once this excess is worn off, the month should make investors happy.