July Rewind
July was able to shine and live up to the expectation of being the second strongest month on the calendar. All the major indices posted their most significant monthly gains since April 2020 (Dow and Nasdaq) or November 2020 (S&P and Russell). Even with continued pressure from inflation, a second consecutive negative GDP number (which would technically be called a "recession"), and no resolution in Ukraine, the market was able to rocket higher during the month.
In our July Outlook, we made the following call concerning a primary bottom on July 12th:
"Considering all our data and traditional midterm year patterns, we feel confident that a primary bottom for this market will likely occur over the next week or so. Specifically, we would look around July 12th as the optimal date for the low, which could lead to a significant bounce within the overall market. A welcomed decrease in inflation pressures and less hawkish commentary out of the Fed later in July should supply the necessary fuel to drive the market higher well into August. A bold call indeed, but one we are willing to make."
While we try to be as specific as possible in our work, we missed the primary bottom by one day as all the major indices traded out of significant lows on July 13th and closed out the month excessively strong. Although we love making these calls (especially the ones we nail on the head!), we know that what lies ahead remains the most critical factor of this market. While July was a great and desperately needed month, it's time to look towards August for signs of a follow-through.
Money Flows
Our Money Flow data on the S&P 500 has shown about as bullish a reading as we can remember. Despite the financial world debating the direction of inflation, the definition of recession, and how many times the Fed will raise or not raise rates for the rest of the year, big institutions are getting back into stocks. Our Money Flow Indicator is a proprietary indicator based on the relative price action of an investment during trading hours. Essentially, it tracks the strength of buyers coming in later in the day, which often comes from large institutions. Money Flow has always led the market as a leading indicator, both higher and lower. What we have seen over the recent months, specifically in July, is very encouraging.
Our S&P 500 Money Flow Indicator hit a low of 21.56% on January 24th, with the S&P 500 trading at 4,410.13. As of the close of July's trading last Friday, 82.44% of the stocks in the S&P 500 had positive money flows, a massive increase over the January number that has created an even larger divergence between this indicator and the price action of the S&P 500. Since January 24th, we have seen positive money flows increase by more than 60%, but the S&P is trading lower by more than 6%. The chart below illustrates how strong S&P Money Flows have been for most of 2022, especially the thrust in money flow we have seen over the last few weeks:
While anything is possible in this market, past Money Flow thrusts like we are currently seeing have occurred at important changes in market direction. We have seen four similar thrust moves over the last 15 years:
March 2009 - coming out of the Great Financial Crisis
November 2011 - coming out of the European Debt Crisis and US Debt Downgrade
February 2016 - coming out of the China Devaluation Crash and Oil Crash
December 2018 - coming out of the Christmas Crash caused by an aggressive Fed
Each of these thrusts has led to significant market moves higher over an extended period. We are pretty confident that the indicator will be correct again, leading to higher market prices in the near future. It amazes us that there has been such incredible strength in money flows while the financial media continues to push the end of the world narratives.
The Fed vs. The Bond Market
Over the past few days, several regional Federal Reserve Presidents have come out trying to talk down the belief that the Fed is getting close to pausing its aggressive rate hiking cycle. Some of my favorite comments:
Loretta Mester, Cleveland Fed President - “...inflation is not going to come down quickly...” and “...we must see convincing evidence that inflation is coming down before stopping rate hikes.
Mary Daly, San Francisco Fed President - “...The Fed is nowhere near being done in fighting inflation...” and “...outlook is for raising interest rates and maintaining rates at a higher level for a while...”
Neil Kashkari, Minneapolis Fed President - “...Fed is a long way from backing off as inflation is higher than the Fed expected and spreading out more broadly across the economy...”
Even with the Fed raising rates by .75 bps last week and continued sticky inflation data, last month, the total bond market posted one of its most substantial moves in several years. It has been a one-way trade lower for the fixed income markets since September of 2021 as yields have pushed toward multi-year highs, and July reversed the negative trend for bond prices in a big way.
Maybe even more important, the high yield sector within the total bond market also saw excessive accumulation during the month. July was the best month for the high yield space since December 2020 and only the second positive month over the last 12 months. Strength in the high yield area of the bond market provides two significant positives for the overall market:
Since high yield debt issues are more sensitive to liquidity issues within the overall market, strength after such a long period of weakness is a strong indicator that liquidity is working itself back into the overall market.
High-yield bonds are also more economically sensitive, given their higher risk. Strong numbers show that investors are not as concerned about the market moving forward and are willing to start adding risk.
The bond market is signaling to the Fed that their work is just about complete. Similar to how the bond market signaled to the Fed that they were being too accommodating in the policies in late 2022 and all of 2021.
Any slowdown or pause in the Fed's current rate hiking cycle will be a big market positive.
August Outlook
The strength of July is typically lost during the months of August and September as both months traditionally represent the worst two performance months for the market. However, Midterm years tend to be a bit more positive for August performance, mostly because there has already been significant market damage that has occurred earlier in the year.
Last month we said that we would use any pullback during the month to get extremely bullish; we are reiterating the same message in August. Improvements in our proprietary indicators are not predicting a retest of the previous lows and any weakness should be used as another opportunity to get even more bullish in our view. After a solid July, we expect August to be more of a "flat month" at worst as we work through the summer doldrums and investors become more comfortable that the worst is behind the market.
As we have stated in recent months, "Fear turns into Fear Of Missing Out" rather quickly these days.