The forthcoming movie Novocaine, set to be released next month, tells the intriguing story of a man who possesses the superpower of being unable to feel pain. This ability, initially seen as advantageous, soon turns perilous as it leaves him vulnerable to significant injury. This narrative mirrors the recent behavior of the stock market, which exhibited an unusual calmness in the face of potential economic threats until it succumbed to pressure on Friday. The market's sudden reaction was sparked by concerns over sluggish economic growth amidst an environment of unpredictable policy changes.
Before the market's downturn on Thursday and Friday, it was exhibiting a seamless rotation across sectors, toggling between growth and value stocks. The buyers' efforts on Tuesday and Wednesday nudged the S&P 500 up a quarter of a percent, achieving marginal new record highs. While this demonstrated a form of resilience, it was not without its ambiguities. Warren Pies, co-founder of 3Fourteen Research, pointed out that the S&P 500 set a record with only 5.5% of its constituents reaching a 52-week high, which is less than half the average seen in past record-setting days.
The market's behavior, akin to a sports team winning close games, is perceived by some as a sign of strength but, in reality, may indicate a lack of dominance. Scott Chronert, U.S. equity strategist at Citi, noted the market's proximity to trailing earnings and its resilience against factors like higher rates, reduced Fed cuts, and tariffs. Despite impressive Q4 results, the market has only posted a modest total return of 3.8% year-to-date, suggesting that breaking strong sentiment will require more substantial challenges.
This steadfast investor risk tolerance was tested by Friday's 1.7% drop in the index, driven by consumer and industrial cyclical stocks, and a decline in Treasury yields. The drop was influenced by several factors, including a dismal University of Michigan consumer sentiment reading and inflation expectations. Although these signals might have been overlooked individually, they were compounded by Walmart's cautious guidance, weak retail sales, and underwhelming service sector performance.
While no immediate U.S. downturn is expected, these developments complicate the optimistic economic outlook that prevailed earlier this year. The S&P 500 has regressed to levels first reached in early December, and sectors like industrials, bank stocks, and small caps have retreated from their post-election highs. This signals a potential reset in prices and assumptions, although it does not yet negate the broader bull market case.
Warren Pies of 3Fourteen has been anticipating a growth scare since the start of the year, not predicting a recession but rather a cautious phase prone to volatility. Seasonal trends starting in late February, combined with other economic pressures, suggest a potential equity market correction. However, historical patterns do not guarantee future outcomes, and seasonal weakness should be viewed as a factor in setting realistic market expectations.
Retail traders' enthusiasm appears to be waning, exacerbated by significant losses in high-momentum stocks like Palantir, Robinhood, and Tesla. Meanwhile, Bitcoin has not kept pace with Nasdaq's recent highs. Despite these challenges, investor sentiment remains difficult to gauge. While equity ETF inflows are strong, survey-based attitudes reflect bearishness, influenced by policy uncertainties.
The recent five consecutive Friday declines in the S&P 500 highlight pre-weekend apprehensions amid a rapidly changing policy environment. Despite these declines, the S&P 500 is still up for the year, and earnings have met expectations. Credit markets show no signs of panic, and the recent market correction, while notable, is not yet a cause for alarm. The market continues to navigate the complexities of high expectations, elevated valuations, and a cautious consumer landscape.
