Siren song? Siren song?\images\insights\article\canoe-misty-forest-small.jpg June 9 2023 June 9 2023

Siren song?

The pain trade is up. The late '90s' parallels are eerie.

Published June 9 2023

Preparing for a Bloomberg appearance this week, I thought I’d assert that “the pain trade is up,” until I tuned in and saw another talking head say those exact words, and flipping the channel, seeing it written on the banner below another talking head. Consensus. Having been in the business for 40 years, I remember the late ’90s “siren song” of riches, which brought an “unprecedented rush into stocks by average Americans,” according to an article written in March 1999. It quoted a young Palo Alto venture capital employee, “You can double your portfolio in three years … if you focus on internet stocks, you can do it in one year.” This week featured travel to Orlando and Richmond. Lots of advisors and investors in a good mood. Meanwhile, my overworked ’70s-something driver in Pittsburgh complained that “nobody wants to work,” while my Uber drivers on the road complained about compensation and the taxi drivers complained about Uber drivers “who work for nothing!” In the markets, breadth continued to improve. It’s no longer just five stocks doing the heavy lifting. Over the past month, small caps are up nearly 6%, regional banks 13% and airlines 16%. The percentage of issues making 20-day highs is a healthy 35% in the broad market and 39% in small caps (Russell 2000), the latter a top decile historical reading. Still, we’re only talking 20 days. And many of these March-May laggards have yet to test the upper end of their trading ranges. With flows from the FOMO crowd, near-term contrarian bearishness from sell-side analysts (only five of 20 expect the S&P 500 to close above 4,300 before year-end) and rising complacency (a collapsing VIX, an explosion of AAII bulls and a drop in put/call ratios), the August ’22 high of 4,325 may be eclipsed. A new bull market??

So, why the caution? Technically, the Russell 2000 has never exhibited such relative weakness off a major bear-market low, nor has the cumulative NYSE 52-week new highs and new lows been as weak this far into a supposed bull move. With the NYSE FANG+ Index up 68% vs. the equal-weighed S&P’s 2% YTD and high beta S&P stocks still outperforming low beta by about 7%, Leuthold Group doubts the staying power of the recent improvement in breadth. JP Morgan views the action as a position squeeze rather than a sustained move to a lower volatility regime. Fundamentally, tougher earnings and a margin squeeze loom. Labor costs remain stubbornly high (more below), inflation’s lift to sales is fading and both liquidity and lending look to tighten further under a stay-put-at-best Fed and a post-debt-ceiling flood of Treasury issuance. BCA Research expects strong resistance at 4,325 and recommends a tactical (0-3 month) equity overweight but a 12-month underweight. As the expectations bar gets raised, it thinks today’s upside economic surprises will morph into disappointments heading into the fall.

More basically, I just can’t shake the memories of the bust. There are some eerie parallels between now and then. The ’90s tech boom was fed by a period of record-low interest rates and the arrival of Microsoft’s Windows 95 software that drove the use of the internet (or World Wide Web, in the vernacular of the day). Money abounded, and a flood of startups sought to capitalize on this easy capital and the massive shift in the way Americans were using technology. That many were more ideas than actual businesses didn’t matter. Then the Fed took away the punch bowl. A tightening campaign that began in late ’98 had, by May 2000, raised its target funds rate to a 10-year high of 6.50%. Capital flows rapidly dried up, taking down a lot of unprofitable startups and sending the Nasdaq into a deep and long bear market. Nasdaq’s high wasn’t to be seen again for 14 years. In the late ’90s, the siren song (today’s FOMO) was rampant, as individual investors were joined by so-called value portfolio managers who bought the Four Horsemen: Microsoft, Intel, Cisco and Dell. Near the very top in March of 2000, a prominent writer at Motley Fool advised, “Never raise cash.” The 1999 article mentioned above stated, “What older investors might see as an unprecedented bubble, younger investors see as normal market growth.” Internet schminternet, that was then. Today we have AI!


  • The case for disinflation The RealPage measure of May rents slowed to just 2.3% y/y vs. its March ’22 peak of 15.6%. Used-car prices fell a second straight month and are now down 7.6% y/y. The services PMI for prices, which leads core PCE for services, has plunged 25 points from its peak to its lowest since May ’20. And participation among workers 25 to 54 (65% of the labor force) rose to a strong 83.4% in May, above pre-pandemic levels, raising odds wage growth could moderate.
  • Services perk up The composite PMI for the U.S. rose to a strong 54.4% in May, representing the fastest pace of expansion in a year on accelerating services activity, which surged to a 2-year high. That said, the separate services ISM, in contrast, slowed for the third time in four months to a low for the year.
  • Signs of manufacturing improvement Weekly raw steel production continues to rise and is now flat vs. a year ago. The metric is a component of the New York Fed’s Weekly Economic Index, which has been running at 1.1% for the last five months, with real GDP tracking at 1.6% as of the end of May. Demand in part is being driving by a boom in factory construction as U.S. companies confront a structural need to invest in new domestic manufacturing capacity due to onshoring and nearshoring. Generous government support has IT-related manufacturing construction up more than 10-fold since early 2021.


  • Wage growth is the main driver of services inflation The Atlanta Fed Wage Growth Tracker, which tends to be more informative about underlying wage trends than average hourly earnings because it controls for differences in skill levels, suggests wages accelerated in May to 6.5% y/y vs. 5.1% in April. Other reports also show wages remaining sticky at best after moderating earlier in the year. Online job-search site Indeed’s series on posted wage growth is down from a peak of 9.3% in January 2022 to a still elevated 5.3% in May.
  • The case for inflation Gavekal Research cites five. It notes fiscal policies across the western nations remain highly stimulative (even at full employment, the U.S. budget deficit tops 6% of GDP); all the liquidity injected into the system between early ’20 and early ’22 has yet to be fully digested; tight labor markets in most advanced economies are pushing up labor costs (see above); semiconductor prices are rising on booming AI and EV demand; and global growth remains resilient, especially in the EM ex China.
  • Deteriorating trade April’s trade deficit jumped to a 6-month high in the U.S. on a big drop in exports amid softening global demand. Disappointing growth in China saw its trade surplus plunge as exports shrank even more dramatically than imports did.

What else

Will the Fed care? Both Australia and Canada surprisingly raised policy rates a quarter point this week, the latter to a 22-year high after pausing its tightening campaign in January. The central banks cited stubborn inflation in economies that continue to exhibit surprising strength.

In this market, should we be surprised? As GOP candidates continue to announce, it’s worth noting that years preceding presidential elections are more likely than others to feature stock-price action that is favorably disconnected from the fundamentals. Since 1926, the average S&P gain in a pre-election year is 14.2%—about double the next-best year of the cycle.

Is Japan no longer lost? After being stuck in a low-growth, deflationary environment for three decades, Japan Q1 growth was revised sharply up this week to 2.7% annualized on rising capex, April inflation hit a 4-decade high, manufacturing activity is expanding again, 2022 corporate profits set a record and the Nikkei is up 22% YTD and 14% so far this quarter alone.

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Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Past performance is no guarantee of future results.

Atlanta Fed Wage Growth Tracker: A measure of the nominal wage growth of individuals.

Beta: A measure of the volatility, or systematic risk, of a security or a portfolio, in comparison to the market as a whole.

Diversification and asset allocation do not assure a profit nor protect against loss.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

Growth stocks are typically more volatile than value stocks.

Nasdaq Composite Index: An unmanaged index that measures all Nasdaq domestic and non-U.S.-based common stocks listed on the Nasdaq Stock Market. Indexes are unmanaged and investments cannot be made in an index.

NY Fed Weekly Economic Index: A signal of the state of the U.S. economy based on data available at a daily or weekly frequency.

NYSE FANG+ Index: An equal-dollar weighted index representing 10 mega-cap tech stocks. Indexes are unmanaged and investments cannot be made in an index.

Personal Consumption Expenditures Price Index (PCE): A measure of inflation at the consumer level.

Purchasing Managers’ Index (PMI) is an index of the prevailing direction of economic trends in the manufacturing and service sectors.

Russell 2000® Index: Measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 8% of the total market capitalization of the Russell 3000 Index. Investments cannot be made directly in an index.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Small company stocks may be less liquid and subject to greater price volatility than large capitalization stocks.

The American Association of Individual Investors (AAII) Bulls Minus Bears Index is a measure of market sentiment derived from a survey asking individual investors to rank themselves as bullish or bearish.

The Institute of Supply Management (ISM) nonmanufacturing index is a composite, forward-looking index derived from a monthly survey of U.S. businesses.

Value stocks may lag growth stocks in performance, particularly in late stages of a market advance.

VIX: The ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility.

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