Under The Lacquer, A Benighted Market

At this point, the narrative is so familiar that just about anybody could pen a passable bear case centered around the narrowness of the US equity rally in 2023.

Recapitulating feels pointless, but somehow obligatory. Now that I think about it, a lot of obligatory exercises are pointless. If it’s rote it’s drudgery, and it’s all rote.

Anyway, anybody who’s anybody (and also a lot of nobodies quoting somebodies) is engaged in a now daily ritual that entails lamenting benighted market breadth. As a quick aside, “benighted” is an underrated word. It made just its 10th terminal cameo in seven years on Monday, when Cameron Crise (who never misses an opportunity to show off his vocabulary) employed it in a short post noting that Friday’s NFP rally found small-caps outperforming, an encouraging, but “not 100% convincing,” sign that the market might soon broaden. The terminal users among you will fondly note that seven of the nine previous occurrences of “benighted” since 2016 were attributable to the late Richard Breslow.

If you like the narrow market narrative and you’re enamored with “name brand” investors, you’ll love the figure below, which is a proxy for a Stan Druckenmiller quote.

As Bloomberg’s Simon White noted last week, the A.I. frenzy is masking “the increasingly recessionary message” from “inside the market” which, as Druckenmiller once put it, “is the best economist I know.”

The indicator shows the median outperformance of banks, retail, homebuilders, autos and small-caps versus the S&P. As you can see, it’s hardly infallible. There are at least a few would-be recessions that didn’t pan out looking back a quarter century.

But everywhere you turn, you’re confronted with additional evidence of what looks like extreme narrowness. SocGen’s Manish Kabra on Monday observed that banks’ relative performance recently dropped to a 50-year low.

“The only sector where high risk has outperformed low risk over the past three months is tech,” Kabra remarked. “Defensive/low risk has outperformed in all other sectors.”

Morgan Stanley’s Mike Wilson chimed in during a 74-page mid-year equity market review, rolling out a familiar list of “internal signals” which speak to a market that’s perhaps unhealthy beneath a shiny, lacquered A.I. veneer.

“We find it very challenging to find a new bull market which began with the regional banks trading so poorly,” Wilson said, adding that in his experience, “small-caps, retailers and transports typically lead at the beginning of a new bull market and that relative performance has been severely lacking.”

The figures above illustrate a variety of ominous developments and dynamics, including troubled commodities. “Commodity prices and other macro variables we track do not support the reacceleration now expected in US earnings,” Wilson went on.

So, all isn’t well. Indeed, the above seems to suggest that almost nothing is outside of the vaunted “Magnificent 7.”

The paradox is always the same: If market internals and macro-sensitive assets are indeed canaries and a recession is near at hand, there’s a case to be made that owning mega-cap US tech is the only trade, particularly given the support long-duration equities would get from falling yields.

Seen in that light, maybe it’s all entirely consistent: If mega-cap tech is the only viable hiding place in a recession, there’d be no surer sign of imminent macro doom than record highs on the cap-weighted benchmarks those stocks dominate.