The S&P 500 gained 3.26% this week with Friday's close at 3,508.01. Friday's close is another all-time high daily and weekly close.
We've been skeptical about the S&P 500's ability to break out and sustain above the ~3,400 level, but that skepticism has clearly been misplaced as of now. August has a reputation as a "reversal" month, but market participants haven't been interested in reversing anything here in August of 2020.
This is a clean "breakout", confirmed by both the 3% rule and the 4-day rule. There is no known resistance left on the charts, and the S&P 500 cleared its last hurdle with ease, even better than Karsten Warholm! (click here)
If we were to title this week's commentary we'd call it "Gone Streaking!", since the S&P 500 is putting up winning streaks all over the place.
The index has increased seven days in a row, with six consecutive all-time high daily closes. The index has increased sixteen of the twenty trading days in August. It has also increased five weeks in a row, and eight of the last nine weeks. The single largest weekly decline since the end of June is just -0.28%. And, we're one trading day away from a five-month winning streak. The upward momentum has been relentless, and that's an understatement.
Naturally, the price action thus far in August is difficult to reconcile. Broadly speaking, we all know prices don't move linearly forever. However, in the moment, the S&P 500 is trading as if stocks will move higher forever. It's both awesome (we're all making money) and worrisome (we're all going to have to give some money back) at the same time.
The climate today reminds us of what we saw in December/January of early 2020. We're not yet as "overbought" as we were then, but with Friday's fourteen-day Relative Strength Index (RSI) coming in at 79.26, we seem to be well on our way. Referencing back to our Weekly Market Update from January 19th of 2020, what we wrote then is exactly what we feel today. Here are the snippets:
"There remains demand for the S&P 500's constituents and derivatives tied to the price of the S&P 500, even at all-time high prices. This is a great sign regarding the collective expectations of market participants over the months ahead.
However, the linearity of the advance the last three months is unsustainable...
It goes without saying, but a "heater" like this isn't the norm and won't last forever...
We do believe most astute observers and investors are aware that a pullback is truly inevitable, albeit impossible to circle the date. Thus, with this being a "when" and not an "if" situation, the better question becomes what type of pullback do we experience: a normal, healthy -2% or -3% decline, or something more violent, along the lines of a -5% to -10% downdraft? The former is always more probable than the latter, but we wrote a few weeks ago that further upward extension would increase the probability of a more violent pullback, and we've most certainly had further upward extension."
Broadly speaking, what's transpired the last two months is a great sign for the intermediate term. However, a pullback is truly a matter of "when" not "if", and further upward extension from here will only exacerbate the pullback we experience.
We'd ask the S&P 500 to take a break the front half of September, perhaps declining -3-5% back toward the ~3,350-3,400 level, prior to then continuing its advance. We doubt the market gods are listening, but it never hurts to ask.
We can also quantify the S&P 500's seven-day winning streak. Since 1970, there are 16 prior seven-day winning streaks that saw the S&P 500 close a new all-time high. Interestingly, thirteen of sixteen saw the index close higher three and four days later, on average by roughly 0.50%. We found this study surprising, as we thought there'd be more red on the table below.
Putting it together, it's clear the S&P 500 is in some form of a "melt-up" (click here). This week's breakout was impressive and solidifies the primary trend as up, or "bullish", across all time frames. We know we're sounding like a broken record here, but prices don't move linearly forever.
S&P 500 Primary Trend - Up
The S&P 500 will close the month of August on Monday, and barring any crash-like price action the index will increase for the fifth consecutive calendar month. The S&P 500 is presently higher by 35.73% the last five months, and a monthly close above 3,471.87 will leave the S&P 500 trailing five-month return as the single best trailing five-month return the index has recorded since 1950. It's all but certain the summer is going to record as the single best summer we've ever seen (i.e., the highest S&P 500 price-only return from June through August).
The S&P 500 trades beyond the limits of imagination - we never imagined a five-month streak like this as of the end of March. But, we'll certainly take it. It's welcomed after that disastrous first quarter.
The "breakout" on the monthly chart is beautiful.
The S&P 500 was stuck in traffic from January of 2018 through April of 2020's close. During that two-year-plus period the S&P 500's price-only return was just ~3.13% and there were two market crashes (December 2018, March 2020). It's clear the index found the left lane and then slammed on the gas.
The primary trend is up, or "bullish", and during uptrends long-term investors are best served investing.
Uptrends are a time to buy 'em and hold 'em and keep your defense on the sidelines. They're a time to mute the talking heads on the television, a time to try to ignore all of the "noise", especially in a year like 2020 where the "noise" is the loudest it has ever been.
This is why we love using a systematic, rules-based, non-discretionary approach to asset allocation and security selection decisions. If left to human discretion, emotions are then involved, and we don't know how anyone would have been a buyer of stocks at any point the last three months. The "noise" has been too loud, and "noise" of this magnitude will always strike an emotional chord.
During volatile climates there's always a reason not to buy stocks, there's always a reason to believe buying them and holding them is a recipe for disaster. This is because the "bearish" case is always known and knowable, thus it's always more articulate than the "bullish" case. Take the election as an example; it's easy to believe the market will find turbulence around the election - it's difficult to have faith in the idea of the market taking the election result in stride (look at 2016's election as an example).
This is why a dispassionate, robot-like approach to investing decisions will generally win over the long term; it overweights faith in the future when the fear in the present is likely too much to overcome.
We encourage all of our readers who are long-term investors to not let the fear of striking out keep them from stepping up to the plate.
This uptrend can continue, the S&P 500 can climb to prices that are unimaginable over the coming twelve months. It's imperative those long-term investors who need to participate (a derivative of your individual investor attributes) participate (importantly, there are plenty of our readers who don't need to participate).
This is where history can help long-term investors make an informed decision. History can't predict the future, but it can be used to dispel the idea that "this can't continue", something many long-term investors are presently feeling. Remember, the null hypothesis in the world of investing is that stocks will rise into the future.
Since 1950, the S&P 500 has recorded 26 prior five-month winning streaks. Following these five-month winning streaks, the index has then produced positive forward one- year returns 25 times. That's 25 out of 26, a 96.15% win rate, for average returns of 12.85%. The lone decliner was barely a scratch, a loss of just -0.65%. Every single instance has traded higher by at least 4.36% at some point over the forward one year, and there isn't a single "top" in the dataset (i.e., the S&P 500 closed a month higher than the monthly close associated with the five-month winning streak 100% of the time).
This is *not* to suggest things are all Goldilocks from here and higher returns are guaranteed. We fully acknowledge that we live in unprecedented times, fundamentally, and should expect unprecedented price action. Heck, the most recent five-month winning streak was August of 2018, and even though the S&P 500 closed higher one year later, we all should remember what transpired in December of 2018.
Powell Sets The Fed's Course, Bonds & Gold Take Notice
Federal Reserve Chairman Jerome Powell gave a speech over webcast from Jackson Hole this week (click here). The speech was from the "Navigating the Decade Ahead: Implications for Monetary Policy" symposium, but in order to truly appreciate the significance of this speech it's important to frame the last decade for the Federal Reserve.
Corey Hoffstein of Newfound Research articulated it best in a recent research piece, stating that the Fed has gone from being analogous to the referee of our financial markets to the major player in our financial markets.
And when the major player in our financial markets has the capacity and willingness to print money, and monetize any and all Treasury debt issuance, you have a future that is seemingly driving directly toward Modern Monetary Theory (MMT, click here).
In our opinion, the actions of the Federal Reserve the last decade has established a course that's forever changed financial markets and the way we perceive "risk" in financial markets. The phrase "it's not your father's market" has perhaps never been more applicable.
This is why Powell's speech was incredibly influential and market moving. Powell said the word "concern" twice, the first being:
"The persistent undershoot of inflation from our 2 percent longer-run objective is a cause for concern."
We've often stated that the Fed's true mandate is to "inflate or die" (Richard Russell said it first) and it's quite clear that the Powell and the Federal Reserve want higher inflation (inflation was said 76 times in his speech). Perhaps the most market moving use of the word inflation came when Powell said:
"Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time."
The last decade is defined as a period where inflation has run below 2%, therefore Powell is effectively saying we're going to do everything in our power to get inflation to run "moderately above 2% for some time".
This sort of average inflation targeting is what the market will now digest as it attempts to price asset classes that are a function of inflation and inflation expectations (bonds and gold).
Naturally, the market's first reaction to the Fed's inflationary wishes was to bid up assets that are perceived to do well in inflationary environments (gold) and sell off assets that are perceived to do poorly in inflationary environments (bonds).
The bond selloff steepened the yield curve meaningfully this week.
The yield associated with 2-year Treasury bond declined two percentage points this week from 0.16% to 0.14%, a vote of confidence in the Fed's desire to anchor the federal funds rate at and around 0% for the foreseeable future. However, the yield associated with a 10-year Treasury bond increased ten percentage points rising from 0.64% to 0.74%. The spread between the two yields equates to the yield curve which increased by twelve percentage points. The yield curve now sits at 60 basis points and appears ready to challenge its 2020 highs at 0.70.
If the Fed is able to convince market participants of the idea of ascending future inflation, then long-term Treasury bonds, as measured by the iShares 20+ Treasury Bond Index Fund (ticker symbol TLT) decline this week was a precursor of things to come. TLT declined -3.06% this week with Friday's close at $161.12. TLT has declined -5.67% thus far in August. This is notable since TLT's favorite month of the year, in terms of seasonality, is August.
It will be interesting to see how the Federal Reserve tries to thread the needle between the conflict that exists in their dual mandate: the desire to keep interest rates across the yield curve low and stimulative to the economy is in direct conflict with the idea of trying to lift inflation and inflation expectations. The Fed's been trying to "inflate or die" for a decade, unsuccessfully.
What makes market participants, collectively, believe this time will be different? And if they do believe this time will be different, and thus continue to sell off bonds (thereby raising interest rates), how will that affect the economy? (Hint: it's not ideal economically). That's where the former referee, now turned player, probably becomes a buyer of long-term Treasury bonds in an effort to lower interest rates. We won't be surprised to see TLT show up on the Fed's list of fixed income ETFs it owns.
As for gold, the metal gained 1.43% this week and is consolidating nicely since breaking out to new all-time highs.
Gold has traded down to $1,874.20, $1,916.60, and $1,908.40 each of the last three weeks, yet the metal has closed each of the last three weeks at $1,949.80, $1,947, and now $1,974.90. From a chart perspective, this fits the description of past resistance becoming present day support, at least for now.
From a fundamental perspective, gold's future seems to be directly aligned with the Federal Reserve.
The Fed wants to thread the needle, they want above average inflation with lower interest rates across the curve. That's the epitome of negative real interest rates and that's a backdrop where gold tends to shine the brightest. In any scenario where the Fed is not meeting their mandate, whether that's due to inflation sustaining below average, or interest rates running too high, the Fed will probably put on their uniform and enter the arena in an attempt to boost inflation and lower interest rates.
From both a technical and fundamental perspective, it's hard to see how the Fed's goals are not aligned with much higher prices for gold. We continue to believe that owning some gold is a prudent, defensible, and intelligent decision for most long-term investors.
One day remains in August and then we're on to September.
Happy Sunday!
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