What happens after the momentum chase?

The Zweig Breadth Thrust buy signal in early November sparked a price surge and a price momentum chase. Already, the S&P 500 made a late-day charge above 4600 for a new recovery high.


The price momentum factor is defined as stocks that beat the market continue to beat the market. The red line in the accompanying chart shows the difference between the one-month price momentum ETF (FDMO) and the six-month price momentum ETF (MTUM). One-month momentum has rocketed upward against six-month momentum, which is an indication that under-invested funds are scrambling to buy beta and momentum in order to catch up on performance.



In all likelihood, the momentum chase will last until year-end as fast money accounts continue to chase returns into year-end. The key question for investors is what happens after the chase?



All systems green

From a top-down macro perspective, all systems are green for a soft landing and Fed rate cuts in Q1 or Q2.


Let’s take a look at the major indicators on the Fed’s dashboard, starting with the jobs market. The November Payroll Report showed an improving economy. Headline nonfarm payroll came in at 199,000 and slightly beat expectations of 180,000 but those figures were distorted by the return of UAW workers after the strike. Average weekly hours edged up to 34.4 from 34.3, which was a welcome surprise of economic strength. The unemployment rate dropped from 3.9% to 3.7%, which puts to rest Sahm Rule recessionary signals.


However, leading indicators of the jobs market are softening. Temporary employment is rolling over, and the quits/layoffs ratio from JOLTS is also falling, albeit in an uneven fashion.



The New York Fed’s estimate of core PCE inflation is down to 2.6%, which is fast approaching the Fed’s 2% target and represents good news for policy makers.



Labour market productivity has been strong. This leaves more room for non-inflationary economic growth.



The improvement in productivity should lay to rest concerns about the pace of change in average hourly earning, which is decelerating but not as fast as core CPI.



Equally important is the recovery in monetary velocity. Recall that monetary theory posits GDP = MV, where M=money supply and V=monetary velocity. Even as M2 growth (red line) has fallen dramatically, M2 velocity (blue line) has been recovering to support GDP growth.



These readings cement the market’s expectations of no more rate hikes and possible rate cuts that begin in May 2024 as the Fed’s way to reduce real interest rates in the face of falling inflation.




The bulls’ challenge

While I expect that a momentum and beta chase will push upward pressure on stock prices into year-end and possibly early January, here is the challenge for the bulls.


In light of the strong macro backdrop, earnings estimates have to keep rising.



From a technical perspective, a constructive sign is the re-emergence of a positive monthly MACD for the broadly based NYSE Composite. If the signal holds until month end, such readings have historically signaled the start of long and sustainable bull runs. Keep in mind, however, that this is the only long-term buy signal and this doesn’t mean that prices advance in a straight line after the signal.



A useful development would be continual broadening breadth away from the narrow leadership of the Magnificent Seven.



Keep an eye on how the internals of value and growth rotation is progressing. It’s not enough to monitor U.S. large-cap value and growth, which is dominated by the outsized effects of the Magnificent Seven, but other value and growth relationships. Even as large-cap growth has been dominant for much of this year, mid-cap growth and value have been flat since June and small-cap value has been outperforming small-cap growth in the second half of 2023. In addition, developed market value has been turning up against its growth counterparts (top panel, red line). An ultimate test of broadening breadth and market rotation is whether small-cap value can continue to beat large-cap growth (bottom pane).



Lastly, the recent scramble for risk assets coincided with a bond market rally sparked by a tamer-than-expected Quarterly Refunding Announcement (QRA) from the U.S. Treasury. Treasury is expected to issue even more debt in Q1 2024 than in Q4 2023 and break above the bond supply of the COVID era. The next QRA will be on January 31, 2024. Mark that on your calendar as a source of volatility and possible catalyst for a bearish reversal.



In conclusion, the market appears to be setting up for a beta and momentum price melt-up into year-end. The question is what happens afterwards. Top-down macro indicators are supportive of a soft landing. From a technical perspective, the bulls need to broaden market leadership and allow the market to sustainably advance.