Instead of worrying about whether it can rally through resistance, here is another index that staged a cup and handle breakout, but to all-time-highs. It’s the NYSE FANG Plus Index, which represents megacap growth stocks, which has been the market leadership. The catch is its relative strength is faltering and its retreated to test a key relative resistance turned support level. Further relative weakness could signal a loss of megacap growth leadership.
Growth or Value?
It appears that value is starting to take over the baton of market leadership. The accompanying chart shows the relative performance of value and growth across different market cap bands and internationally. In all cases, value stocks are beating their growth counterparts. Even more astonishing is that small-cap value is turning up against large-cap growth (bottom panel).
The predominant value sectors are financials, industrials, energy, materials and selected consumer discretionary stocks, except for heavyweights Amazon and Tesla. In other words, value has a significant cyclical exposure. The accompanying chart shows the relative performance of selected key cyclical industries. With the exception of oil & gas extraction, most are exhibiting positive relative strength against the market.
In summary, the bottom-up internals of the stock market are discounting a cyclical revival. This view is confirmed by a longer-term analysis of the relative performance of growth and value. Historically, investors have flocked to growth stocks when economic growth is scarce. We can see the dramatic outperformance of growth in 2020 during the COVID Crash and in 2023 when the consensus called for a recession which never arrived.
It appears that growth stocks are faltering, and cyclicals and value are starting to lead the market.
In other words, a bottom-up analysis of the stock market shows that it is discounting a “no landing” scenario, in which economic growth revives, instead of the consensus top-down “soft landing”, where economic growth slows and inflation decelerates sufficiently for the Fed to cut rates. An economy that achieves “no landing” may not slow sufficiently for inflation to drop to the Fed’s 2% target, which implies a scenario of higher-for-longer interest rates. Such a development would be a jolt to interest rate expectations, which are discounting a series of quarter-point rate cuts that begin in March.
That said, a more detailed analysis of the jobs data from the JOLTS and December Employment Report shows that data is still inflation friendly, despite the stronger than expected headline prints. Temporary jobs, which lead nonfarm payroll, fell -33,000 in December.
While headline average hourly earnings came in ahead of expectations, average hourly earnings of production and nonsupervisory personnel, which mainly excludes the effects of management bonuses, continues to decelerate. As well, the quits rate from the JOLTS report is also falling, which is another sign of a cooling jobs market.
In conclusion, I have highlighted the risk of transitory disinflation before (see A Bull Market With Election Year Characteristics). A divergence has appeared between the top-down and bottom-up expectations of growth. The top-down consensus is a soft landing, while the bottom-up consensus is no landing, which could put upward pressure on inflation and interest rates. Investors need to closely monitor these developments as the market could be rattled by a transitory disinflation narrative and a higher-for-longer monetary policy response.