The time off also helped me gain some perspective.

Two years ago, I made the decision to start building a research service. My blog was already a couple years old at that point, and I believed I had a lot more to offer. So I went out and built the product before you today. 

In some ways, Grindstone has been the most rewarding thing I’ve ever done. I created something from nothing and met some amazing people along the way. That was clear from all the well wishes I received a few weeks ago after my newest family addition. But truth be told, growth has been underwhelming. 

I always talk about risk management, and risk management is about more than just trading. It applies to life choices, too. I’ve held onto this ‘trade’ for awhile now, hoping the trends would improve - all while telling my readers every day that trends are more likely to continue than reverse course. When a trade isn’t working, the best thing to do is cut it loose, no matter the cost to your pride. It’s high time I applied that same approach to life.

No decision has been harder than this one, but I’ve decided to take a step back from my commentary here on Substack. If you’re currently a paid subscriber, I’m working to issue a refund for the remainder of your subscription term.

The changes in my personal life don’t stop there. I’ve also made the decision to leave the wealth management firm where I’ve spent the first 9 years of my professional career and pursue a new challenge on the other side of the state. Fortunately, this opportunity happens to be a lot closer to my parents and siblings, who I haven't spent nearly enough time with over the past decade. 

I haven’t yet decided whether this will be THE end for Grindstone or just an end. Before I figure that out, I need to wrap my arms around what life looks like in a new place, with a new house, a new job, and a new baby.

I truly appreciate each and every one of you that have taken the time to read my work, especially those of you that have shown your support with a paid subscription. Hopefully you've gotten some value out of Grindstone along the way. In my absence, don't forget to follow trends, own relative strength, and manage risk.

That's all for now.

Austin

I promise it’s for good reason.

My wife and I welcomed another beautiful baby girl to the family, so I’ll have my hands full with Miss “Genny” for a little bit. Mom is a champ!

Since this isn’t my first rodeo, I know that trying to get a daily newsletter out over these next couple weeks isn’t a great idea. Once things settle down, though, I’ll be right back to churning out charts and setups for you guys.

Thanks for reading Grindstone. Until next time.

Austin

P.S. My last two kids were born just after bear market bottoms and the first one arrived about two months before a major top. Do with that what you will.

It looks like we’ve got our answer: the bull market lives on.

Communication Services, the worst sector during the bear market of 2022 but the best so far this year, is back above its prior cycle highs.

So are the Financials.

And the Materials.

The same goes for the Health Care sector, despite its status as one of the year’s laggards. After surging to new all-time highs in February, Health Care has been the single worst performing sector over the last three months. In other words, even the worst areas of the market are doing pretty well - that tells you a lot about the type of environment we’re in.

And let’s be clear. Health Care is one of the worst places to be right now. Relative to the S&P 500, the group failed to find support at the 2021 trough. We’d been eying that bullish momentum divergence forming at those former lows and believed that was a perfect time for the bulls to step in on Health Care. But instead of working off that divergence with a rally higher, we worked it off through time. Now, the Health Care/SPX ratio is at decade-plus lows.

Breadth readings support the negative bias towards Health Care. More than half of the sector’s constituents are above the 50, 100, and 200-day moving averages, so it’s not as if we want to be shorting the group - this is a bull market, after all. But no sector has fewer stocks trading above their long-term average than Health Care does. There are simply better uses of our time and resources than to be buying a bunch of Health Care stocks right now.

What could change our mind? A breakout for the SmallCap Health Care ETF would be a good start. Someone forgot to tell these guys that the stock market bottomed all the way back in October 2022 - PSCH was hitting new lows in October 2023.

A break above $44 would put an end to the downtrend that’s been in place for the 40 months, and that might be enough to shift the narrative around Health Care going forward.

Digging Deeper - Top charts and trade ideas

Over the last year, only one Health Care sub-industry has managed to outperform the 27% gain of the S&P 500. The Distributors have narrowly edged the index, gaining just over 28%.

Similarly, only one sub-industry has failed to move higher over the last year: Health Care Supplies has fallen 7%.

Near the middle of the pack is the Life Sciences Tools & Services sub-industry, where we’ve got a potential reversal shaping up. Here’s the group relative to the rest of the market.

Trends are always more likely to continue than reverse, so we can’t discount the likelihood that this cup and handle pattern doesn’t pan out, but it’s an intriguing setup. Especially as the sub-industry’s largest component threatens to break out of a big, multi-year trading range.

Thermo Fisher Scientific is knocking on the door of new highs. We like TMO above $610 with a target of $900, which is the 685.4% retracement from the 2020 decline.

Leaders

Moderna is another stock working on a major reversal, and this recent break above $120 was confirmation that the downtrend has run its course. That $120 level, which is also the 38.2% retracement of the 2023 decline, is a good level to manage risk against. We like it long from there with an initial target of $155, and a longer-term target back to last year’s peak of $215.

It’s not enough to just own stocks that are rising in bull markets. We want to own the stocks that are rising the most. United Health Services was among the sector’s best performers of the last month, and it’s hitting new multi-year highs relative to the rest of the sector, too. That’s the type of relative strength we like to see.

The risk/reward setup is pretty clean here, as well. Universal Health Services just went nowhere for nearly a decade. From big bases come big resolutions. We continue to like UHS from the long side as long as it stays above $160, with a target of $225.

Losers

The opposite of relative strength is CVS. We didn’t bother to adjust the y-axis on our chart for a reason. This is a bull market. Why on earth would we waste our time on stuff like this?

More Charts to Watch

Boston Scientific, on the other hand, is anything but a waste of time. It’s not just showing strength versus the weak Health Care sector, it’s been setting new highs against the rest of the market as a whole. That’s not bearish.

The risk-reward here isn’t great today for new entries as it approaches our target of $81, but if we see a pullback that closes the gap from the end of last month, we can be buying BSX above $68 with a target of $81.

Eli Lilly has shown even more relative strength than BSX. Check out LLY vs. the S&P 500: it’s been above a rising 200-day moving average for almost all of the past 3 years.

As Lilly consolidates at the 685.4% retracement from the early 2023 selloff, we have a clean setup to work with. We like it long above $740 with a target of $1000.

We also continue to like this setup in Intuitive Surgical. ISRG just broke out of a 2-year cup and handle base and has been consolidating above the former highs.

We like ISRG above the former highs of $375 with a target of $480, which is the 423.6% retracement from the 2020 decline. Especially if it can complete this same cup and handle continuation pattern relative to the rest of the sector.

That’s all for today. Until next time.

We’ve been seeing some posts floating around on social media about how the Utilities are the best-performing S&P 500 sector in 2024, and we feel like that needs to be addressed.

The Utes have done well this year, but they are NOT #1.

Communication Services is still out front, and by a fairly wide margin. Here’s the year-to-date S&P 500 sector performance derby:

So what’s causing the confusion? Are people just that ill-informed? Or is there something else going on?

The problem can be traced to the difference between following the market and following an ETF that attempts to track the market.

As a general rule, we try to always use indexes at Grindstone. We want to analyze the market in its purest form - not one that’s been diluted by fees or the decisions of individual managers - and then we can look for the best vehicle to use afterward.

Usually their isn’t much distinction between our analysis and that of those using funds to track sector or industry performance. This year, however, the popular SPDR Sector ETFs have done an especially poor job of reflecting the true market action. As a result, XLU, the Utilities ETF, has outperformed all the other sector ETFs.

Take a look at what’s happened. The Communication Services ETF (XLC) has lagged the sector index by 6%. The Information Technology ETF (XLK) has understated the sector’s performance by almost 5%. And XLY has underperformed the Consumer Discretionary sector by 3%.

How did that happen? It’s not that State Street dropped the ball. Their ETFs did exactly what they were designed to do and they’ve tracked their benchmarks admirably. The problem is that their benchmarks aren’t what most people think they are.

The S&P 500 is a market cap weighted index, meaning the largest stocks are the most important. The sector indexes are the same way - each stock’s importance within the sector is directly related to the market capitalization of the stock.

The select sector ETFs use what’s called a Modified Market Cap Weighting. That ‘modification’ keeps any single company from exceeding a 25% weight in the fund and keeps the sum of all companies with weights greater than 4.8% from exceeding 50% of the total. Here’s a summary of their process for reducing the weights of companies that violate their modified market cap thresholds:

1. If any company has a float-adjusted market cap weight (FMC) greater than 24%, the company’s weight is capped at 23%, which allows for a 2% buffer. This buffer is meant to mitigate against any company exceeding 25% as of the quarter-end diversification requirement date.

2. All excess weight is proportionally redistributed to all uncapped companies within the relevant index.

3. After this redistribution, if the FMC weight of any other company breaches 23%, the process is repeated iteratively until no company breaches the 23% weight cap.

4. The sum of the companies with weights greater than 4.8% cannot exceed 50% of the total index weight. These caps are set to allow for a buffer below the 5% limit. If this rule is breached, rank all companies in descending order by FMC weight, and reduce the weight of the smallest company whose weight is greater than 4.8% that causes the breach to 4.5%. This process continues iteratively until the rule is satisfied.

These rules are causing BIG distortions.

Let’s briefly walk through Communications. Alphabet’s market cap share of the Communication Services sector going into the quarterly rebalance stood north of 40%. But since the weight is capped at 23% in the ETF, that means the ETF only gets about half of the GOOGL weight it’s supposed to. Meta was north of 25%, too. Result? Underweight META. Put those two together and you’re at a 46% weight for the ETF, a little more than 20% below what their true market cap share is. Now we have to distribute that 20-odd percent across the remaining 17 companies in the sector, which pushes another 6 companies above a 4.8% weight.

Except GOOGL and META are already at 46%, and adding any company at more than a 4.8% will violate the 50% cap in rule 4. So each of those 6 companies is iteratively reduced to a weight 4.5%. It’s a messy process that effectively overweights each of the smallest companies in the sector and underweights the largest.

There’s also a large distortion for the Tech sector. Microsoft and Apple were the two largest stocks in the sector at quarter end, and neither were in breach of the 24% market cap share threshold. So far, so good. But then add in NVIDIA, at about a 17% weight, and you’ve got a problem. Since the 3 together represent 60%, rule 4 is broken. To correct that, “reduce the weight of the smallest company whose weight is greater than 4.8% that causes the breach to 4.5%.” So the weights of MSFT and AAPL aren’t changed, but NVDA goes from a 17% weight to a 4.5% weight.

NVIDIA is the second-best stock in the entire S&P 500 so far in 2024, yet XLK is underweight the stock by 12%. No wonder we’ve got performance distortions.

We’re not here to bash the ETFs - these modifications could have resulted in outperformance of the true market just as easily as they have underperformance. All we’re saying is that it’s important to know what you own.

That’s all for today.

Sell in May and go away? Not so fast.

The S&P 500 rose 1.85% last week, bringing its year-to-date total back to nearly 10%. It’s the third straight week of gains for equities after prices experienced their first 5% decline since last October. Gold was even better, rising 2.5%.

This week, all eyes will be on inflation data for April. First up is tomorrow’s Producer Price Index update, where consensus expectations call for a slight acceleration to 2.2% on the headline number. Wednesday’s CPI report will be even more important. Core inflation - the measure that excludes volatile measures like food and energy - accelerated in March after 11 consecutive months of declines. Forecasters are hoping expecting that inflation will resume its downward trend and dip to a multi-year low of 3.6% in April.

Relatively Speaking

It may be a new year, but some things in 2024 look awfully familiar to 2023. The Communication Services and Information Technology sectors are both outperforming the S&P 500, with Communications the year-to-date leader, up nearly 19%. Participation in the bull market has broadened out, though. Last year, only the growth sectors did better than the benchmark index. This time around, 6 of the 11 sectors have outperformed. One thing that hasn’t changed? Real Estate is lagging. That sector is down almost 6%.

Risk-off areas of the market have dominated over the past month, as the Utilities jumped almost 10%, and the Consumer Staples rose 4.5%. Risk-off outperformance is often a reflection of a waning market, but it’s hard to make that argument right now - 9 of the 11 sectors were up over the period.

In Case You Missed It: Last Week’s Insights

What's Ahead

Here are the key data releases and events to keep on eye on in the coming days.

Not every area of the market is feeling the love - Real Estate is still down in the dumps. From the start of the 2022 bear market to today, the S&P 500 Real Estate sector has fallen 23%. The next worst sector is Consumer Discretionary, down just 7% from its highs by comparison.

If you’re looking for a reason for Real Estate’s troubles, blame the rise in interest rates. Take the trend of the sector vs. the rest of the market, then overlay that with Treasurys. The relationship speaks for itself.

When interest rates go up, Real Estate underperforms.

Higher interest rates are a two-fold headwind. One, they make fixed income more attractive to investors and lower the relative appeal of stocks with high dividend yields. Consider this: Two years ago, 10- year Treasury rates were just 1.5%, while the dividend yield on Real Estate stocks was among the highest in the S&P 500 at about 3%. Today, the risk-free Treasury yield is above 4.5%, while Real Estate pays the highest dividend yield of any sector at just 3.5%. For income-focused investors, there’s little comparison.

Second, rates are a problem for the business activities of real estate stocks, which tend to have high debt loads. Real Estate has just a 2% market cap share of the S&P 500, but it has a 6% share of net interest expense. By that measure, Real Estate stocks are already paying 3x more interest than the average S&P 500 company. Only the Utilities compare, and they’re even worse, with a ratio of interest expense to market cap share of 8x.

The Utilities have one distinct advantage, though. The average maturity of debt for Utilities stocks is more than 10 years - double that of Real Estate at about 5 years. That means Real Estate companies will be repricing their large debt loads at higher interest rates at a much faster pace.

Things could be worse. Even though they were among the worst performers in 2022 and failed to participate during most of the 2023 rally, Real Estate is making progress on reversing this multi-year downtrend. Last fall’s failed breakdown below the October ‘22 lows was a start, but now we’ve yet to see a series of incremental new highs. The sector is a rangebound mess - that’s not good, but it isn’t so bad either.

Unfortunately, waiting around for new highs while the rest of the market is screaming higher doesn’t make for a compelling investment opportunity. Compared to the S&P 500, the Real Estate sector has been trending steadily lower throughout this bull market.

And Real Estate still has the weakest breadth characteristics of any sector in the market. Just 29% of the sector’s constituents are in long-term uptrends - defined as trading above a rising 200-day moving average.

Relative weakness and poor breadth makes the Real Estate sector a place we’d rather not visit - at least not until we see clear and convincing evidence of a change in the trend.

Digging Deeper - The Best Houses Stocks in a Bad Neighborhood Sector

The underperformance within Real Estate this year isn’t limited to a handful of names. Every single sub-industry has lagged the S&P 500 in 2024, and 9 of the 13 are in negative territory.

Leaders

Welltower was one of the best-performing stocks in the sector over the last month, rising nearly 10%. That also makes it one of the best performers of the year.

The most interesting thing about WELL is that it just broke out to new all-time highs, showing a ton of relative strength by surpassing its 2022 highs well before the sector as a whole.

New highs are a characteristic of uptrends, and this uptrend was just confirmed by momentum hitting its highest level since those prior cycle highs. We like the risk/reward opportunity here with WELL just now breaking out, and we can own it above $98 with a target of $123, which is the 161.8% retracement from the bear market decline.

Losers

Costar Group found itself on the ‘Losers’ list for the last month, but it stands out because it’s the only one of the Losers that’s put in a positive performance year-to-date.

The recent weakness followed a failed breakout from multi-year highs earlier this year, and CSGP has been trying to regain its footing ever since.

Sometimes failed moves are the start of trend reversals, but more often than not, they just delay the next leg of the existing trend. We think that’s what’s going on here. There’s no reason to be involved if the stock is below $94, but on a renewed breakout we think it goes to $118.

We continue to like CBRE above $87 - which is the 161.8% retracement from the COVID decline and an important high in 2022 and 2023 - with a target of $122. While the Real Estate sector as a whole has been messy and rangebound for the past year, CBRE has been consolidating above its prior range. That’s a sign of relative strength to us.

The One to Watch

All these other names we’ve looked at are showing relative strength within the sector, but remember that the sector we’re comparing to is literally the worst sector in the index. It’s not hard to do better than that.

Only one Real Estate stock is showing relative strength vs. the S&P 500 as a whole, and that’s Iron Mountain.

We love this setup as IRM consolidates above the 423.6% retracement from the 2020 decline. As long as it’s above $76, we want to be buying it with a target up at $110.

That’s all for today. Until next time.

Zoom out for a minute and look at what gold prices have done over the last 30 years. Does this look like a big top to you? Or does it look like the early stages of a new uptrend?

We’re betting on the latter.

We’re eying $3200 over the next few years, which is the 1794% Fibonacci retracement from the 1990s decline. Prices have respected these retracement levels all the way up: The hiccups in 2006 and 2008 occurred near Fib levels, the ceiling from 2013-2019 was the 684.4% retracement, and for the last few years we were stuck below the 1109% retracement. It would make a lot of sense to go up and touch that next level. Even $3200 might be too conservative of an expectation – prices rallied a lot more after the 2004 breakout.

First things first, though. Gold has to deal with near-term supply at $2440, which is the 423.6% retracement from the spring 2020 selloff. From a tactical standpoint, we can afford to wait and see a fresh breakout above that resistance level before initiating new longs, and our near-term target is just over $3000.

A coinciding breakout from silver would give us more confidence in gold’s ability to hit those upside targets. Silver came out of nowhere to erase more than two years of absolute mess, and now it’s knocking on the door of a major breakout. If silver is above $29, we think it can rally all the way to $39, which is the 423.6% retracement from the 2020 decline:

What’s so important about silver? We think of silver as a ‘risk-on’ version of gold. Prices for the two tend to be highly correlated, but silver tends to move in greater magnitudes. As such, when precious metals are rising, silver should outperform. That’s what we’ve typically seen during gold’s best runs, and that’s something that had been lacking for most of 2022 and 2023. Right now, the gold/silver ratio is rangebound.

But here’s something to take note of: the silver miners are outperforming. Below we’ve got SIL, the Silver Miners ETF, divided by GDX, the Gold Miners ETF. Last month, the SIL/GDX ratio jumped back above the 2020-2022 lows, an area that acted as resistance in January. This looks to us like a clear reversal of the multi-year downtrend that had been in place since early-2021.

The silver miners are showing relative strength, but as a group they’re still stuck below the highs they set last summer. So long as SIL is stuck below $33.50, it’s hard to justify a trade here.

Fortunately, we aren’t limited to looking just at ETFs. We took a look at the individual miners and found a few that really stood out. All three are already above last year’s highs (aka showing relative strength) and all three have attractive risk setups right now.

Coeur Mining is consolidating above the 38.2% retracement from the 2020 decline, a level which was also resistance in the back half of 2022 and throughout 2023. Consolidating above support - rather than below resistance - is something we tend to see in the strongest uptrends. Our risk level in CDE is $4, with an initial target back at the pre-pandemic highs above $8.

Taseko Mines is knocking on the door of 10-year highs at $2.65. This level is the 38.2% retracement from the entire 2007-2016 decline, and it acted as support in 2011 and 2012 before turning into resistance in 2013, 2014, 2017, and 2021. In other words, there’s a lot of memory here. A breakout would serve as proof of the bulls’ control, we we’d want to be buying TGB with a target of $3.90.

And finally we’ve got Fortuna Silver Mines. FSM is breaking out TODAY above the 38.2% retracement from the 2020-2022 decline. We just spent the last few weeks consolidating below that area of former resistance, so we think this breakout is the real deal. We want to own it as long as it’s above $4.90 with a target of $6.70, which is at the next key Fibonacci retracement level.

That’s all for today. Until next time.

Despite all that, the ‘crisis’ was over almost as soon as it began. From the March 17th, 2023 lows to today, the Financials have tracked the S&P 500 nearly step for step.

Beneath the surface, they’ve been even better. Here’s the equally weighted S&P 500 sectors since those March 17 lows - the Financials are among the leaders, right up there with the Industrials, Tech, and Energy.

So are the Financials going to continue leading?

We think that depends on the outcome of this ongoing retest of the 2020-2021 highs for the Russell 1000 Growth to Value ratio. A successful retest here would mean we should put renewed attention on AI and mega-cap growth names that have dominated the bull market thus far.

A failure, though, and we could find ourselves at year-end talking about the dominance of Energy and Financials stocks in 2024.

The latter would fit with what we’re seeing for the Financials relative to the S&P 500. The ratio below is above its 200-day moving average and spent the first few months of the year consolidating above a key, one-year rotational level. Then it hit new 52-week highs in April. This is an uptrend until proven otherwise.

And we know that uptrend breadth is strongest in the value-oriented cyclical sectors of the market. The Financials sector has more of its constituents trading above a rising 200-day moving average (81%) than any other group. Energy (75%), Materials (73%), and Industrials (68%) aren’t too far behind.

What’s the biggest headwind for Financials sector bulls? It’s the January 2021 highs, which are once again acting as overhead supply after a failed breakout earlier this year.

Sometimes failed breakouts are the beginning of trend reversals. Other times it just marks a false start, one that requires some time for all the ‘racers’ to regain their footing and get ready for the real race. The weight of the evidence says we’re still in a bull market, and that means the latter is the more likely outcome.

We’re betting on higher prices for Financials stocks.

Below, we highlight our favorites.

Digging Deeper - Top Charts and Trade Ideas

As we mentioned above, no sector has stronger breadth characteristics than the Financials, and you can see what that means at the industry level. The weakest industry is still up nearly 20% over the last year.

The banks are what interest us the most right now. First, take a look at the Regional Banks sub-industry, where last year’s failures were located and where the ongoing risks from CRE are most acute. The group just hit new 52-week highs.

That doesn’t necessarily mean we need to be buying them - and in this case, we don’t, because they still aren’t showing any relative strength compared to the rest of the sector.

But the fact that bears can’t even keep down the worst areas of the market tells us a lot about the type of environment we’re in. Knowing that the bulls are in control should give us more confidence in buying the areas that are showing relative strength. Like the big banks.

Bank of America (BAC) just broke out to new 52-week highs versus the rest of the sector.

So did Citigroup (C).

And so did Wells Fargo (WFC).

These are the types of themes we want to be looking for. It’s one thing for a stock to be breaking out. It’s another thing altogether for a stock to be breaking out while it has a stiff industry-wide tailwind.

WFC has the best setup of those three as it breaks out of this 9-year base. We can be buying it above support at $58 with a target of $81.

Did you really think we’d ignore the best of the best, though? Those other banks are all successfully reversing relative downtrends. JPMorgan was just setting new ALL-TIME highs vs. the Financials sector. There’s relative strength, and then there’s relative strength.

We still want to be buying JPM above $180 with a target of $275.

Leaders

Goldman Sachs was the top-performing stock in the sector over the last month, and that leadership has it threatening to break out of a massive, decade-long base relative to the rest of the sector.

If that breakout comes, we could easily be talking about several years of outperformance going forward. Our initial target on GS is $580, which is the 261.8% retracement from the 2007-2009 decline.

Insurance stocks continue to rally.

This has been one of our favorite areas over the past year, and we don’t see much to change that.

Progressive still has a solid setup in place. It moved past our former target of $205, and now we’re using that level to manage risk on new entries. We like PGR long above $205 with a target of $265.

Arch Capital Group was one of the best stocks out there in 2022 and 2023, but then it hit our target of $91 late last year and stopped going up. For awhile anyway. Now ACGL is setting fresh highs, and we have a new entry point with a level to manage risk against. We want to be buying it above $90 with a target of $135

Losers

The opposite of relative strength is relative weakness. Losers tend to keep on losing.

Franklin Resources has lost 85% of its value when compared to the rest of the sector over the last 13 years, and it just hit new 20-year relative lows.

MarketAxess Holdings just broke multi-year relative support. There’s no reason to be involved with this one unless you’ve got a penchant for grabbing falling knives.

More charts to watch

Trends are always more likely to persist than reverse. That’s why we spend most of our time focusing on stocks in uptrends and avoiding the ones in downtrends. But that doesn’t mean trends never reverse. We’re eying a potential downtrend reversal in Fidelity National.

It’s been one of the worst stocks in the world over the past few years, but compared to the S&P 500, FIS stopped going down last fall. The FIS/SPX ratio is further above its 200-day right now than at any point since March 2020. Oh, and it just hit new 52-week highs.

On an absolute basis, the downtrend reversal is even further underway. We continue to like FIS above $63 with a target of $90, which is the 38.2% retracement from the entire 3 year decline. New entries right here don’t make a lot of sense, but it’s one to keep watching.

Fiserv has no downtrend to reverse, though it’s currently stuck below our former target of $155. We still like the relative strength profile of FI longer-term, though, so we don’t want to forget about it. On another break above $155, we want to own it with a target of $205, which is the 261.8% retracement from the 2020 decline.

That’s all for today. Until next time.

The Federal Reserve decided to keep their interest rate target unchanged last week. Just 5 months ago, market participants were pricing in as many as seven 0.25% rate cuts in 2024. Today, that expectation has fallen to under 2.

What’s changed? It’s persistent inflationary pressures. Here’s a look at the Consumer Price Index over the last 15 years. Throughout the 2010s, inflation was largely a non-factor as prices oscillated around the Fed’s 2% annual target. That all changed in 2020, when stimulus-fueled demand for goods met a supply chain snarled by pandemic restrictions. CPI surged to nearly 9% - the highest rate since the early 1980s.

As supply chains were repaired and stimulus wore off, inflation began to moderate in the second half of 2022 and throughout 2023. And by the end of last year, it seemed things were well in hand. Soon, the Fed would have the confidence it needed that inflation was moving sustainably toward 2 percent, and that would allow them to reduce the target rate for the federal funds rate.

But the CPI this year has stopped normalizing and instead stabilized above 3%.

In the words of Fed Chair Jerome Powell, “We didn't see progress in the first quarter, and I've said it appears then that it's going to take longer for us to reach that point of confidence. So I don't know how long it'll take.”

Fortunately for Mr. Powell, achieving the 2% inflation target by the end of 2024 is still possible. All it would take is for shelter inflation to follow its expected path.

Here’s Mr. Powell from back in November 2022 explaining the dynamics of measuring shelter prices: “Housing inflation tends to lag other prices around inflation turning points, however, because of the slow rate at which the stock of rental leases turns over. The market rate on new leases is a timelier indicator of where overall housing inflation will go over the next year or so.”

There are plenty of third-party providers we can use to look at the market rate on new leases - Zillow, ApartmentList, and Redfin all provide versions of that data - but if we’re trying to chart the future path of the CPI, why not go straight to the source of the CPI itself? The Bureau of Labor Statistics is here to help:

“The rent component of the official CPI measures the change in all rents, including new leases, renewals, and rents in the middle of a lease. In contrast, the New Tenant Rent Index uses only a subset of the data the official CPI uses, namely the first survey observations after new tenants move into their sampled housing units. The All Tenant Regressed Rent Index measures the rent paid by all renters, both new and continuing, and incorporates most of the survey data used for the CPI Rent of primary residence index.”

Take a look below at the New Tenant vs. All Tenant Rent indexes over the last 20 years. The post-pandemic period stands out, when the growth rate on New Tenant Rents accelerated at an unprecedented rate. As Powell noted above, the All Tenant Rent index lagged on that initial acceleration. Likewise, though New Tenant Rent has stabilized over the last year, All Tenant Rent has barely slowed.

The post-pandemic dislocation was so large that we’ve just been playing catch-up for the last year. Now it’s time for the growth rate to catch-down.

We wondered how much of a tailwind Powell & Co. might get over the rest of the year, so we set about trying to quantify it.

Since the average renter in the US stays put for a little over two years, that means taking a two-year average of New Tenant Rents should give us a pretty good idea of where the All Tenant Rent is at any given time. And that’s exactly what we see. Check out the year-over-year change in the 8-quarter average of New Tenant Rents and compare it the the y/y change in All Tenant Rents. They track almost perfectly.

We took it one step further. We extrapolated the New Tenant Rent Index over the next few quarters (using seasonal pattern of the last 20 years) to project where the 8Q average might end up by year-end. The result? A sub-1% growth rate.

That’s good news for the future of Shelter inflation in the CPI, because Shelter inflation tracks closely with both the change in All Tenant Rents and the 8-quarter average of New Tenant Rents.

What might that mean for Mr. Powell and his 2% inflation target? We won’t go so far as to say he’s destined for success - we’re not economists, and we do our best to avoid making economic predictions. We can do basic math, though. The difference between 5.6% inflation and 1% inflation on a component that has a 36% weight in the CPI comes to a 1.6% change at the index level.

With inflation today at 3.5%, it’s not hard to see a path to 2%.

That’s all for today. Until next time.

Rate cuts? Not so fast

Last week, the Federal Reserve kept interest rates unchanged, citing the disappointment of higher-than-expected inflation readings throughout the first quarter. At Fed Chair Jerome Powell’s post-FOMC meeting press conference, his message was clear: interest rates are going to be higher for longer. Here’s a clip from Powell’s opening remarks:

“We've stated that we do not expect that it will be appropriate to reduce the target range for the federal funds rate until we have gained greater confidence that inflation is moving sustainably toward two percent. So far this year, the data have not given us that greater confidence. In particular, and as I noted earlier, readings on inflation have come in above expectations. It is likely that gaining such greater confidence will take longer than previously expected. We are prepared to maintain the current target range for the federal funds rate for as long as appropriate. We're also prepared to respond to an unexpected weakening in the labor market.”

Powell went on to repeat some variation of “longer than previously expected” four more times during the Q&A portion of the press conference.

“We didn't see progress in the first quarter, and I've said it appears then that it's going to take longer for us to reach that point of confidence. So I don't know how long it'll take.”

“We see three inflation readings, and so I think you're at a point there where you should take some signal. We don't like to react to one or two months' data, but this is a full quarter, and I think it's appropriate to take signal now, and we are taking signal. And the signal that we're taking is that it's likely to take longer for us to gain confidence that we are on a sustainable path down to 2 percent inflation.”

“We didn't gain confidence and it's going to take longer to get that confidence”

“We've said that we didn't think it'd be appropriate to cut until we were more confident, that inflation was moving sustainably down to 2 percent. We didn't get - our confidence in that didn't increase in the first quarter and, in fact, what really happened was we came to the view that it will take longer to get that confidence.

We’ve written in the past about the importance of forward guidance in Fed policy making. It’s not what the Fed does, so much as it is what they say. And right now the Fed is saying that rate cuts are off the table until further notice.

No Stag, No Flation?

The message Jerome Powell wanted to send was the one we highlighted above. The clip that everyone seems to be latching onto instead is his answer in response to a question from a reporter at the Financial Times:

Here’s the exchange:

Q: “The Q1 GDP-1 print has led to some to start mentioning the term stagflation with respect to the U.S. economy. Do you or anyone else on the FOMC think this is now a risk?”

A: “I guess I would say I was around for stagflation and it was, you know, 10 percent - 10 percent unemployment. It was high single digits inflation… And very slow growth.

“So right now we have 3% growth, which is, you know, pretty solid growth, I would say, by any measure. And we have inflation running under 3 percent.

“I don't - I don't really understand where that's coming from. And in addition I would say most forecasters, including our forecasting, was that last year's level of growth was very high, 3.4 percent in I guess the fourth quarter, you know, and probably not going to be sustained and would come down. But that would be, that would be our forecast. That wouldn't be stagflation.

“That would still be to a very healthy level of growth. And of course with inflation, you know our - we will return inflation to 2 percent and that won't be - I don't see the stag or the flation actually.”

To Powell’s point, even though progress on inflation has stalled and growth rates have come down to start 2024, things aren’t so bad. Retail sales last month rebounded to a 4% growth rate, and even after Friday’s jobs report showed a notable deceleration in hiring (the 175k jobs added were the lowest since October), the unemployment rate is still as low as anything we saw in the 45-plus years from 1970-2017.

In Case You Missed It: Last Week’s Insights

What’s Ahead

Here are the key data releases to keep an eye in the upcoming week:

The S&P 500 Energy sector has been dealing with stiff resistance at the 2008 and 2014 highs for the better part of the last 2 years, and last month, we finally got that long-awaited breakout. Energy stocks hit their highest levels ever.

From big bases come big resolutions.. or maybe no resolution at all? Rather than capitalize on the momentum, Energy bulls haven’t been able to keep the rally going. Now we’re on the verge of a big, nasty failed breakout. If the Energy sector is below the spring 2022 highs (that’s at about 700 for the index and $92 for the XLE), we’ve got a problem.

If Energy does end up failing here, we know who to blame. It’ll be crude oil, which already put in a failed breakout of its own in mid-April. $85 has been the level to watch for WTI - we couldn’t not be bullish Energy as long as we were trading above it. But that’s no longer the case. We need to see a recovery sooner rather than later.

So why shouldn’t we be betting against Energy just yet?

In part, it’s because this is still a market where the value-oriented cyclical sectors are seeing the strongest breadth readings. 74% of S&P 500 Energy stocks are above a rising 200-day moving average, which is second only to the Financials at 77%. The Materials and Industrials sectors are next up, at 68% and 63%, respectively. That’s not a theme we want to be fighting - not until we see some real evidence of a reversal.

The other thing Energy bulls still have going for them is this chart of the sector relative to the rest of the market. Energy looked dead when it was breaking through a key area of relative support to start the year, but that breakdown was short-lived. We’re back above the 1999-2000 lows, and Energy is well-positioned to outperform going forward so long as that’s the case.

Digging Deeper - Our Favorite Energy Setups

The Refiners are still the best performers of the year, with the industry up 17% in 2024. They’ve given a lot back, though.

We set targets for a reason. It’s not because we can predict the future or because we know where a stock will peak. It’s because we need a way to assess the risk/reward of positions we take on.

Marathon Petroleum briefly surpassed our target of $200, but now it’s back below the 261.8% retracement from the 2018-2020 decline.

The same goes for Valero, whose breakout above our target of $175 turned into a failed move. After it hit our target, it was no longer our problem.

Both MPC and VLO are still in uptrends, and we’re still approaching them from a bullish perspective, but we can leave them both alone until the setups improve.

Leaders

If the Energy sector as a whole manages to stabilize above those prior highs instead of falling back below support, we want to be buying Energy stocks. But not just any Energy stock - we want the ones showing relative strength.

Like Diamondback Energy. Check out this beautiful 5 year base breakout for FANG vs. the rest of the sector.

On an absolute basis, FANG moved past the 161.8% retracement from the 2022 decline, and now that level should act as support here on the pullback. We like the risk/reward here, and we can own it above $195 with a target of $250.

More often than not, trends continue rather than reverse. That doesn’t mean trends never reverse. Look at Williams Cos relative to the rest of the sector. From the 2020 highs until this time last year, WMB was a textbook example of a downtrend - lower highs and lower lows, stuck below a falling 200-day moving average. Today, the opposite is true.

And WMB just broke out of a 2 year base. We want to be buying that breakout and want to continue owning it above $38 with a target of $44.

No stock has shown more relative strength than Targa Resources - it’s the sector’s top performer this year. There’s no trade here though, as it consolidates just below our $120 target.

Losers

Own relative strength, avoid relative weakness. The Energy sector was just at all time highs, APA Corporation just hit multi-year lows. Unless you’re bearishly inclined and approaching this one from the short side, there’s no reason to be involved.

That’s all for today. Until next time.

In 2023, it was mega cap growth stocks or nothing. Yes, more than just growth areas of the market were participating in the bull market. But the only way to outperform was to invest in those growth areas.

Check out the performance of the S&P 500 last year when you break it down by sector. In green are growth-oriented sectors, blue are value-oriented, and red are the risk-off sectors. It’s pretty clear who the leaders were.

2024 is a different story altogether. Communication Services - a growth sector - is at the top of the leaderboard, and Real Estate is again a clear loser, but there’s no theme to be found for everything in between.

That’s a reflection of a market at a crossroads. Earlier this week, we weighed the evidence supporting a continuing bull market against that of an emerging bear. The bull is still intact for now, but bearish indicators are adding up.

There’s similar indecision within the market about which group is going to lead going forward.

Check out the ratio of the Russell 1000 Growth ETF (IWF) relative to Russell 1000 Value (IWD). This ratio was trending higher (growth > value) until September 2020, and then spent the next 3 years trying to surpass that former high. We finally got the breakout late last year, and we’ve spent most of 2024 consolidating above that key level of support. Consolidations like that usually resolve in the direction of the longer-term trend, which in this case is up. Growth should continue to be a leader. But last month that support level was broken.

From failed moves usually come mean reversions, and sometimes those mean reversions turn into outright trend reversals. Value sectors have a chance to take charge.

Here’s the Financials relative to the S&P 500 index. The ratio below is above its 200-day moving average and spent the first few months of the year consolidating above a key, one-year rotational level. Then it hit new 52-week highs in April.

The bank failures of a year ago are now firmly in the rearview mirror. This is an uptrend until proven otherwise.

The Industrials sector isn’t too far behind. It just hit new 8-month highs relative to the rest of the market.

And the Energy sector, which looked dead when it was breaking through a key area of relative support to start the year, is now back above the 1999-2000 lows.

So clearly value is the place to be, right?

Not so fast.

The Communication Services sector is still very clearly a leader. When compared to the S&P 500, it just broke out to multi-year relative highs after a 6-month cup and handle consolidation pattern (which itself followed a big inverse head and shoulders reversal pattern).

And don’t let Tech’s weakness over the last few months distract you from the fact that it just broke out of a 20-plus year relative base. That’s not bearish action.

Maybe - just maybe - it doesn’t have to be growth or value leading the way. Maybe it’s growth and value leading.

That would be healthy, and it can happen as long as the risk-off areas of the market continue to lag. Real Estate is at all-time relative lows.

Health Care broke to its lowest level against the S&P 500 in more than a decade earlier this year, and it’s still below those prior cycle lows.

And even though the Consumer Staples have outperformed over the past month, they’re still stuck below their own prior cycle lows.

April was a down month for stocks, but the weight of the evidence says we should continue to favor risk-on areas of the market.

Here’s an overview of how we’re looking at the sectors right now. Despite the selloff, we haven’t seen anything over the past month to warrant a shift in our ratings.

The Grindstone Intelligence Sector Ratings are based on our top-down technical approach. We assess the relative strength and trends within each sector and gauge risk appetite in the broader market to determine which sectors we think are best positioned to lead over the coming weeks and months.

In addition, here’s an update on the Model Portfolio - since our sector ratings were unchanged, there isn’t much reason to adjust the holdings. The US Equity Model Portfolio is a hypothetical allocation designed to align with our Sector Ratings. The positions are chosen with investment horizons ranging from one to several months. The Model chooses only funds that track sectors, industries, or categories of stocks - no individual stocks or cash positions are used.

That’s all for today. Until next time.

The Industrials have come off their highs, but the decline hasn’t done any significant damage to the longer-term uptrend that’s been in place for the last 18 months. While former leaders like Tech are stuck trading below former targets, the Industrials are consolidating above theirs.

The underlying strength in the Industrials reflects underlying strength in the stock market overall. No sector is more highly correlated to the S&P 500 than the Industrials, a statistic exemplified by the performance since the bear market lows back in October 2022. Since then, the Industrials have tracked the SPX almost perfectly.

Owning the Industrials over the benchmark index hasn’t given investors much of an edge - they’ve tracked each other step for step - but below the surface, it’s a different story. If you strip out the outsized influence of market cap weightings and look instead at the equally weighted versions, the Industrials are setting new relative highs. Ever since breaking out of a 2-year base in early 2022, this ratio has been stair-stepping steadily higher.

The further you dig, the better things get. Check out the ratio of the small cap Industrials relative to the S&P 600. A breakout from a 10 year base has turned into an asymptotic rise. Every time we see this chart, we have to double-check the settings to make sure we still have the y-axis set to log scale.

Can the recent relative strength continue? Of course. We never want to discount the odds of a trend continuing.

But we’re also entering the worst seasonal period of the year for the Industrials relative to the rest of the market. Since 1990, the sector has underperformed on average in each of the next 6 months.

For the Industrials/S&P 500 ratio, ‘sell in May and go away’ has worked out pretty well.

Digging Deeper - Top Charts and Trade Ideas

Over the last year, only one Industrials industry has failed to move higher. Air Freight & Logistics has fallen more than 10%.

FedEx hasn’t exactly been blowing the doors off, but the real problem for the industry has been UPS. In the opening section we talked about how impressive it is for the Industrials as a whole to be consolidating above support within an existing uptrend. For UPS, we’ve got the exact opposite: it’s consolidating below resistance within an existing downtrend.

We’ve got the same thing for the stock on a relative basis. Yes, momentum for the UPS/SPX ratio didn’t get oversold on the most recent decline, but RSI hasn’t even approached overbought territory for the last year. This is anything but an uptrend.

Leaders

GE finished its spin-offs and changed its name to GE Aerospace, but nothing else changed. It added to its sector-leading year-to-date performance with an 18.5% gain over the last 4 weeks. Just three S&P 500 stocks have been stronger that General Electric in 2024, and one barely counts since it was just added to the index. That’s the result of a stock that just reversed a multi-year relative downtrend and is now setting 6 year highs vs. the S&P 500.

Following the spin of GE Vernova (GEV), we have to update our levels to watch. The 2007-2009 decline is what we’re using to manage risk from here, with the key level being the 61.8% retracement at $135. If GE is above that, we like it long with a target of $200.

Also among the biggest winners of the last month, Carrier Global just broke out of a huge, 2-year cup and handle base. We want to buying this breakout with a target of $74.

Losers

During bull markets, we like buying pullbacks within uptrends. That’s what we’ve got right now with Hubbell, which dropped almost 11% over the last month. Right now, the stock is just below our risk level of $380, which is the 423.6% retracement from the 2020 decline. We still want to be buying a move back above that level with a target of $560, but we can also manage risk at the 2023 highs of $330 if this pullback continues. Only a break below $330 would make us question whether this uptrend was still intact.

The reason we still like HUBB is that it continues to show strength relative to the rest of the market. The HUBB/SPX ratio just went nowhere for a decade - we think the rally still has legs.

Sometimes, though, buying pullbacks in uptrends doesn’t pan out. We’ve liked ODFL for awhile, and we believed this consolidation below the 161.8% retracement from the 2022 decline would resolve higher. But the breakout never came.

Now, the bigger question for ODFL is whether the stock will break below those prior cycle highs and begin a downtrend.

Could it find support here and rally back higher? Sure. And that’s the higher probability outcome if equities as a whole remain in a bull market. But what really concerns us is this trendline break for ODFL relative to the S&P 500. There’s no reason to be involved with ODFL until the damage is repaired.

More charts to watch

As evidenced by Old Dominion above, just because trends are more likely to continue than reverse doesn’t mean trends never reverse.

Few stocks have been worse than 3M over the last 6 years. From 2017 to the lows a few months ago, MMM lost 80% of its value relative to the rest of the market. It lagged in bull markets, bear markets, and everything in between.

Finally we’re seeing signs of life. The MMM/SPX ratio is further above its 200-day moving average that it has been at any point since 2017.

And the stock on its own just set new 52-week highs after bottoming near the 2007-2011 highs.

This isn’t one we want to own blindly - it could very easily turn this into a failed breakout and recapture its long-term loser status - but the risk/reward is intriguing. We can be buying MMM above $95 with an initial target of $125.

Builders Firstsource is in a monster uptrend relative to the S&P 500. Nothing we’ve seen this year changes that.

On an absolute basis, BLDR is consolidating below the 423.6% retracement from the 2022 decline, following a bearish momentum divergence at the highs. On the pullback, though, momentum has stayed out of oversold territory, telling us that the bears don’t really have control. We like it on a resumption of the uptrend above $200 with a target of $300.

Much like the Industrials sector overall, United Rentals is consolidating above a key Fibonacci retracement level. And earlier this week, URI set an all-time high compared to the rest of the market. Relative. Strength.

We want to be buying it above $650 with a target of $900.

The same goes for peer Caterpillar as it tests the 423.6% retracement from the 2019-2020 decline: as long as CAT is above $335, we can buy it with a target of $485.

That’s all for today. Until next time.

That question sets the stage for everything else we're doing. If our big picture view says that stocks are trending higher, we're going to be focusing our attention on favorable setups in the sectors that are most apt to lead us higher. We won't waste time looking for short ideas - those are less likely to work when markets are trending higher. We still monitor the risks and conditions that would invalidate our thesis, but in clear uptrends, the market is innocent until proven guilty. One or two bearish signals can't keep us on the sidelines.

For the last month, the bearish signals have been adding up, and we’ve been forced to take them more seriously. The trouble started with the US Dollar Index.

All throughout the bear market of 2022, it seemed the US Dollar was driving the boat. Every time the Dollar rallied, stocks were under pressure. And when the Dollar relented, equities moved higher. For most of 2023 - and even the first few months of this year - the US Dollar Index was stuck between 100 and 105. So long as that was the case, we believed any changes in the USD could be chalked up to chop within a trading range. In the middle of April, though, the Dollar Index broke out above that range.

Interest rates have been a problem too. The stock market set its ‘22 and ‘23 lows at the same time that 30-year Treasury rates were peaking. Lower rates have been good news for stocks, but higher rates are a problem. Around the same time the Dollar Index was breaking out above 105, rates were blowing past their 2022 highs.

The dual headwinds from a strengthening US Dollar and rising interest rates pushed stocks to their worst selloff of the year in April, with the S&P 500 falling nearly 6% from its intraday peak. That selloff came from a pretty logical level, too. The SPX stalled out just short of 5300, which is the 261.8% Fibonacci retracement from the 2020 decline and the 138.2% retracement from the 2022 bear market. The drop also confirmed a bearish momentum divergence that had been shaping up throughout 2024.

Fortunately, S&P 500 weakness has yet to do significant damage to the longer-term trend. Momentum failed to hit oversold territory on the selloff (a sign that bears haven’t taken outright control) and prices are still above the year-end 2021 highs.

We can’t say the same about the NASDAQ Composite. This was a textbook failed breakout:

More often than not, momentum divergences and failed moves lead to mean reversions. Sometimes, those mean reversions turn into full fledged trend reversals.

So which is it this time? Is this just a ‘normal’ consolidation within an ongoing bull market for stocks, or is this the start of a big bad bear? First, let’s recall what we said at the outset: the market is innocent until proven guilty. This is a bull market until we have clear and convincing evidence that it’s not.

True, we’ve lost some leaders. The biggest and most important sector in the index, Information Technology, stopped going up two months ago when it ran into the 161.8% retracement from the 2022 decline.

But failing to surpass a logical area of resistance isn’t the same as breaking below support. Tech is still trading above a rising 200-day moving average, and it’s still much closer to hitting new 52-week highs than it is to touching new 52-week lows.

Meanwhile, other areas of the market are still holding up quite well. The Energy sector just broke out of a 15-year base:

The Industrials have come off their highs just like the Tech sector has, but there’s one key difference between the two. While Tech is stuck below the 161.8% retracement from the 2022 bear market, the Industrials are consolidating above theirs.

And while the Utilities are a tiny and rather inconsequential sector, we can’t ignore that they just reversed a multi-year downtrend and set an 8-month high yesterday. New highs aren’t something you see in bear markets.

Here’s the chart that we think puts it all in perspective. The NYSE Composite includes all the common stocks listed on the New York Stock Exchange, so it’s a pretty good representation of what the total market is doing. The NYSE Composite peaked on March 28, dropped 5.5% over the next 3 weeks, and then found support right at the prior cycle highs. So far, this has been a perfectly logical pullback within an ongoing bull market.

Does that mean we can ignore the bearish evidence? Of course not. Bear markets have to start somewhere, and they always look like nothing more than logical pullbacks at their beginning.

So what do we need to see before turning more bearish? First, a weakening in market breadth. Stocks are off their highs, but we haven’t seen a bunch of trend reversals below the surface. Without that, how can we expect to see a trend reversal at the overall market level? Today, 58% of S&P 500 stocks are trading above a rising 200-day moving average. Those stocks can’t be in a downtrend. On the flip side, less than a quarter of stocks are below a falling 200-day.

Even on a short-term basis, the number of technical uptrends outnumbers the number of technical downtrends (46% to 39%).

We’ll also be watching for an expansion in the number of new lows. The list of new 52-week lows was setting year-to-date highs earlier this month, but the number of new lows was still well short of levels we saw throughout 2023:

To be fair, we shouldn’t expect to see a bunch of new 52-week lows when the market is just a month removed from setting an all-time high. Even on a short-term basis, though, the number of new highs outweighs the number of new lows.

We can look at whether a stock has more recently broken out or broken down and determine whether that stock is in a cycle of setting new highs or new lows. Today, two-thirds of S&P 500 members are in a new 3-month high cycle, and 80% are in a new 6-month high cycle. When this table starts showing more red than green, we’ll know for sure that the trend has shifted.

And finally, we’ll need to see a shift in risk appetite before believing that the big bad bear has come back to town. Consider the ratio of the Consumer Staples relative to the S&P 500. The Consumer Staples tend to outperform during risk-off periods, and that’s exactly what we saw throughout the bear market of 2022. The Staples outperformed again in the month of April, but not by enough to damage the downtrend. The ratio just got rejected at its 2021 lows.

Risk appetite is running rampant in the fixed income market, too. Below we’re comparing high yield bonds to Treasury bonds. When this ratio is moving up and to the right like it has been for the past year, it’s a sign that investors are favoring riskier high yield bonds to risk-free Treasury issues. And yesterday the ratio hit another new high.

That’s classic risk-on behavior. This bull market may be on hold, but it’s still a bull market.

That’s all for today. Until next time.

After the three straight weeks of declines and the biggest selloff since last October, stocks rallied sharply last week. The NASDAQ Composite led the way, jumping 4.2%, and the S&P 500 rose 2.7%. Prices rallied in spite of weak economic data to end the week. The first estimate of Q1 GDP came in at a 1.6% annualized rate, a sharp slowdown from Q4’s 3.4% rate and nearly a full point lower than consensus expectations. On Friday, the bad news continued: the PCE Deflator, the Federal Reserve’s preferred measure of price inflation, accelerated to 2.7% year-over-year, the highest since October. Three-month annualized inflation, which tracks shorter-term trends in prices, was the highest in a year.

On Wednesday, we’ll get to see how Jerome Powell and his colleagues are thinking about the latest data release after their scheduled FOMC meeting. Hotter-than-expected inflation readings all but assure that the Fed won’t be cutting rates this week (and probably won’t be any time soon), but slowing GDP growth and the risk of recession is something Powell may address during the post-meeting press conference. Also be on the lookout for details regarding the wind-down of quantitative tightening.

Earnings Expectations and Valuation

The 2022 bear market decline was not driven by a deterioration in corporate earnings. Though stock prices dropped well over 20% from their peak to trough, expected future earnings remained stubbornly high. That divergence pushed the S&P 500 forward price-to-earnings ratio from more than 22x (a level previously seen only during the late-1990s) to 15x (a level in-line with historical averages).

Almost 18 months after that bear market reached its lows, and valuations are right back to where they were. The S&P 500 forward p/e ratio is above 20x.

Fortunately, profits are expected to grow at an annualized pace of about 10% over the next 3 years according to Bloomberg consensus estimates. That would help make current valuations easier to digest. There’s just one wrinkle. Expectations imply that S&P 500 profit margins will have to jump to the highest level in decades by 2025, and expand even more in 2026.

More from last week:

What’s Ahead

Here’s the economic calendar for the week ahead

That’s the type of environment we’ve with been dealing with for most of the last year. The Consumer Staples sector - the one filled with companies selling toothpaste, diapers, tobacco, and frozen peas - peaked relative to the rest of the market in January 2023 and has been setting lower highs and lower lows ever since. Even though we saw a bullish momentum divergence and have gotten a mean reversion rally higher over the past month, the long-term downtrend is still intact. That’s the case so long as the 2021 lows are acting as resistance.

Another way to gauge risk appetite is to look at the Staples and compare them with the Consumer Discretionary sector. Consumer Discretionary companies are more similar to the Staples than say, a regional bank earning money on net interest margins, so we get a relationship that’s more apples to apples. The only difference is the products sold by companies in the Discretionary sector are more closely tied to economic strength. You’re probably not getting a new car or doing a big home remodel during a recession, but you’re still going to the grocery store and buying toilet paper.

So when the Consumer Discretionary/Consumer Staples ratio troughed at the end of 2022, then rose steadily for the next 10 months, that was evidence of buyers showing preference for the riskier, growthier stocks in the market.

However, the Discretionary/Staples ratio peaked in December after running into a key rotational level from the 2021 lows, and this week dropped to new 5-month lows.

Is that a sign of investors fleeing for safety and a harbinger of bad things to come? Maybe.

But things aren’t quite as bad as they appear at first glance.

The relative weakness in Consumer Discretionary over the last few months is largely attributable to just one stock. Tesla is the second largest stock in the sector, even though it’s lost 40% of its value since last summer. If we strip away the outsized influence of stocks with big market capitalizations and look at equally weighted versions of the sectors instead, the Discretionary/Staples ratio hasn’t broken down.

If we see the equally weighted Consumer Discretionary sector break down vs. the equally weighted Staples, and also see the Staples stabilizing above their 2021 lows relative to the S&P 500, then we’ll have serious concerns about the level of risk appetite in the equity market. For now, that’s not the world we’re living in.

Here’s one more thing to keep an eye on: the Consumer Staples on an absolute basis are trying once again to break out of this 3-year trading range.

The Consumer Staples and other risk-off areas of the market don’t outperform by rising in bear markets, but by falling less. Breakouts are bullish.

Digging Deeper

Only half of the Consumer Staples sub-industries have fallen over the past year, but the underperformance has been broader. No group has managed to outperform the overall S&P 500 index over that time.

Merchandise Retail has been close, though.

In a world where the Consumer Staples sector is getting crushed by the rest of the market, Costco is an outlier. Late last year, it broke out to new relative highs against the S&P 500. The pullback over the last few months hasn’t damaged the structure of the uptrend in place.

However, COST topped out just shy of our $800 target, and it could take some time to digest its gains over the last few months. This isn’t a great place for new entries.

Costco peer Walmart is similarly strong. It’s not showing quite as much strength relative to the overall market, but check out this inverse head and shoulders pattern shaping up vs. the rest of the Staples sector. That sets WMT up for a big run of outperformance.

We still think WMT will go to the 423.6% retracement from the 2018 selloff, which is at $66 (instead of $200) following the stock split earlier this year. Don’t ignore how momentum has stayed out of oversold territory for the last 18 months and is getting overbought on rallies - that’s a big feather in the cap for the bulls.

Leaders

Tyson has been on our radar for a few months now given its potential for a massive reversal in relative strength. It’s trying to bottom against the rest of the market at the same level it did back in 2012.

We never want to be blindly betting on a trend reversal just because prices approach a logical level of support - we need to see price confirmation. For Tyson, that’s what we got. The stock rebounded from those former lows and just hit new 6-month highs vs. the rest of the market.

The bottoming action continues for TSN on an absolute basis, too. We’ve liked it long above $57 and continue to do so with a target of $70.

We like Church & Dwight, too, but for different reasons. This isn’t a downtrend trying to reverse - CHD just hit a new all-time high.

And compared to the rest of the sector, it’s breaking out above a key resistance level that’s been in place for most of the last 5 years.

We can be buying CHD above $105 with a target of $126.

Losers

“We never want to be blindly betting on a trend reversal just because prices approach a logical level of support - we need to see price confirmation.”

We just said that when talking about Tyson. Here’s why:

Walgreens had all the pieces in place for a bottom. It still wasn’t able to stop going down. We probably say it too often, but we’ll say it again. Trends are always more likely to persist than they are to reverse.

One more to watch

Kroger hails from a different sub-industry than Walmart and Costco - that leadership area we mentioned earlier - but KR is showing relative strength of its own. So far this year, no Consumer Staples stock has been better. The risk/reward today in KR is much cleaner than it is in those other two supermarket names, too, as the stock tries to break out of a 2-year consolidation. We can be buying Kroger above $57 with a target up at $79, which is the 261.8% retracement from the 2015-2017 decline.

That’s all for today. Until next time.

There is nothing truly “magical” about the formula, and we don’t really subscribe to the belief that any one tool guarantees investment success. What we do believe is that the majority of stock market returns over the long-term usually come from just a handful of the best-performing names, and we should use every tool available to look for them.

Though we primarily stick to a technical approach at Grindstone, how we find the winners doesn’t really matter. Remember, we’re all looking for the same stocks - the ones will end up on the fat tails of the distribution curve - and over the long-term, the best charts are going to be for stocks with the best fundamentals. Greenblatt’s results have shown that sometimes, the biggest winners come from the lowliest of beginnings.

We built our scan with that in mind, focusing first on the best companies in each sector (those that generate the highest returns) and then finding which stocks on that list are held least dear by investors.

Here’s a list of the top-ranked stocks in our universe:

Our goal here isn’t to buy the whole list.

Buying good companies at good prices is a fine place to start, but that alone isn’t enough. Often, there’s a reason that seemingly good companies are trading at rock-bottom prices, and buying them blindly can have us on the wrong side of prolonged downtrends.

The intrinsic value of a stock changes over time, so even cheap stocks that are bought below their current intrinsic value can lose us money over time. There’s no rule that says a stock price has to move towards its ‘true’ value - and it definitely doesn’t have to do it quickly.

That’s why we couple trend identification with our value scans to find the best companies with the best setups. Merging fundamental and technical analysis helps us manage risk and increases our odds of finding big winners with sustainable trends.

Here are our favorite setups from the list.

Alpha Metallurgical Resources, a $4B steel stock, just found support at the 261.8% retracement from its 2022 range. Check out the momentum profile in the lower pane. RSI has stayed out of oversold territory for the last year, even after that bearish momentum divergence towards the end of last year. Now that we’ve worked that divergence off with a mean reversion, we can approach AMR from the long side. We want to be buying it above $300 with a long-term target that’s 2x from here, at $640.

Miller Industries is one of the smallest stocks in our coverage, with a market cap of less than $600M. But there’s nothing small about this base breakout. We think Miller goes to $63 next, which is the 161.8% retracement from the 2021-2022 decline, and we can own it above the former highs of $47. Longer-term, we think it could go to $88.

SLM Corp is also breaking out of a multi-year base. It peaked in 2021 at the 261.8% retracement from the 2020 decline, and now that it’s finally surpassed those former highs, we can be buying it with a target of $30.

And CNX Resources, an oil and gas producer, just came out of a big base of its own. Since early 2022, CNX had been stuck below the 138.2% retracement from the 2018-2020 decline. It just completed a beautiful cup and handle continuation pattern.

There’s likely some resistance at the 161.8% retracement near $26, but we think CNX eventually goes to $40. We like it long above $23.50.

The next breakout could come from Signet Jewelers. SIG has spent most of the last 6 months knocking on the door of its 2021 highs, and momentum has stayed out of oversold territory over the course of the consolidation. A bullish resolution is the higher probability outcome.

On a move above $110, we want to be buying SIG with a target of $147, which is the 161.8% retracement from the 2021-2022 decline.

Discover Financial Services is similarly positioned. It’s been stuck below the 161.8% retracement from the COVID collapse for the last 3 years, and the stock has been knocking on the door of new highs all year. If that breakout comes, we think the next stop is $200.

There are big bases, and then there are big bases. How about this decade-long consolidation within a long-term uptrend for Cal-Maine foods?

We saw a failed attempt to climb out of this range back in December 2022, and we got above the 2015 highs on an intraday basis just a few weeks ago. The more times a level is tested, the more likely it is to break. Eventually, there won’t be any sellers left. On a close above $63, we want to keep CALM and buy Cal-Maine with an initial target of $81. Our long-term expectation is for prices to hit $110.

That’s all for today. Until next time.

Leadership in 2024 hasn’t been too much different. It’s still Communication Services at the top, and Tech is still an outperformer. But the Consumer Discretionary sector has been notably absent from the leaderboard.

Since year-end, only the Real Estate sector has been worse.

The year-to-date weakness has pushed Consumer Discretionary to new 11 month lows relative to the S&P 500 Index:

Consumer Discretionary is generally considered a ‘risk-on’ sector.

If the value of a stock is the present value of all its future cash flows, then the stock of a company that will grow future cash flows at an above-average rate should be worth more. If above-average growth rates fail to materialize, though, the higher price is no longer justified, presenting investors with considerable downside risk as valuation multiples correct.

That’s a key dynamic for the Consumer Discretionary sector - earnings trajectories for Discretionary companies are closely tied to economic strength, so during healthy economic periods, we should expect the sector to outperform. That fact that they aren’t outperforming is a warning sign.

Or perhaps not.

Discretionary’s relative weakness in 2024 has more to do with the disastrous performance of one especially large component (we’re looking at you Tesla). If we strip away the impact of market capitalization, we see a different story: Discretionary is still above its October lows.

And if we go one step further and look at the small cap space, risk appetite looks even more healthy. Here, small cap Consumer Discretionary is stair-stepping higher.

There’s more good news. Despite the selloff across the broader market landscape over the past few weeks, the sector is still in a clear uptrend on an absolute basis.

As long as last summer’s highs continue to act as support, we can continue to approach both the sector and the rest of the market from the long side.

Digging Deeper

Take a look at the year-to-date industry performance within Consumer Discretionary, and you’ll find a dichotomy. On the one hand, you’ve got Broadline Retail - home to Amazon, the sector’s largest component - up 18%. On the other, you’ve got Tesla and the Automobiles industry off 35%.

Tesla’s weakness isn’t anything new. Compared to the S&P 500, it stopped going up in January 2021. And it’s really fallen apart over the past few months. Now TSLA is threatening to hit multi-year relative lows:

It’s already hit new 52-week lows on an absolute basis.

There’s no reason to be buying TSLA down here. In fact, if you’re bearishly inclined toward the overall market, TSLA is a pretty attraction short option.

What’s interesting is that some of the other autos aren’t looking too bad at all. General Motors has been outperforming all year, and has successfully put an end to the relative downtrend that persisted from 2021-2023.

We really like the risk/reward potential here for GM as it tries to break out above the 2017 highs. We don’t want any part of it as long as it’s stuck below $46, but on a bullish resolution higher, we can be buying it with a target at the former highs of $65.

Leaders

Amazon reversed a multi-year downtrend relative to the S&P 500 index in the middle of last year, and it’s been rising steadily ever since.

An entry right here doesn’t make sense while it consolidates below the former highs, but we definitely want to be approaching it from the long side. On a breakout above $188, we think AMZN goes to $250.

Ebay is worth watching as it consolidates just below resistance from its 2018-2022 lows relative to the S&P 500. On a completion of this failed breakdown, we want to be looking for buying opportunities.

On an absolute basis, the risk is very clearly defined. We could see both absolute and relative resistance broken at the same time if the stock jumps above $52. And if that happens, we want to be buying EBAY with an initial target of $61.

Royal Caribbean was down over the last 4 weeks, but it still snuck in on the biggest winners list. We love the relative strength profile in RCL - compared to the S&P 500, it just broke out of a multi-year base.

The target on RCL is $200, which is the 161.8% retracement from the 2020 decline. We can be buying it as long as it’s above the 2020 highs of $135.

Losers

A month ago we had our eye on CarMax as it tried to break a 2 year downtrend line versus the rest of the market. Unfortunately for KMX, trends are more likely to persist than reverse course. This one is best left alone until it can show sustainable relative strength.

Deckers Outdoor is the opposite: it’s a picture of relative strength, despite an 11% drop over the past month. DECK broke out of a 10 year base versus the S&P 500 index in late-2022, and it hasn’t looked back.

Here’s how we’re looking at the stock right now. Longer-term, we’re targeting $1500, which is the 1109% retracement from the 2020 decline. But, as always, we want to be able to manage risk on our entry. We can do that on a pullback towards $615 (if it happens during the course of a broader market correction) or on a breakout above the 685.4% retracement at $950.

More Charts to Watch

We stepped to the side on the homebuilders after they stalled out near our targets.

One of the homies continues to show relative strength, though, despite rising interest rates. NVR is setting new highs compared to the S&P 500:

And it’s consolidating above the 161.8% retracement from the 2022 decline. We like that we can manage risk with that $7500 level on new entries. From there, we’re targeting $9900.

Tractor Supply has been one of the sector’s best performers this year, gaining 19%. What we really like about it is this structural strength relative to the rest of the market. That was a textbook backtest after a big, multi-year base breakout.

And we just got a big absolute breakout, too. The risk is very clearly defined as TSCO consolidates above the former highs of $240, which is also the 423.6% retracement from the 2015-2017 decline. Our target is the next key retracement from that decline, which is up at $360.

That’s all for today. Until next time.

Today we’ll run through our favorite breadth metrics to help us sort out what’s going on beneath the surface.

When we talk about breadth, we’re talking about how many stocks are participating in a trend. The more stocks moving the same direction, the stronger that trend is. Sure, a handful of large stocks can drive market cap-weighted indexes higher all by themselves. Sometimes they can do it for a lot longer than people expect. But they can’t do it forever.

Monitoring stock market participation is a way to monitor the health and durability of a trend.

In 2023, everyone knows that handful of mega cap stocks drove the vast majority of market returns. Even my friends that don’t really follow the market were telling me about how the S&P 500 was really just the S&P 7. They weren’t far off - the average stock lagged the S&P 500 return by the most since 1999 last year.

But just because the average stock is lagging the return of the market cap weighted index doesn’t mean breadth is bad. It just means that certain types of stocks are doing better than others. In this case, it was growth stocks rising faster than value stocks. Take the ratio of the equally weighted S&P 500 vs. the market cap weighted index and compare it to the ratio of the Russell 1000 Growth index vs. the Russell 1000 Value index. They look exactly the same. This chart is a leadership story, not a breadth story.

So when we look at breadth, we aren’t so much concerned with the magnitude of moves in each stock, but the direction. As long as the majority of stocks continue to move higher, we can be confident that underlying breadth remains healthy and the current bull market will continue.

And for now, that’s still what we’re seeing. Short-term trends have undoubtedly weakened, but the longer-term structure is still intact.

If the goal is to count uptrends and downtrends, one of the simplest ways to do it is with moving averages: a stock higher than its average price over the last month or year can be assumed to be trending higher, and vice versa.

Today, more than two-thirds of large cap stocks are above their long-term moving average. That’s below the year-to-date high of 82%, but still a reading consistent with uptrends of the past, and in-line with the high end of last year’s bull market action.

Comparing the current price to a moving average is fine, but we can take it one step further to glean even more information. A stock whose price is above a rising moving average cannot be in a downtrend. A stock whose price is below a falling moving average cannot be in an uptrend.

Adding this component confirms that for the majority of stocks, this bull market lives on. In every single offensive sector, including both growth-oriented (Information Technology, Consumer Discretionary, and Communication Services) and value-oriented (Financials, Industrials, Materials, and Energy) ones, at least half of stocks are above a rising 200-day moving average. They’re undeniably in long-term uptrends. Even in the weaker sectors, we’re seeing a more balanced view as opposed outright bearish characteristics. Only Real Estate (which comprises less than 3% of the S&P 500 index) has more constituents below a falling 200-day than above a rising one.

This is where the market’s troubles are more apparent. Check out the moving average breadth dashboard on a 50-day basis - there’s less green and more red in this table:

Again, though, we’re not yet seeing outright bearish characteristics across the board. Five of the 11 sectors still have more stocks in short-term uptrends than they do in short-term downtrends. There’s nothing fun about stock market selloffs, but it’ll take more than what we’ve gotten so far to put an end to this bull market.

New Highs and New Lows

If a stock is rising, that stock will set new highs. If lots of stocks are rising, lots of stocks will set new highs. If lots of stocks are falling, lots of stocks will set new lows. If that seems too simple, that means we’re doing something right. Keeping it simple is a good thing.

Last week, we talked about the failed breakouts that fueled this market decline:

Selloffs sparked by failed breakouts are mean reversions until they’ve proven otherwise.

But all new bear markets have to start somewhere.

If we could only watch one thing to tell us that this mean reversion was turning into an outright trend reversal, it would be the list of new lows. You can’t have a bear market without an expansion of that list.

The list of new 52-week lows are setting new year-to-date highs. We shouldn’t ignore that, but we also need to add some context - the number of new lows is still short of levels we saw throughout 2023:

Another way to monitor ‘breakout breadth’ is by looking at the difference between the number of new highs and new lows - a ‘net’ new highs index. We also like throwing a short-term moving average on that net to smooth out the day-to-day action and help us identify the underlying direction.

It’s been in positive territory all year.

But wait, is it really fair to be looking for new 52-week lows when the market is just a few weeks removed from all-time highs? Maybe not. We’ll see an expansion in the number of new short-term lows before we see a bunch of new 1-year lows. Fortunately, the story is the same even on a short-term basis.

We can look at whether a stock has more recently broken out or broken down and determine whether that stock is in a cycle of setting new highs or new lows. Two-thirds of S&P 500 members are in a new 3-month high cycle.

We’ll be more concerned when this dashboard starts to show more red than green.

Momentum

What about momentum? When stocks are rising, they tend to get overbought. When stocks are falling, they tend to get oversold.

If we look at whether a stock’s 14-day RSI has eclipsed 70 or fallen below 30 more recently, we get another assessment of whether the buyers or sellers are in control of a stock. Once again, the sellers have yet to really seize control. The Utilities sector is the weakest area in the market with just 40% of its members in an overbought momentum regime - and that sector traded at a new 26-week high yesterday.

The Averages

The cumulative advance-decline line might be the most well-known breadth indicator out there. Its calculation is fairly simple: an index is created by cumulatively adding or subtracting the net of rising vs. falling issues for each trading day. If a greater number of stocks are rising than falling, the advance-decline line rises, and vice versa. No indicator is infallible, but the NYSE Advance-Decline line has diverged from prices before several major stock market selloffs.

That’s not what’s happening today. Just a few weeks ago, the NYSE A/D line finally surpassed the highs it set at the end of the prior bull market. If anything, the A/D line was just confirming the bull market in stock prices.

Some of you might look at the chart above and worry about the failed breakout. We aren’t fans of applying traditional pattern recognition on an advance-decline line - it’s just a little too far removed from something that’s actually being traded for our taste.

This failed move in the Value Line Geometric Index is more interesting. This index is designed to track the median change in stock price, so it gives us a great feel for the ‘average’ stock.

Failed breakouts are mean reversions until proven otherwise, and the Value Line Geometric Index is already back to its 200-day moving average. Now it’s time to see whether bears can push stocks below their mean.

That’s all for today. Until next time.

The NASDAQ Composite gave up nearly all of its year-to-date gains and the S&P 500 erased almost half of its own as both indexes fell for the third straight week. The Dow Jones Industrial Average briefly dipped into negative territory for 2024, but rallied back on Friday to (barely) end the week in the green. For the S&P 500, the three week selloff is the largest since December 2022, shortly after the bear market bottom.

The bond market hasn’t been any better: 10-year Treasury note futures have hit the lowest level since November after falling 2.5% in April. Gold, however, continues it be a bright spot. Gold prices have risen 8 of the last 9 weeks and reached another record high on Friday.

Market Internals

Short-term trends have reversed sharply lower over the month of April. Just 20% of S&P 500 stocks are above their 20-day moving average, and one-third are above their 50-day. The weakness is widespread. Just one sector - Utilities - can say that more than half of its constituents are in a short-term uptrend.

For now, that short-term weakness has yet to do significant damage to the longer-term structure of the market. Two-thirds of stocks in the index are still above their 200-day moving average, and only one sector (Real Estate) has fewer than half of its members in a long-term uptrend. Breadth is strongest in the value-oriented, risk-on sectors: Financials, Energy, Industrials, and Materials.

More from last week:

What's Ahead

Here's what to watch in the week ahead: