One of the more common skeptical comments I hear is that “stocks have gone nowhere for 18 months (and things are getting worse).” This is a relatively intuitive statement, as Standard & Poor’s 500 index has basically hovered near all-time highs in that period, but it has not managed a breakout, despite a pretty nice gain since start of 2019.

The natural question investors wonder about is whether plateauing/flat stock markets are a sign of a major market top or of a “pause that refreshes.” In my view, the investor consensus generally takes a negative view on flat markets—that it is a bearish signal. Therefore, go the bears, it looks like Mr. Market is “ringing the bell at the top.”

However, the historical facts of the matter around this “nowhere” markets idea suggest the exact opposite. What we see in 2019, a flat market while hovering near all-time highs, is actually uncommon. Since then of WWII, this has only happened three times, which is surprising but it again highlights the rarity. Interestingly, history suggests plateaus are a base, before a strong upward stock move.

In those three previous cases, “markets going nowhere” has resolved to upside in three of three times, or a 1.000 batting average. This supports my 2H19 rally thesis.

Let’s look at these three precedent instances since 1945 where stocks were near all-time highs (within 3%) but produced little gains over the previous 12-months (<3%) and 20months (<5%), a situation similar to today’s environment. These prior periods were July ‘52-March ‘54 (mini-recession), May ’83-Dec. ’84 (post-inflation peak) and Nov. ’14July ’16 (oil crash). The current plateau stems both from Trump’s trade war and the Federal Reserve’s heretofore overly aggressive tightening. See chart below.

Stk Mkt 'Going Nowhere a Prelude to Next Rally Leg
Source: FS Insight, Bloomberg

In all three cases, the resolution was a strong upside move in S&P 500, with an average gain of 51% over the next 24 months (+30% to +73%). In other words, “nowhere markets” have been resolved by a massive upside breakout in stocks. To me, a similar move now would imply the possibility that we could see S&P 500 reach 4,500 by the end of 2021. This would be pretty eye-opening upside.

Here are some more facts for the bears. Since 1945, there have been six major equity tops, that is, levels followed by a 30% or greater decline in equity prices. The major tops, highlighted in red in the chart above, show the path of markets in the 20 months leading to the highs.

Fact: six of six times, S&P 500 market tops are “mountains,” that is, in each case the major tops, S&P 500 returns were strong and accelerated at the top. That’s not the case now. In other words, major stock tops are not plateaus but mountains, with a steep acceleration, and the euphoria that comes near a bull market’s end. No euphoria now, only doubt.

There’s an old market maxim that says “Don’t Fight the Fed,” and it exists for a reason. In my view the Fed only needs another 25 more basis points to cut, down from 75bp. A month ago, the severity of the yield curve distortion in mid-August showed Fed needed to cut 75bp to normalize the rate structure.

Stk Mkt 'Going Nowhere a Prelude to Next Rally Leg
Source: FS Insight, Bloomberg

But US rates have drifted ~30bp higher and the Fed cut 25bp this past week. Hence, the dual movements suggest Fed now only needs to cut 25bp to normalize the US term structure. The lowest US rate today is the 5-yr yielding 1.6%, which is below the current Fed funds 1.75%-2.0% target rate. Hence, 25 bps fixes this.






What could go wrong? The biggest risk to my view remains a large escalation of the trade war. Earlier this week oil surged, but as we alerted our clients on Monday, we felt it was a “nothing burger.”

Bottom line: We continue to look for a 2H19 rally in stocks into year end, with an S&P 500 target of 3,125. In the prior three “nowhere markets,” cyclicals were leaders over next 24 months. The following 25 cyclical stocks are ranked Quintile 1 by our DQM model: CSCO, QCOM, XLNX, MSFT, DISCK, ATVI, TTWO, GOOGL, VIAB, TPR, NKE, LEN, EXPE, LYB, EMN, CF, NUE, LMT, CAT, EMR, ROK, AMP, SCHW, LNC and PBCT.

Stk Mkt 'Going Nowhere a Prelude to Next Rally Leg
Figure: Comparative matrix of risk/reward drivers in 2019
Per FS Insight
Stk Mkt 'Going Nowhere a Prelude to Next Rally Leg
Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019

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