This Midyear Theme May Surprise You

Time for a midyear checkup... The stories of 2023 so far... What history suggests after a 'strong start'... Market breadth is average... Stocks aren't that expensive when you take out the 'Magnificent Seven'... Getting over shell shock...

Just like that, we're halfway through 2023...

The midpoint of the calendar year, no matter how much I (Corey McLaughlin) know it's coming every time, can tend to sneak up on us.

It's the first trading day after Independence Day... which I feel is as great a time as any to take a pause from the daily market noise and analyze what has actually happened in the markets over the past six months.

As we've done here in the Digest the past two years, I want to perform a "midyear checkup" to see what we find... And, as we'll explain today, the findings might surprise you given all the risks to the economy today. But that's why I like to do this exercise.

A brief refresher...

Regular readers may remember that in 2021, we pointed out that "hated" energy stocks were leading the benchmark S&P 500 Index higher... as commodity prices were soaring... and inflation fears were a concern, at least among us. As we wrote on June 30, 2021...

The central bank has kept dollars cheap and has kept lending to itself at near-zero rates. All the while it continues to discount present inflation as "transitory" during what will be a long pandemic recovery...

Of course, real-world inflation – higher prices at the gas pump, grocery store, and lumberyard – hit everyday folks in a very real way...

CEOs in various industries don't see global supply chains getting back to "normal" until later next year or even 2023...

And until then, the Fed promises to stay pat with its monetary policy, which like it or not, drives stock prices, home prices, and all other asset prices...

That led to some things, eh?

This time last year, we noted the first six months of 2022 marked the worst start to a year for U.S. stocks since 1970. They fell more than 20% as the Federal Reserve reversed policy course and started making dollars more expensive, hoping to slow the pace of inflation (that it helped create).

The "strong dollar" was the story of early 2022 and the second half of 2021. You could argue that's really what a bear market is: the rising value of the U.S. dollar versus other financial assets. So until the dollar started to weaken (and the Fed signaled a slowdown or pause in interest-rate hikes), it would be more of the same pain for stocks and bonds.

But we also did note the dollar was approaching a 20-year high. It looked like it didn't have too much room to go higher once the Fed determined inflation may be "peaking." That told us we were closer to a stock market bottom than the "top" markets showed at the start of 2022.

The turn lower in the dollar – and higher for stocks – happened last fall. In November 2022, we wrote...

If you've been following along the past few months to my "bottom is (probably) in" indicators, you'll know that my last update leaned more bullish than anything I'd shared previously.

Of late, market breadth – the number of stocks going up versus down – has strengthened...

A good measure of a long-term market-breadth trend is the percentage of S&P 500 stocks trading above their 200-day moving averages. Over the past two weeks, that percentage has gone above 50%, its highest level since March.

At the same time, the U.S. dollar's relative strength has weakened significantly – counter to a key theme we've seen in 2022, even in bear market rallies. A strong dollar has been a headwind for stocks all year. If that ends, it helps stock prices.

Only knowing what we wanted to look at led us to make observations like that. Point being, it's useful to tune out the noise and look at what's really going on with the markets. When we do this now, we find that...

This year, the trend for stocks is up again...

The S&P 500 is up roughly 16% since the start of the year. Why? Well, we can get into all kinds of debate about that. But generally speaking, the widely expected recession that many market pundits have been talking about for more than a year hasn't arrived yet.

The jobs market is still strong, with the unemployment rate still near lows. Enough folks are still spending money on needs and (some) wants. And while high inflation remains "sticky," it's showing signs of deceleration (though not across the board).

That's, in a nutshell, one argument you could make. In any case, the price action says that the major U.S. stock indexes are up, and many tech stocks that were among the biggest losers of 2022 are the biggest winners in 2023.

Case in point: The tech-heavy Nasdaq Composite Index is up more than 30% in the past six months while the boring old Dow Jones Industrial Average is up less than 4%, and the S&P 500 is just about splitting the difference...

Whatever you think about the "why" or "how" of what has happened so far, let's put it in the past. As investors, the future is all we have to work with now.

History suggests more gains are ahead...

A strong start for stocks like we've seen in 2023 has more often than not portended good things for the rest of the year. There are a lot of different data points to use as supporting evidence. It doesn't mean it will happen, but odds suggest higher prices ahead...

Our colleague and Stansberry Research senior analyst Matt McCall discussed this on a recent midyear edition of his Making Money podcast. He noted that when the S&P 500 has gained 10% or more through the first half of the year, it has finished even higher more than three-quarters of the time.

To be specific... since 1950, the S&P 500 has been 10% higher through the first six months 23 times. The average gain for the U.S. benchmark index over the next six months is 12%, and it has been higher in 77% of those 23 instances.

If this midyear exercise interests you at all, be sure to check out Matt's latest podcast for more. He covers a variety of angles, including the Fed's continued influence, recession probabilities, and what to watch in the second half of 2023.

But wait, it's just a few stocks leading the market higher, right?...

It may feel like it if you listen to the mainstream financial media. The buzzword we heard come out of nowhere but some anonymous television producers' brains is "narrow," meaning only a few stocks have led the overall market higher.

But we've debunked this argument a few times recently.

No doubt, the headline-making tech stocks – many of which are heavily weighted in the S&P 500 and even more so in the Nasdaq – have had some uncommon gains and mainstream hype associated with them.

Names like Nvidia (NVDA) and Apple (AAPL) have made headlines – again – and have benefited from the artificial-intelligence buzz that seems a bit suspect. And stocks like Meta Platforms (META) and Netflix (NFLX) are up nearly 140% and 50%, respectively.

The so-called Magnificent Seven – Apple, Meta Platforms, Nvidia, Alphabet (GOOGL), Amazon (AMZN), Microsoft (MSFT), and Tesla (TSLA) – are up an average of 85% since the start of 2023 and make up 30% of the S&P 500's market cap as well.

So when one of these names moves – higher or lower – it can skew the widely-followed S&P 500 Index, yes.

But the 'market' is way more than these names...

And when you look beyond the tech buzz, you'll see perhaps an argument to be made for the rest of the market possibly "catching up" rather than falling for the rest of 2023.

Market breadth – a good gauge of overall market health – is about average, not too high or too low. That's a good thing. As I write today, around 60% of S&P 500 stocks are trading above their 200-day moving averages (a technical long-term trend).

As we wrote last week – when this number was closer to 50% – you could take this market-breadth argument one of two ways...

Either roughly half of U.S. stocks can still get into an uptrend from here – meaning more upside for the broader market ahead – or half can get into a downtrend, meaning more downside.

Whichever of those outcomes happens, that's less risk than, say, 2021... when nearly every stock on the New York Stock Exchange was trading above its long-term technical trend.

Today, the number of NYSE-listed stocks going up versus down each week has plateaued since a decline back in January and February... And while market sentiment has turned more bullish, it is not at an extremely bullish level yet.

That tells me there is possibly more room for stock prices in general to move higher... At the same time, the simple indicators for short- and long-term technical trends for the major indexes have been bullish for several months.

The technical traders in our group like Ten Stock Trader editor Greg Diamond and DailyWealth Trader editor Chris Igou have been making and eyeing more bullish trades in their daily services. Take note.

And if you take the popular names out of the equation...

Disregard the Magnificent Seven and you'll find a market that isn't overvalued. That's an important piece of information for long-term investors... Stansberry Research senior analyst Alan Gula shared a terrific analysis about this in our most recent issues of Portfolio Solutions.

Those flashy tech names we mentioned earlier have undoubtedly risen a lot... and their valuations have appeared to make stocks "expensive" in short order based on some popular metrics.

This is worth thinking about because the more "expensive" the market, the less upside potential remains. Turns out, though, as Alan showed, the market really isn't historically expensive if you take the popular names out of the equation.

For Portfolio Solutions subscribers, Alan ran the entire stock market – with and without the Magnificent Seven – through his proprietary free-cash-flow ("FCF") valuation model. Without giving away the details, the higher a stock's percentage of FCF yield, the cheaper it is.

What Alan found may surprise you...

The market may be expensive as a whole, but that's because it's top-heavy. So when I exclude the Magnificent Seven, you can see that the rest of the market isn't all that pricey...

The rest of the S&P 500 has an FCF yield of around 4.4%. That's about average since 2016, and it's cheaper than the 3.7% FCF yield from early 2021.

Another useful analysis: Look at the "equal weight" formula of the S&P 500 and you'll find it's only up 6% this year. The regular S&P 500 Index that you find most often quoted tracks the 500 largest stocks by market cap. The equally weighted form is just that... an average of all 500 stocks' returns, regardless of their respective sizes.

Now, you can say that this means the start to 2023 for U.S. stocks isn't as strong as it would appear on the surface... that these flashy names like Nvidia and Tesla could be due for a pullback, or the market could be susceptible to a shock.

Yes, that's true. That's why I always find it useful to chart market breadth... If only a few names were leading the indexes higher, we'd be inclined to be more bearish. But more than half today are trading in longer-term uptrends.

The bullish case is that this "divergence" in the market could suggest that if stocks, generally speaking, remain in an uptrend, there is still room for the majority of other stocks not in the Magnificent Seven to push higher before 2023 ends.

Our colleague and Stansberry Research senior analyst Brett Eversole also shared a similar take in this month's Portfolio Solutions issue. He found that history suggests the better bet is for a "catch up" by the rest of U.S. stocks rather than a "catch down" or a crash.

Find all the details here.

In sum...

I thought Brett also described the overall environment really well when he wrote...

Even though the bear market is over, the pain of last year is far from gone. Everyone is still a bit shell-shocked... And that makes it easy to fall prey to all kinds of scary stories about the market.

The newest fear, he said, is the "narrowness" of the current rally. But as Brett also explained (in more detail than we did today)... even if this is true, this fact doesn't necessarily mean the market is on shaky ground.

If anything, it might suggest more gains are ahead before the year is out. You may sense a theme.

Now, I'm not saying a recession isn't ahead... or that inflation isn't still a problem... or that no geopolitical risk could upend the status quo for U.S. stocks...

Those are all risks, and market sentiment can change quickly. We'll always be looking for signs of that, as well as whether key technical indicators show signs of bigger risks ahead for stocks. (We also haven't even talked about bonds or commodities or anything else today.)

Personally, I believe we'll see some kind of "official" recession – with higher unemployment – though it may not happen until 2024.

But one of the first lessons I ever learned about Mr. Market is that he doesn't necessarily care what we think.

For now, the market is reflecting that the "worst" for stocks is further in the past than it is ahead in the future.

New 52-week highs (as of 7/3/23): Aehr Test Systems (AEHR), Booz Allen Hamilton (BAH), Berkshire Hathaway (BRK-B), Covenant Logistics (CVLG), Expeditors International of Washington (EXPD), Floor & Decor (FND), iShares Convertible Bond Fund (ICVT), Iron Mountain (IRM), JPMorgan Chase (JPM), MasTec (MTZ), New York Community Bancorp (NYCB), Parker-Hannifin (PH), SPDR Portfolio S&P 500 Value Fund (SPYV), ProShares Ultra S&P 500 Fund (SSO), TE Connectivity (TEL), Visa (V), VMware (VMW), Vanguard S&P 500 Fund (VOO), and Walmart (WMT).

In today's mailbag, feedback on Sunday's Masters Series essay by Stansberry's Credit Opportunities editor Mike DiBiase... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com

"When things go wrong, there are usually two competing explanations: 1. Incompetence; 2. Malice. I think the current mayhem is malice, it is engineered. The overreaction to COVID was engineered in order to wreck the world economy. The low base rates were bait of a trap, where the plan is to bankrupt people later with hiked rates.

"Governments shouldn't borrow money, but should entirely work from tax revenues. If they do not have enough tax revenues, then only two options: 1. do without; 2. raise taxes. But all governments borrow, borrow, borrow, and any politician who tries to defy this will be removed." – Subscriber Richard M.

All the best,

Corey McLaughlin
Baltimore, Maryland
July 5, 2023