by Jurrien Timmer, Director of Global Macro for Fidelity Management & Research Company
Remembering the Great David Lynch
Sadly, the world lost one of its great creative geniuses last week. David Lynch (along with Wayne Coyne of the Flaming Lips) has been a hero of mine ever since I started my journey down the rabbit hole of nonlinearity. My first milestone, during what Joseph Campbell would call the hero’s journey, was seeing the Flaming Lips in concert for the first time in 2014. This was the tour following the release of “The Terror,” a deliciously dark and brooding double-album. This experience helped me lean into my journey in a big way.
Shortly after that I learned that David Lynch was organizing a festival in LA. I had always been a Twin Peaks fan and this event happened at a pivotal time in my life when I was wandering through the proverbial desert (fortunately in the right direction). This event led to an annual event called the Festival of Disruption, which featured screenings of David Lynch films and interviews with his casts, talks about Transcendental Meditation (of which Lynch was a great proponent), and some great indie music.
Lynch created some dark and disturbing films, yet he always seemed serene and at peace with the world. He credits TM for that, which enabled him to reach into the deep field of the collective unconscious. That’s where he transcended the ego mind and reached into the well of creativity and bliss. Meeting David Lynch in person was a reminder that it’s better to own your shadow and find a way to make it productive (as he did through his art), than to cast it aside and hide it in the closet (from where it will eventually return to haunt you). Rest in peace, David Lynch.
In Other News
It has been a volatile month so far, with stocks zigging and zagging as investors try to gauge how much the Red Wave Trade has been priced in, and how the known unknowns of immigration and tariffs will play out. The cap-weighted S&P 500 remains in a solid uptrend (defined as higher lows and higher highs), and the percentage of stocks trading above their 200-day moving average has rebounded a bit to 61% (still not great). This breadth measure has made a series of lower highs, not unlike the 2021 and 2014 periods. This bears watching.
Short-Term Oversold
The equal-weighted index also remains in an uptrend, but there has been more damage here. The good news is that the market got short-term oversold last week, with only 17% of stocks trading above their 50-day moving average.
And the daily chart shows that at the lower low last week, the breadth stats produced a bullish divergence. So perhaps the worst is over for this 5% correction.
Sentiment
It’s always interesting to see how quickly the tide turns from optimism to pessimism after even the smallest drawdowns. After a period of post-election ebullience, sentiment has turned sour again, with the Investors Intelligence survey (II) down to 42% bulls and 32% bears. This is what you want to see if you are bullish.
And the American Association of Individual Investors (AAII) survey now shows more bears than bulls (granted, this is a volatile series).
Earnings season
Q4 Earnings season is now underway, and with 42 companies reporting, 83% are beating estimates by nearly 1000 bps. It’s too early to draw conclusions with less than 10% reporting, but the odds seem good that the quarter will follow the ones that preceded it, with double digit year-over-year growth. The earnings-driven advance is alive and well.
Investment Clock
With the earnings cycle only a year and half old, the question seems less about earnings and more about valuations at this point. It still seems likely in my view that the market is transitioning from the upper left quadrant of the investment clock (rising earnings, easier financial conditions) to the upper right quadrant (rising earnings, tighter financial conditions). That’s not bad per sé, but it’s not as good as what we had it in 2024, when two thirds of the gains came from multiple expansion.
Real Rates
Other than the known unknowns of immigration and trade policy, real rates remain one of the major drivers for equities. With the 10-year yield in that critical 4.5-5% “yellow zone,” the stock market has to pay attention to the bond market. The risky asset is supposed to yield more than the risk-free asset, so when the latter approaches the former, the former has to reprice in order to remain competitive. That’s the Fed Model dynamic that prevailed during the 1980’s.
The Fed
As for the Fed, I don’t see a compelling reason for it to cut rates further until the inflation rate is closer to 2%. Last week’s CPI report didn’t push us in any particular direction on that front. The forward curve suggests 4% this year or next, which doesn’t seem unreasonable as a neutral rate.
But there certainly doesn’t appear to be any urgency in getting there. What happens to the long end is a lot more important at this stage. The instant declines in equities in recent weeks when rates ratcheted higher, and the immediate relief rally last week when rates fell, is exhibit A in how long yields are running the show right now.
The January Barometer
Finally, with another week or so left in January, talk will inevitably start to focus on the fabled January Barometer. This is an age old indicator that says that “as January goes, so goes the rest of the year.” It’s good to keep in mind that statistically speaking this is true, but it is true for every other month in the year as well. All this indicator really says is that markets trend, which means that if the month in question is up (or down), it is likely part of a trend, suggesting that the months that follow will do the same.
Overall, I still think we are in the 7th inning of both a cyclical and secular bull market. That suggests that there are more gains to come, but at a less impulsive pace than what we got in 2024. Earnings will have to do the heavy lifting (which they are), with rates either supporting the valuation side or detracting from it.
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