The past two weeks were volatile and highly informative for the direction of equity markets during the rest of 2018.

 

When the global economy moves from middle to late cycle, it is very common for the breadth of equity markets diminish. Said differently, price gains tend to concentrate in an ever-shrinking group of stocks. Eventually these market leaders also lose their momentum, and as they do so, assets start to rotate out of equities which catalyzes either a correction or an outright bear market.

 

The leaders of the current market cycle are obvious: FANG in the US and BAT in Asia (let’s refer to these as “The Complex”). So when Facebook dropped 20% in a single day last week after reporting earnings, the key question was if the shock would halt the momentum for all of The Complex, and therefore also the broader equity market. The importance of this set-up was further increased in that it came in the middle of an otherwise very strong earnings reporting season for the broader market.

 

In the event, The Complex dropped in a very uncomfortable fashion for two days following Facebook’s earnings. However, it then stabilized, before ultimately turning to show fresh upward momentum over the past few days following Apple’s remarkably strong earnings. Importantly, a mini rotation of investment styles also occurred over this short period, with Value indexes suddenly sharply outperforming Growth indexes – a situation rarely seen in past two years. When The Complex recovered its momentum late this week, the Value indexes nevertheless held on to their gains. The end result: the S&P is just below its all-time highs, with ironically much better market breadth now than it had at the start of July.

 

We appreciate that this probably appears to be over-reading market minutiae, especially during low volume, summer months. The former trader in me really does see meaningful signal in this recent price action, though. Through 2018, the bullish case for equities that we have been discussing has been based on fundamentals: US economic data remains strong, a trade war with China only has a modest impact on GDP, tax cuts are driving very high earnings growth, etc. Positive fundamentals are nice, but to translate those into actual portfolio returns they ultimately need to be supported by price action. In an unexpected and backhanded way, I see the past two weeks as having given us exactly that price action.