Is There A Culprit Leading To A Crash?

1.) CULPRIT – Every major market cycle top has a villain…a culprit that breaks first. In 2021, it wasn’t just “tech,” for example. It really was more about speculative growth. ARKK. SPACs. Unprofitable software. Chinese internet stocks. Biotechnology. Electric vehicle startups…anything with a story and no earnings. That entire theme peaked together in early 2021 and then completely fell apart, causing many of those stocks to crash 70%-90% in short order. By the time the S&P 500 finally rolled over in 2022, the culprit had already been identified. That speculative growth bubble burst. You saw the same thing happen in previous cycles. Financials, for example, were the culprits in 2008. Again, every bear market has a culprit. If there’s no culprit, there’s no top. Since 1991, whenever the top-performing sector gained more than 40% year over year, the S&P 500 went on to generate above-average returns over the following 12 months. But wait…conventional wisdom says extreme outperformance is dangerous. Well, the data suggests the opposite. Strong leadership has historically been a feature of healthy bull markets, not a warning sign. Now consider the “culprit” theme: When a sector declines 20% or more over a 12-month period, the S&P 500 has historically gone on to deliver below-average returns over the following year. A sector doesn’t lose 20% of its value by accident. If that happens, something is broken. Maybe credit is tightening, or demand is just evaporating. Either way, investors are voting with their feet and leaving the party. Anyway, that’s what a market culprit looks like, and today, we don’t have one. The current bottom-performing sector is consumer staples. And it’s roughly flat over the past year. That’s not a culprit; that’s just healthy rotation. Identifying major market tops is about whether a major area of the market is actually breaking down, and right now, the evidence simply isn’t there.

2.) OIL – I’ve explained my thesis that this surge in oil, followed by a top and lower high from the 2008 and 2022 spikes, is not likely to result in a total collapse of oil prices, bringing about a deflationary scare that results in an overall stock market crash. At least not yet. I think this chart below also helps to support/explain that. This is a picture of oil and Speculator Positioning…”dumb money.” And right now, the dumbest money on earth has never bet this aggressively against crude oil. I’d take the opposite of what they are doing. This doesn’t mean that oil has to rally hard here, but it also doesn’t mean that it is likely to completely crash either.

3.) CPI – Yes, inflation is an issue. But how are markets seeing it? They’re not looking at what was, but what is coming. Next month’s CPI is highly likely to not just roll over from this inflation cycle peak, but drop 31 basis points back below 4%. That would be a large deceleration, and bond markets appear to, so far, agree. The US Treasury 2YR Yield (Fed Proxy) is putting in its first lower high of the cycle, and the 10YR is signaling that highs in yields are very likely in. Now, this is a double-edged sword. Most think that declining inflation data is awesome. And, for a consumer, it usually is. However, markets don’t think like consumers. Decelerating inflation is okay, but not when growth is decelerating as well. Coming in July, there is a high likelihood that we see both growth and inflation prints for June decelerate together. Oftentimes, that can spell volatility for markets and provide a recipe for a correction/pullback of some type. But, the overall macro picture is still positive, so any correction is likely to be buyable. We’ll see what happens, but as noted above, we still don’t have the ingredients for a major market top.