- Evercore ISI’s Julian Emanuel wrote that market momentum can continue despite the latest Fed news.
- He found 16 stocks that can ride the rally higher thanks to stronger fundamentals and positioning.
- But he also warns investors to watch for 5 signs that momentum is fading.
When the market has momentum like this, the best thing investors can do is simply ride the wave.
At least that’s what analysts at Evercore ISI believe. In a note to clients published in late May, a team led by senior managing director Julian Emanuel pointed out that today’s market looks oddly similar to the market of the late 1990’s.
In that so-called “momentum market,” which lasted from the market bottom in October 1998, to the top of the tech bubble in March 2000, volatility was the rule of the day, markets were led higher by a small group of stocks, and the tech-heavy Nasdaq 100 dramatically outpaced the S&P 500.
That rally, Emanuel wrote, was catalyzed by “the postponement of the recession that would “normally” have been signaled by the 1998 yield curve inversion max/re-steepening; that recession arrived 33 months later, in 2001.”
Fast-forward to 2023. While volatility is down this year, narrow market breadth has returned as a small group of Big Tech stocks pushes the S&P 500 higher on the back of AI excitement. As a result, the Nasdaq 100 has risen over 38% year-to-date, more than doubling the S&P 500’s 14% gain this year.
And let’s not forget that the 2-year Treasury yield inverted with the 10-year Treasury yield in March 2022. Usually that would signal an imminent recession, but despite widespread calls for exactly that by market watchers earlier this year, a downturn has yet to materialize.
Considering how the last “momentum market” ended in a catastrophic bubble burst, investors might want to know how they should approach today’s market, and if they’ll be able to anticipate all of this momentum suddenly evaporating.
Luckily, Emanuel and his team at Evercore have outlined exactly what to watch for, and where investors should be putting their money today.
5 signs the market rally may begin to falter
With the Fed’s pause on interest rate hikes earlier this week, the market’s upward momentum could suddenly be in jeopardy. After all, 10 consecutive rate hikes punctuated by a sudden pause could throw markets for a loop.
But Emanuel says that’s not the case. “Even 1999 had a volatile/sideways summer, and the definition of a “Momentum Market” is one where “outside forces” like the Fed don’t end it,” he wrote in a June 14 note.
So how exactly will investors know when the market has finally run out of steam? Emanuel noted five signs that the momentum market is nearing its end.
The first is complacency, or a lack of fear in markets. Emanuel measures this with the CBOE Volatility Index, or VIX, and wrote that if the VIX falls lower than 11 it’s a problem. As of June 15, the VIX stands at just over 14.
Next is the opposite end of the spectrum: ebullience. Emanuel uses the American Association of Individual Investors Bulls Index to determine whether or not the market is overly bullish. If the index rises over 60, investors should be wary; today it’s hanging around 45.
Emanuel also wrote that investors should keep an eye on the market’s narrowness, particularly if small caps and banks begin to fall behind the rest of the market once again. And he wrote that the capitulation of record shorts in today’s market is a warning sign as well.
Finally, investors should keep an eye on jobless claims. If they rise to over 300,000 a week and stay there, then today’s momentum market might be coming to an end. As of the latest report, jobless claims hit 262,000 last week, the highest it’s been since October 2021.
How to profit from today’s stock market momentum
That said, Emanuel himself noted that calling a market top is easier said than done.
“Timing whether this is the beginning, middle or end of a Momentum Market is extraordinarily difficult,” Emanuel wrote. “This is especially so since the ‘stock’ of M2 money continues to support the labor market and consumer even as the flow (M2 contraction) signals a recession in the offing.”
Instead of trying to time the market by selling or even shorting stocks, Emanuel wrote that now could be a good time to find investments that will continue to rise on the back of the market’s momentum.
Emanuel found these so-called “momentum masters” stocks by screening Russell 1000 stocks for “medium and near-term momentum leaders,” as measured by both year-to-date performance and performance since April 30 that puts these picks in the top 20% of the Russell 1000 index.
Next, he searched for stocks with a “fundamental edge.” These were stocks that are expected to post a profit this year as defined by 2023 EPS, stocks with EPS year-over-year growth in the top 50% of the Russell 1000 index, and stocks that saw their 2023 expected EPS revised higher this year.
Finally, he looked for stocks with a “positioning edge.” These stocks have a defensive posture, as indicated by “short interest and/or options skew in the top 33rd percentile of respective 1 year ranges, and neither in the lower 10 percentile,” Emanuel wrote. In other words, downside puts were expensive compared to upside calls.
The 16 stocks Emanuel uncovered that could outperform as today’s momentum market continues are below. Along with each stock is it’s ticker, sector, market cap, year-to-date percentage change, price growth since April 30th; 2023 expected EPS, EPS year-over-year growth, and EPS year-to-date revision; and the stock’s one-year short interest percentile, as well as its three-month 90% to 110% implied skew. All figures are as of May 26.