The stock market has steadily rallied since early October. Overbought conditions have been worked off by sideways trading rather than dips. Over this period, the S&P 500 (SPY  ) is 8% higher and has moved decisively to all-time highs.

One strange circumstance of this rally is that manufacturing data and the broader economy continue to slow and lose momentum. Based on recent data, Q4 GDP is expected to come in at 1% which would be close to a cycle-low. Manufacturing continues to be contractionary in the US and across the globe with almost nine months of sub 50 ISM readings.

Stocks dropped immediately dropped following the report, however, the weakness was quickly bought, and the S&P 500 finished almost 1% higher off the day's lows. This dynamic of sell-offs on bad news immediately being bought is a sign that markets have priced in the bad manufacturing news and art anticipating future improvements. If those improvements don't materialize, stocks will certainly give back these gains.

Stocks are behaving as if this is the nadir of the manufacturing slowdown, and growth is going to pick up in future quarters. In this context, the price action along with the newsflow makes sense. This is confirmed by the price action of leading cyclical stocks like Caterpillar (CAT  ) which missed earnings and lowered guidance but saw its stock rally. This indicates capitulation and often correlates to turning points in individual stocks and broader markets.

Supporting the above possibility is improvements in manufacturing data at a deeper level. New orders after leading on the downside for the past 12 months are back into expansion territory. This is a necessary but not sufficient condition to mark a bottom in manufacturing. Additionally, inventories are at three-year lows which kicked off the previous risk-on trade from mid-2016 to late 2018.

Another positive is continued progress in trade talks between the U.S. and China with expectations of a 'Phase 1' deal being signed sometime before the year ends. And, it seems likely that some portion of tariffs will be peeled back as a concession.

The trade war intensified late last year. Before the imposition of tariffs, there was a frenzy of buying as companies stocked up on items that were going to be affected. Due to this effect, comps are elevated and not giving an accurate picture as they are computed based on data from the same month last year. This is another factor why the weak manufacturing data has been met with a collective shrug by the market.