Really Bearish on Stocks Right Now?
Post the strong first half move in the overall stock market, we have been trading sideways. The S&P 500 has gone net? Nowhere in a sloppy and choppy manner since Wednesday July 19th, which for trading nerds was the day volatility options and futures expired for July. As this was written the SP500 has been flat for 2 months. As the OHFG investment team warned clients and prospects in early summer videos, we were set to enter a sloppy, choppy sideways at best, pullback at worst, time frame. Call it a trading range, call it a general consolidation, call it a lull. A good swing stock trader will call it heaven or goldilocks, buying selloffs and selling rallies, and a bad trader will call it a nightmare getting chopped up selling lows or breakdowns and buying false breakouts or highs.
Investors the fact is we can back up a little more in time, into mid-June and we have now seen very little appreciation in the S&P 500. On Thursday June 15th the cash S&P 500 was at 4425. Almost exactly 3 months later, the overall S&P500 sits within 2% of that level. I must remind investors this was only 3 days after hedge fund billionaire, and market guru to many CNBC viewers, Ray Dalio, having missed almost +20% off the October 2022 lows said it was time to buy stocks. Here’s the daily chart of the S&P500 for the last 18 months.
The bad news? We expect another 4 weeks of the same. Sloppy markets with a downward bias. The good news? Well, that’s our title for this week’s episode, the summer chop ages, but investors, it’s still too early to be “REAL”ly bearish. Before we press onward, please take a moment to click on both the subscribe and notification bells so you will be alerted when our investment team uploads our latest content. Or better yet, give our OHFG team a call at 877-896-0040 to speak to our team and set up an initial consultation with an OHFG advisor to discuss your personal financial situation.
We got oversold late option expiration Friday August 18th just as many bears emerged once again from their caves preaching “crash forthcoming” calls for the umpteenth time the last few years, or decades if you’re Jeremy Grantham or “Black Swan” guru Nassim Taleb. Of course, just as sentiment had gotten dour, the markets started to bounce, just as they have historically more often than not in 3rd year Presidential cycle years in late August through mid-September option expiration as this video is being released.
While, investors should now expect another month of sloppy and potential downward pressure on the overall markets as 3rd quarter earnings reports are released, 4th quarter and 2024 revenue and earnings outlooks are conservatively lowered, and many institutional investors close out their fiscal year ends harvesting gains and losses at the end of September and October, it’s likely that 1- its still “real”ly too early to get uber-bearish on stocks for 2024 and 2 – the coming 4 to 6 weeks should present themselves as the buying opportunity many investors have waited for in front of a late 4th quarter 2023 and 1st quarter 2024 rally.
Ok, so why do we believe that we are quickly approaching a buying opportunity when so many other strategists are back preaching their “can’t buy stocks, inflation is rebounding narrative?” Because first and foremost, a 4th quarter bounce in inflation has been expected by the markets for months. It’s the way base affects pulling inflation down since June of 2022 and now pushing it higher work in the calculation. The markets are already anticipating this event.
5 year “real interest rates”. Which is the premium over inflation investors earn by buying 5 year treasury bonds has peaked and rolled over. Here’s that chart. Let it sink in.
The market is saying you will earn a roughly 2.15% real return vs. inflation over the next 5 years by buying 5-year treasury notes. Of course, you will have reinvestment risk after 5 years, but that is a historically high real return except for the period into the Great Financial crisis 15 years ago.
Ok, so I know what you’re thinking. Chris, pretty chart, thanks for the update on real interest rates, but what does it mean to investors. Well, first the bad news. The bad news is that there is no perfect correlation in the stock markets, one that works, every hour, every day, every week or month, and bats 1.000 all the time. But the good news is that when one looks at historical time periods such as we look to be at, when real interest rates “peak”, break uptrends, and begin declining, they are historically very bullish for equity assets and the overall markets over the next 2 to 6 months. How bullish? Look at the last 3 times this happened. Late December 2018, late April 2020, and mid-October 2022. Each time the S&P500 ultimately gained over 12% over the next 2 to 6 months. Did the rally start immediately? No it took a bit of time and we expect the same here but ultimately it turned into a tail wind for stocks.
Why? Because the real interest rate premium is one of the key components that many equity quants use in calculating the Equity Risk Premium, or ERP, that goes into calculating a “fair value” or “fair” P/E for the overall market. Lower “real yields, lower real interest rates, translates to higher equity valuations, and higher P/E’s all else being equal. Where the “all else” is usually earnings. The markets performance in the first half of 2023 is a great case study in this dynamic in that almost all of the markets +15% first half gain was “P/E” expansion. Most equity strategists who were bearish on 2023 and missed the move up in equities in the first half of this year were focused on either 1-there being little to no earnings growth in the SP500 in the first half of 2023 or 2- the rise in nominal interest rates and inflation levels. Their theories or models being either or both dynamics would be bad for stock returns.
Oak Harvests 1st half outlook 2023 outlook, which played out as we expected, was based on a realized peak in October of 2022 in “real interest rates”, peak in volatility, and the historic norms for a Presidential Election cycle. So far, the summer is also as expected and playing the tune of “normal”. What do we see for the 4thquarter of 2023 and 1q24? Well, much to the dismay of many, we expect more of the same. What’s that? More normal. Normal by historical standards. Which is up and to the right in the markets post mid-October. Besides the recent breakdown in real interest rates supporting valuations and equities, the seasonals and Presidential election cycle work becomes favorable after 3rd quarter EPS.
Per Steve Suttmeier’s work at Merrill, when the S&P 500 has an above average January through August return in year 3 of a Presidential cycle, the rest of the year tends to be much stronger than average. Here are the 4thquarter returns.
Oak Harvest has had a year end target of 4750-4800 on the S&P 500 since early in the year. Using the above data with the 4th quarter up 79% of the time averaging 3.28% would equate to roughly 4650-4675, a little short of our triangulation but in the ballpark. For what it’s worth? If the market were to continue what has been an and eerily similar path to a “normal” cycle we have been following, one would expect after a brief first half October selloff, a rally into Thanksgiving nearing 4600, a year end rally nearing 4750-4800 and a mid-first quarter peak approaching? 5000. Very bullish overall yes, but with increasing volatility.
It’s interesting to note that the strongest year-end stock returns for the markets have come not when the markets are up the most through summer. Not when they are up over 20%, but rather when they are up between 10-20% for the first 8 months of the year. So, all those dire warnings of impending crashes like 1929 or 1987, Mott Capital and the rest, while possible, are historically unlikely as those came after runs of over 20% through August. Which we fell short of this year. The most recent >20% run through August was? 2021 and while 2021 closed strongly and at all-time highs, we know how the first half of 2022 turned out.
The biggest risk to the economy and the markets in the 4th quarter is that Jerome Powell, and the rest of the crew at the Fed are too tight into the 4th quarter. And the US consumer doesn’t show up for the holidays. That the Fed creates a repeat mess in the stock markets and banking system just as they did in the 4th qtr of 2018 when liquidity evaporated into year end and J. Powell had to reverse course.
Will the same things happen in the 4th quarter 2023 that happened into Xmas 2018 because the Fed wants to prove a point? They want to prove they have it, inflation, under control even though it already mostly is? Our investment team thinks no, and we expect the 4th quarters of 2023 and 1st quarter 2024 to play out much the same way most 3rd year Presidential cycle years do. A pause and consolidation in the 3rd and early 4thquarter that refreshes, a year end rally and a strong initial 2024.
At Oak Harvest, we currently manage broadly diversified equity portfolios that balance risk and reward for our clients. We don’t concentrate our clients’ funds in only one or two sectors, seeking to hit a grand slam. We try to hit singles, doubles and occasionally a homer if someone makes a mistake and we find a stock at the right price at the right time. For those investors who are less optimistic and risk taking, those seeking higher dividend income that grows, those investors willing to forgo some potential price appreciation in favor of lower volatility, we have a dividend growth equity model.
Those investors who are more in the optimistic camp, seeking higher long-term price appreciation which does carry higher expected volatility without the focus on dividend income, we have a Blue-Chip growth equity model. The overall tools our advisors and financial planners use are usually a combination of markets based and insurance based tools to meet your retirement goals. Our investment team is busy working on some new, and highly unique equity models, and few advisor teams have the experience our investment team has. We plan on introducing one of these new equity products for our advisors to use as tools for our clients in the not-so-distant future. One of these tools may even allow our investment team to express negative views on single stocks, sectors, or the markets in general if we so desire. Stay tuned. The future and stock markets are always uncertain and that is why our retirement planning teams plan for your retirement needs first, and your greed’s second.
Give us a call to speak to an advisor and let us help you craft a financial plan that helps you meet your retirement goals. Call us here at 877-896-0040 or click here to schedule an advisor consultation. We are here to help you on your financial journey into and through your retirement years.
CFA®, CLU®, ChFC®
Chief Investment Officer, Financial Advisor
Chris is a seasoned investment professional with over 25 years of experience working with some of the most successful money management firms in the world. Chris has made it a point in his career to adapt as the market landscape changes, seeking to utilize the appropriate investment strategy for a given market environment. His transition from managing billions of dollars at the institutional level to helping individuals and families retire is guided by a desire to see first-hand the impact he is making in the lives of clients at Oak Harvest.