Stock Market Turning Point – Make or Break Time?
Turn on the financial news, and almost daily you are libel to hear “this is the most important” interview, economic release, Fed meeting, earnings period, or employment report of the year. Almost daily, the financial channels try to hype the importance of some little tid bit of information, playing on their viewership and investors emotions. If this is the most important piece of information of the year, I better not change the channel. I might miss something key to my money, they want to lead you to believe. More often than not, the piece of information or opinion being presented as news, is insignificant economic dribble and investors are best ignoring these segments.
That said, I am going to use this phrase for the second time in the last 12 months. This week, the week that we’ve just completed by the time this is released on Friday October 20th and next week are probably the most important weeks for your money for the next 6 to 12 months. And with that statement, the title of this week’s episode, is “it’s make or break time”.
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Post the strong first half move in the overall stock market into mid-July, the broad markets as measured by the S&P500 have been trading, down in a very normal seasonal fashion just as our investment team laid out back in late June in our Oak Harvest video S&P500 4300+, “it’s summertime for a break”. Here’s a chart of the S&P500 since last Octobers low.
You’ll see the overall market has gone nowhere since mid-June of this year. Zooming out further the overall S&P500 is now flat for 2 years since June 2021. This dynamic is NOT unusual for the stock markets.
Well, we have now entered what is historically the sweet spot of the seasonal calendar for a 4th quarter rally. Believe it or not, I’ve had October 17th/18 through Monday October 23rd circled on my calendar since October 2022. Yes, for over a year. Yes, investors, like it or not, seasonal stock moves have been a real thing in our markets for years. Regardless of how much it is advertised it continues to work most years.
I think it keeps working for a few reasons. Earnings and earnings growth in our economy and the S&P500 tend to be seasonal with the middle of the year showing low or no growth and the end and beginning of the years accounting for almost all earnings and economic growth year to year. Why? Because America is largely a consumer economy. Around 70-75% of our economy is consumption of goods and services. We tend to consume more seasonally around the 4th quarter and 1st quarter of the year taking the middle quarters off more for our jobs and fun. Those patterns show up in the EPS levels and growth rates of the major stock indexes. Here’s the quarterly S&P500 reported earnings and forward estimates compiled by Bank America from 1q2023 through 4q2024.
Whether these forward estimates prove accurate or precise down the road, we don’t know, but we do know what’s happened already in 2023. It’s interesting to note that the EPS growth estimates for already reported 2q23 earnings was down -6% YTY. From its July peak post 2q EPS reports, the S&P 500 has fallen about -6-7% inline with the reported EPS decline. Looking forward to the next 6 to 9 months for the 4q2023 through the 2q2024, the comparable numbers get easier, and the estimated growth rate of earnings in the S&P 500 accelerates from 0% in the 3rd quarter of 2023 to a +9% year to year gain in the 4th quarter of 2023, stepping up to +12% growth YTY in the second quarter of 2024. Over longer time periods, stocks follow earnings and earnings growth rates, assuming interest rates don’t vary to wildly. This earnings acceleration would support a strong seasonal 4thth quarter 2023 through 1st quarter 2024 rally.
And once again here is the monthly seasonal returns for the S&P 500 from CFRA and the daily, yes daily average returns since 1945 from Merrill Lynch.
Earnings and earnings growth rates in our economy tend to be seasonal, and so do stock market returns in the large US indexes. So, the good news is, what we have experienced the last 2-3 months is seasonally very normal and should be nearing an end. The bad news? If this positive dynamic from here, doesn’t start kicking in shortly, something is off and what has been a very “normal” 12 months off the October 2022 lows, is quickly morphing into something that “it’s different this time”. The most dangerous phrase in investing. Remember though past performance is not a guarantee of the future and nothing in the stock markets is ever perfectly accurate and precise.
Sentiment and positioning also are now at pretty extreme negative levels which, historically have lined up to support a strong rally over the next 3 to 5 months. One of the most overused phrases I’ve heard repeated in the investment business over the last 2 decades is this one, “cash on the sidelines”. It’s often used to support a bullish call on investors shifting money from cash, money market funds, or other short term liquid investments into stocks. Folks, I look at reems of data, and It’s almost never been proven to work as a good short term timing tool. With that said, I have found a chart that might support this position at least for the next 6 months. Once again past performance gives no guarantees of the future but this chart does say investor optimism is not high. This is the allocation of Merrill Lynchs private client base that is in short term cash and its substitutes. It’s now reached over 15% of their allocations, levels only reached during the depths of the GFC in 2008 and the Covid induced bear market in 1q2020.
More broadly, turning away from just Merrill’s client base, with the S&P 500 -6.5% off its highs, investor sentiment as measured by AAII Bear and Bull surveys, and hedge fund positioning measured by short interest in Nasdaq stocks has turned much lower in only 3 months. This has historically been a good contrary indicator that it’s nearing a better buy time in the overall market than sell time. Here’s a chart of the rolling 2 month change in AAII bearish sentiment. It’s tripled since the July highs in the S&P 500 and doubled in the last month.
It has accelerated negatively as fast as it did during the XMAS 2018 market bottom, and close to the rate at the Covid lows in March 2020. Here’s an additional sentiment chart measuring the put/call ratio. I spoke about this one in last weeks video.
As one can see, this ratio has quickly approached levels that except for the Covid lows in April 2020 and year end spike in the ratio late 2022, marked coincident short-term bottoms in the S&P500.
I’m going to leave you with a few more charts that all triangulate to the market finally being set up for a very normal and quite strong year-end rally. Here’s a market breath chart from Steve Suttmeier at Merrill. The breadth of the market has gotten so bad now that historically, it’s now good. You are looking at the yellow highlighted time periods with the SP500 chart on the top half of the chart and the market breadth below it.
This overlay screams to me, after waiting for a pullback all summer, we are finally in the pocket to broadly buy stocks. Likewise, as I have tried to stress time and time again since the markets lows in October 2022, the behind-the-scenes key to the markets is not inflation or nominal interest rates, but rather the trend and level in the “real rate” of interest rates. Essentially the risk premium one is getting paid to buy Treasuries and other bonds. Higher real interest rates lead to lower PE multiples in stocks, particularly high growth stocks that act like a zero-coupon bond with most of their value being their “terminal value” years or often decades down the road. Here’s a chart of the real time, 1-year real rate calculated from Bloomberg.
The short-term uptrend has been broken. That’s a great thing! Look at the similar prior peak from this level. What was the date of that peak? Yes, it was Xmas 2018. Investors, recall what the stock markets did after XMAS 2018? Yeap, they V-bottomed and vaulted higher for the next 3-5 months as the Fed “walked back” some of their overly aggressive hawkish comments and tone. The markets ex-haled and rallied against the backdrop of negative calls for further market weakness. It appears to me that the Fed is already hinting to the markets that they’ve done enough on the interest rate front and are willing to sit back and watch how this plays out for the 4th quarter and year end.
Investors, that’s it for this week. After waiting for 3 months, the market has pulled back and volatility has spiked as our team expected. We are finally in a very important time for the markets in both price and time. The pullback has created some value across the markets, and things should be looking up from here into year end.
Oak Harvest Financial Group manages 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 and doubles. The investment tools our advisors and financial planners use are usually a combination of markets based and insurance-based tools to meet your retirement goals.
Our dedicated in-house investment team is busy working on some new, and highly unique equity models. Models and tools that few RIA advisor teams have access to, and few investment teams have the experience ours does. One of these tools may even allow our investment team to express negative views on single stocks, sectors, or the overall markets 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.
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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.