Wouldn’t it be great to be able to predict the future as well as “The Simpsons”?
Maybe Homer, Marge, and the rest of the family could share some insight on where stocks are headed?
This question becomes seemingly most important when we hit a speed bumps like the recent consolidation we are experiencing. Remember, a few weeks ago we warned of pending seasonal volatility. Almost on cue, the S&P 500* began the month with a drop of -4.7% through Aug. 17. But remember that is normal from a seasonal perspective as August and September are historically the weakest months of the year for stocks.
Furthermore, MAPsignals’ trusty Big Money Index (BMI) – a 25-day moving average of “big money” investor stock buys versus sells – began to fall after peaking at 83.9% on Aug. 1. As of this writing, the BMI now stands at 66.8%:
As our readers know, when the BMI falls from overbought, that's when historically we expect weaker prices. That supports our historical basis of weaker Augusts and Septembers. As the BMI has dropped, there’s been a notable slowing of “big money” buying coupled with an increase in selling:
Given these insights, can we now predict what’s next for stocks?
Well, since anything can happen in investing, future predictions can be unreliable (not many folks foresaw a pandemic). That said, with earnings season ending, here are several data points laying out the base case support for a strong fourth quarter for stocks this year and the momentum could continue in early 2024.
1: Falling inflation
The consumer price index (CPI) report recently showed all categories are down significantly from a year ago:
Notice how since January 2022 the green trend lines on the right side of the table show lower numbers in all cases.
2: Interest rate clarity
It’s becoming clearer every day that the Federal Reserve is close to, or perhaps even done raising interest rates as inflation continues to fall closer to the Fed’s “goal” of 2%. Currently inflation sits at 3.2%, which is significantly below the effective federal funds rate (the spread is 1.92%, the biggest since July 2009):
At the current rate of core CPI reduction, there is an increasingly stronger argument to be made that the Fed doesn’t need to raise interest rates any further because the current rate will become more and more restrictive based on current projections:
3: Earnings are working
More support for the longer-term bull narrative is that despite softening prices, the second quarter earnings cycle for has been strong for stocks in general. According to FactSet, as of Aug. 7th with 84% of companies reporting, 79% of S&P 500 firms beat their earnings estimates:
And 65% of S&P 500 companies beat their sales estimates:
It seems to be clear that 2023 will not bring the feared “earnings apocalypse” that many pundits called for at the beginning of year.
4: No economic “hard landing”
It's further clear the economic “hard landing” pundits called for also has not come to fruition. In our opinion, it’s beginning to become debatable if we’ll even have a “soft landing” at this point. Folks at J.P. Morgan seem to agree:
In short, earnings are working, the economy is still robust, and the labor market remains sturdy.
5: Strong seasonality
It’s time to revisit one of our favorite charts. Just as the third quarter tends to be seasonally weak, the fourth quarter is historically the strongest time of the year seasonally:
Bulls tend to run at the end of the year, and that could happen in 2023 if there is no material change to the current data.
6: Rate cuts ahead?
We think a point will come where investors begin to speak about the need for the Fed to cut interest rates in 2024. The question becomes, is the Fed is trying to fight inflation or kill the economy? We believe the Fed will want to lower rates to keep real rates not overly restrictive:
If the Fed does cut rates in early 2024, it would likely be a positive surprise to the markets, even if the Fed funds futures are now currently implying March 2024 as the first cut:
Fed fund futures projecting an interest rate cut is a big deal. If the narrative about “higher for longer” falls apart, that's extremely bullish for 2024.
7: Ample reserves
We think a lot of the money on the sidelines will eventually be put into the market. That’s especially true if the Fed begins cutting money market short-term interest rates. In the last three weeks alone, institutional money market cash has increased by $41 billion and retail money market cash is has jumped up by $31 billion:
That said, with earnings season nearly over and seasonal volatility in effect, it represents a great opportunity to reset and begin looking out over the next couple of quarters for what to expect. We think opportunity will be there, and the data currently backs that up. Still, time will tell for sure.
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* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
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