Historically speaking, in October the stock market should’ve bottomed out and risen. But, as we know, October was late to the party.
After weeks of battering, many investors (well, perhaps just retail investors) are skeptical of the significant and quick surge in equities since Oct. 27. But these gains have come on the heels of tone and data we've been awaiting since late summer.
More specifically, the change to a dovish tone by the Federal Reserve and economic data that continues to support cooling inflation have led to substantial improvements in the market after the recent bottom on Oct. 27. Since then, the S&P 500* is up 6.3% and the Nasdaq Composite Index# is up 7.9%, as of this writing:
It's understandable the media would think this is a false rally or that markets will consolidate these gains in the short term. However, we think there’s significant data supporting a strong intermediate term run for stocks in the absence of any unforeseen bad macro news into the end of the year.
First and foremost, continuing Fed Chair Jerome Powell's bullish tone, this week has been loaded with dovish echoes from other Fed officials:
It’s clear the Fed now considers itself patient, especially as the supply drivers of inflation have normalized.
Perhaps most importantly, this language has helped continue to push the 10-year U.S. Treasury yield lower. As of this writing, it’s at 4.575%, which is more than 50-basis point drop in about a week (a massive drop in such a short span):
Also, there is technical data indicating the 10-year yield could continue to drift lower towards 4.45% in the near term. This would be enormously supportive for equities, especially from a price-earnings ratio standpoint.
Furthermore, the Manheim Used Vehicle Index report for October showed prices down 2.2% for the month, which is the largest decline since July:
Used car price declines aren’t easing. They’re arguably accelerating downwards. Why is this important? It points to further downside readings for so-called “core consumer price index,” of which 52% is housing and cars:
The Manheim Index is about two months ahead of core CPI. So, it's further forward-looking data of continued downward pressure on the CPI, which is big for stocks.
Additionally, from a contrarian perspective, it’s noticeable how retail investors have increased put buying activity:
This is interesting because it’s not coming from “big money” professional investors, but retail investors, who are traditionally driven more by fear than data. Retail trader put buying is at its highest level in 24 years, and if continuing to cover those shorts is necessary, markets will rally:
Lastly, earnings season has turned out to be much better than anticipated. As of this writing, 81% of S&P 500 companies have reported. Of those, 82% have reported earnings per share above estimates, which is above the five-year average of 77% and the 10-year average of 74%:
Interestingly, companies that miss EPS estimates are being hurt on price changes at a more than two-to-one ratio versus the five-year average:
We spoke of how important earnings would be and that’s proving to be true. While there’s isn’t a “positivity premium” as in past earnings seasons, there is a steeper price to pay for EPS misses and dampened forward guidance:
It’s been a solid run since the end of October. But is there supportive data that this can continue moving forward through the end of the year? For the answer we turn to an unheralded calendar item – the Treasury refunding announcement.
That data point created the start of the release in Treasury yields as our country's refinancing tab was significantly below estimates. When combined with the Federal Reserve’s second straight pause in interest rate hikes and its newfound dovish language, in our opinion it led to the biggest catalyst for this upward swing, which was the decrease in rates. Also, there’s now a clear path towards the Fed rate falling in 2024, as early as the first half of the year.
Yes, we’re still pounding the table on interest rates falling next year. Here’s why: since 1960, CPI data shows an average reading of 3.77%, which is slightly above the latest reading, and we know that inflation is going to continue to fall off a cliff. This is important because the normal relationship with rates lower than inflation is heavily inverted right now, and historically that does not last long:
The inversion inevitably needs to reverse, and we believe this is why the Fed’s language turned dovish. Chair Powell even mentioned how long-term rates were doing some of his job for him, which is something he hasn’t admitted in the past.
This language, along with continued cooling inflation, allowed Wall Street to naturally rejoice as two big headwinds were removed and significant buying began. It started as short covering, which is good because shorts being covered can turn into a real rally. Also, remember there’s nearly $6 trillion in cash on the sidelines, the highest on record:
If/when interest rates begin to fall, that money will flood into stocks because that cash won’t be earning as high of an interest payment anymore.
We mentioned the increase in retail consumers’ puts. To support why we view that as a contrarian indicator, see Wall Street's reaction to all this recent data – money flowing into stocks. In the chart below, the amber bars show unusual volumes surging as markets lifted recently:
This is a strong “big money” indicator that a bottom has been established. It also supports higher equity prices in the near and intermediate terms, and coincided with an almost complete drying up of selling in stocks:
As well as exchange-traded funds (ETFs):
That’s allowed MAPsignals’ trusty Big Money Index (BMI), a 25-day moving average of “big money” professional investor net buys and sells, to rise above the 25% oversold line:
The dip to oversold and eventual recovery indicates strong momentum. It might mean the violent, capitulation-like selling has vanished. And while occasional pain will materialize in any market, we can see from earnings reports that pain this time around is being largely focused on the companies with earnings disappointments.
An Avalanche of Supportive Data for Equities
A lot is packed into this post, so let’s summarize.
We received the initial market catalysts needed to begin changing the negative, fear-based narrative via positive news from the Fed and Treasury refunding. In our view, that led to an avalanche of supportive data for equities:
- The fundamental picture continues to be supportive, with slowing growth but even more slowing of inflation.
- The Fed has shifted away from “data dependence” and is now more forward looking, which is dovish and positive.
- Equity valuations have significantly more upside now as interest rate pressures eased.
Earnings are working. Sentiment is negative at the retail level (a contrarian bullish indicator). We’re in a seasonally strong time of the year. And “big money” is waking up to beat up the retail shorts. It appears that once again, when fear and fright are at their highest, the best deals reveal themselves.
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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.
# The Nasdaq Composite Index is a market capitalization-weighted index of more than 2,500 stocks listed on the Nasdaq stock exchange.
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