You may feel whipsawed from how markets started October. That’s understandable. But if you’ve been reading this blog, you’ve been prepared as our message was to expect short-term turbulence into Election Day.
And with the past week’s significant amount of data, markets might be reactive.
Let’s first turn to September's consumer price index (CPI) information, which showed a 2.4% year-over-year rise and a 3.3% jump in core CPI, which excludes food and energy costs. This is somewhat conflicting data as overall inflation hit a new three-year low, but with uneven progress.
For example, year-over-year CPI was below August, but slightly above the expected forecast. Meanwhile, core CPI came in slightly above forecast and the previous month’s reading:
The market reacted negatively. Some “experts” even claimed inflation was surging and a policy error was made.
That’s overly reactive in our opinion for three reasons.
First, sometimes an extreme outlier data point sticks out, even if we don't know why. It's so extreme that it's inconsistent with any trend.
In this case, inflation surged in the East South Central region at a 0.97% month-over-month rate while no other region came close:
We don’t know why. But it's clear that it’s an outlier.
Next, the percentage of deflating CPI components now stands at 44%:
This is a new cycle high, up from 43% last month. Encouragingly, it’s above the 50-year average of 32%.
And third, the percentage of CPI components below pre-pandemic averages is now 55%:
That’s a new high versus the previous high of 54% last month and above the 50% long-term average.
This inflation dynamic is also reflected in the per-share earnings growth of the small-cap-laden Russell 2000* for the third quarter, per Fundstrat:
Why is this important?
Small companies are more affected by inflation and capital costs. The third quarter is not even fully reflective of any incremental benefit from the falling costs of goods, shrinking capital costs, and easing financial conditions. So from a macroeconomic data standpoint, this is a good sign that small-cap earnings could grow significantly faster than large-cap earnings.
Finally, we want to look at volatility more. Specifically, the inversion of the VIX term structure for the CBOE Volatility Index (VIX), known as the market’s “fear gauge,” is getting even more inverted:
This measures the spread between four months out and one month out. This inversion is now steeper than the recent past, indicating markets see near-term volatility peaking around Election Day.
If volatility is high in the near term, it contributes to the whipsaw of the market and is consistent with our expectation leading up to this “much-anticipated” election. It’s also more data supporting how markets will likely go “risk on” after Election Day.
We're not outright bearish to be clear. However, it’s important to acknowledge the short-term headwinds while keeping in mind that the three tailwinds we mentioned last week are bigger and more durable.
October is a Perplexing Month
Since 1990, October historically has been strong for stocks. But it's not quite that simple. When you peel back the layers of the onion, the month is volatile. And Octobers in election years make you wonder how navigable the month really is.
Thus, October is a perplexing month.
Going one layer deep, October starts a seasonally strong time of the year. Average returns for Octobers through 2023 are solidly positive:
While 22 of the 34 Octobers were positive for the S&P 500# (64.7% of the time), November and December were stronger. They generated positive returns 73.5% and 76.5% of the time, respectively.
When we peel the onion one more layer, we see Octobers’ tumultuous side. The first half of October is visibly weaker on average than in the second half:
Sellers run the show from Oct. 1-15, with an average buying ratio of 43% (so 57% of the action is selling). But from Oct. 16-31, buyers rule, generating 56% of all signals. The daily average returns (right table) reflect this too.
Now let’s peel a third layer of the October onion and look only at election years since 1990 (1992, 1996, 2000, 2004, 2008, 2012, 2016, and 2020). The first halves of election year Octobers are even weaker than usual:
Sellers are in control to start, with just 37% of signals being buys. But as with normal Octobers, the second half is stronger. However, returns don’t necessarily reflect that, for obvious reasons.
Perhaps most frightening, Octobers during election years are negative, with an average fall of 2.48%, while all Octobers produce an average gain of 1.51%. That is a huge difference.
So, don't sweat the choppy start of the month. It’s expected. And even in an election year, the second half of the month starts to pick up.
Understanding the onion’s layers, it’s helpful to show this is also consistent with the setup of MAPsignals’ trusty Big Money Index (BMI), a 25-day moving average of “big money” investor buys and sells.
There was a mammoth rip in the BMI since July as money flooded into stocks. But since late August, the BMI flattened out:
If October follows its historical path, the BMI may fall soon. Looking at unusual buying and selling, buying hit a local peak on Sept. 19 and has been steadily declining since:
Taking what VIX, historical data, and “big money” data are all telling us confirms our belief that October will see continued volatility. Granted, this is totally expected, especially in an election year. It’s normal after the recent strong runs.
Will we get an October surprise? History says there is a chance, but also that election years bring higher odds for volatility.
Thus, we continue to focus on the best part of the year being November and December. They are probabilistically and seasonally the strongest months, especially in election years.
Uncertain times don't mean you should abandon course. Remember philosopher Lao Tzu. He said, “If you do not change direction, you may end up where you are headed.”
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*Past performance does not guarantee future results.
* The Russell 2000 Index is a stock market index measuring the performance of the 2,000 smaller companies in the Russell 3000 Index and is widely regarded as a bellwether of the U.S. economy.
# 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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