Investment Insights

 — Steve Orr 

Rip and ...

This is a November to remember for markets. The S&P 500 and NASDAQ both ripped higher by 8% or more this month through last Friday. Our trusty Stock Trader’s Almanac says that turkey month is #1 in performance for the S&P 500 and #2 best for the Dow Industrials. Bear in mind that the average return since 1950 is around 1.7%, so 8.8% for the S&P is a rare month indeed.

Bonds have also done well this month. The Barclays Aggregate index is 3.3% through last Friday. The 10-year Treasury note is now a half of a percent lower in yield, hovering near 4.4%. Longer dated Treasurys and municipals have added over seven points to their prices. Gold joined the party last week, breaking the $2,000 barrier for the fourth time this year. Some of gold’s move is related to the U.S. dollar’s moderating against other currencies; we do not see stress in gold prices at present.

Finger-pointing is always in vogue on Wall Street, and all hands are waving “thank you” to the Fed and inflation this month. The Fed’s decision November 1 to stand pat on rates and issue a mild press release sparked all markets. A steady consumer price index reading on October’s inflation levels added fuel to the stock rip higher. Another big driver is institutional positioning. CTA and trend-following funds were leaning very negative and short stocks for most of September and October. When the Fed and CPI news hit the tape, they had to buy in wagonfuls — and quick. We would add that seasonals are kicking in, too. 

'tis the season

By mid-November most companies have reported earnings. Those with stock buyback programs may have more stock to buy from investors to finish their annual program. Pension plans and other institutions have cash to put to work near year-end. Individuals have some tax loss selling, but we generally see that during the Santa period after Christmas.

The big stock indices have moved very fast in a short period of time. Breadth is improving. Very short-term — next couple of weeks — the market is overbought and needs to pause to rebuild energy. Think rip and pause. Over the medium term the trend and outlook are improving. Sentiment has improved to neutral from pessimistic, another positive sign.

Sadly, we must remind our readers that #1 November is about over. December ranks only #3 out of 12 months in performance, with an average return of 1.5% for the S&P 500. Over the last 10 years, returns have been a flat -0.04%, with seven positive years. That flat reading is skewed by 2022’s crummy -5.9%, deep in the middle of the Fed’s rate hike program. The seven positive years have averaged a 2.4% return. Let’s have more of that.

What do we need for a Santa rally after Christmas? First, rates to remain at about these levels. As noted earlier, long rates are off their highs. Check. Second, positive earnings growth. We got a return to positive growth in the third quarter. Fourth quarter early estimates are around +4%. Check. Finally, small caps need to join the party. They have risen 9% this month but are still up just 4% year-to-date. Small caps tend to shine in mid-December, so we will be watching. 

Up enough

Inflation continues to hover between 3.5% and 4.5% as measured by the “core” — without food and gasoline. We find we need both, so we also pay attention to the headline number. Gasoline pump prices are 13% lower than a year ago. That helped keep October’s headline lower at 3.3%. We expect that level to be near the low for the next several months. Healthcare costs for Medicare and insurance calculations are supposed to be adding about 0.1% to 0.2% to CPI. October’s reading for that line item showed a 34% drop year-over-year. That’s a head scratcher.

The Fed is making noises that they think rates are high enough to slow the economy, but not so high that they trip the economy into recession. They will stand pat at 5.25% to 5.5% on the Fed Funds target for the next couple of meetings. If they were to change policy and cut rates, we would expect the dollar to fall, which would in turn be inflationary.

Rates are higher than Wall and Main Street would like, but the Fed is determined to bring inflation down. The Fed’s favorite inflation measure, the Personal Consumption Expenditure gauge, comes out this Thursday. The November CPI report will be released on the 12^th. 

Ahead

Black Friday and Cyber Monday sales rose 7.5% above last year’s levels, according to Adobe. Depending on what inflation measure you chose, the real sales increase was somewhere around 3.5%. Not bad considering our wallets are crimped by inflation and higher interest rates. Target, Home Depot and Walmart warned in their earnings calls that consumers were scaling back, especially on big items. Fourth quarter earnings are projected to rise by 3.7% over 2022’s final quarter.

Our charts suggest markets will consolidate around these levels over the next couple of weeks. Rates are now high enough to slow the economy. The Fed believes it can be patient and let these rate levels slow business activity. Their theory is that lower activity should in time slow hiring. We will see.