Investment Insights

 — Steve Orr 

Onward

Hard to believe this is the last week of the month. Equally hard to believe are stock returns this month. A typical election November registers modest gains of less than 1% for the techie NASDAQ and solid 2.5% gains for small caps. The rest of the big indices fall somewhere in between. How about double and triple those numbers? As of last Friday, the NASDAQ, thanks to the Magnificent 7’s 8% run, has risen 5% this month. Small cap stocks, typically strong this time of year, have led the November parade, posting a 9.6% return. A gentle reminder about small cap: The table above this article shows they trail the 500 by nearly 700 basis points this year. Easy to do when the S&P 500 is posting record revenues while about 40% of the Russell 2000 stocks have no earnings.

Drivers of these pre-holiday returns? From lowest percentage to highest, our humble rankings follow. First, relief over the election. Few protests and vote challenges. Senator Casey finally conceded last week in Pennsylvania. Second, U.S. economic prospects for the next few quarters are at worst flat, and more economists are raising their forecasts. Third, the Fed, although “in no hurry” according to Chair Powell, is in rate-cutting mode. Finally, the incoming administration’s cabinet picks appear to support President Trump’s deregulation agenda.

Seasons

As a reminder from two weeks ago, November and December rank No. 1 and No. 3 for stock performance over the past 70 years. History does rhyme, to paraphrase Mark Twain (we think), and investors rarely change habits. In the prior 17 cases since 1950 when the S&P 500 is up 17% or more in mid-October, its returns the rest of the year are positive. Private sector balance sheets are in their best shape ever, and borrowing spreads are near all-time lows. Companies are using flush balance sheets and low borrowing costs to buy back stock, putting a soft floor under prices.

What could turn a positive fall into a nasty winter for stocks? A few flags are popping up on our radar. We wonder how long the good news for jobs will continue. Most of the gains in the payroll numbers this year came from government and education. The private sector needs to start growing. Client reports from the field suggest high material prices and labor costs are keeping hiring plans on hold. The country remains near full employment, and historically the unemployment rate spends very little time around 4%. Usually, the 4% is on the freeway down to 3.5% or on the rocket ride to 5%, not a vacation spot for unemployment. 

Looking at stock market internals, the advance/decline line has stopped rising since mid-October. In any market environment, we would like more stocks going up than down. The Philadelphia Semiconductor index has a decent track record for leading S&P 500 returns. Its recent strength relative to the big index is near a 52-week low. Bespoke identified four cases since the mid-2000s when the S&P 500 was near an all-time high (today!) and the Philly SOX was at a 52-week relative low. In other words, semiconductor stocks were breaking lower while the S&P was rising. In each of these four cases, the big index was lower three and six months later. Say it ain’t so. But that lead time would fit with another seasonal pattern, that of the presidential cycle. Years one and two are generally the weakest for stock returns, as new administrations try to clean out problems from their forebears (foredonkeys?). Weaker returns over the medium term also fit historical patterns of year three of an average Bull cycle having flat or low single-digit returns and years following slowing earnings growth.

Going up

Interest rates did an about face on Monday. We think the small 10th of a percent drop was due mostly to short covering by traders. Most were encouraged by the news of Scott Bessent’s nomination to be Treasury Secretary. Regardless of the name on the door, the incoming Secretary will have a tough go lowering borrowing costs for the government.

The trend for longer-term rates remains higher. Treasury rates crossing 4.5% for 10-year maturities will create some angst. The 5% level remains a trouble zone for stock returns. We think the Fed wants to cut short-term rates again on December 18. Inflation expectations and a deficit that is at 6% of our entire economy means traders are worried about more supply of debt. These valid worries will continue to frustrate the Fed’s efforts to lower borrowing costs for the Treasury.