Thus far, 2023 has been characterized by skepticism of the economy and markets and yet equities have risen. The best entry points have been when market skepticism has been the highest, á la March 2023 or even Oct 2022, and if history is a guide, we are getting close to a one in this month. This is the perspective I have been harping on in my weekly comments as we look towards the final 3 months of 2023. Both historically and statistically, the late August into September period tends to be unfriendly, but as earnings begin to be released in the second week of October, the year-end rally often begins. See below the measure of fear in the major indexes. When the blue line comes down to the green horizontal bars, fear is high, and it tends to be a better time to be deploying capital. This chart is as of last week, so with the difficulties of the first few days of this week the blue line is now solidly in the green bar range.
The selling pressure we have experienced of late has pushed the S&P 500 down -3.6% in Q3 of this year, yet the market is still up a respectable 11% year-to-date. Since the measures of market internals have continued to worsen, the boo birds have been coming out that this year will be different and, due to fear and skepticism the fourth quarter, might not deliver the year-end rally that has been seen in the past. A graphic representation of this fear measure is the measure of call options vs. put options. As all will know, calls are a gamble on prices advancing and puts are an insurance policy to protect against prices declining. We are currently at an extreme of put buying. In looking at these situations going back to 1995, it can be seen that there appears to be a fairly high probability that the markets may be hammering out a kind of bottom as this decline has extended for over the past eight weeks. As can be seen below, it is appearing that the markets have digested the gains seen since May and are falling into the “mattress top” of the market hit it in both late January and May. Often this can act as support.
It appears that the Government shutdown came and went with minimal consternation, and the UAW strike is still in full swing. These were the two most recent (political) friction points in our economy and our financial markets. Both are more emotional than economic, yet they tend to make people sit on their hands till the turmoil is over. This clearly slows economic growth as they only add to emotional stresses to the investor.
So why is it that interest rates continue to rise if the economy is continuing to slow? I believe, as I’ve often said in previous notes, that it is a function of the huge liquidity floating in short-term banknotes and US Treasuries. As long as this uninvested cash stays in the system, there is little chance of interest rates coming down. Both rising rates and large liquidity represent potential shocks that could finally tip the US into a recession. An uncommon shock is historically needed to create a recession dynamic (that is, a sudden change in business conditions). But the US economy remains resilient, defying many expectations. On Tuesday we got a JOLT number (new job openings) that was far stronger than expected by economists. This speaks to underlying strength in the economy. This then leads to rates being higher for longer as the slowdown has yet to truly manifest itself.
We remain comfortable with the view that equities can rally into the end of 2023. There has been significant technical damage over the past 8 weeks (as seen in the above picture), and this breakdown is not instantly reversed just because we have moved into October. But as Ari Wald, Head of Technical Strategy at Oppenheimer notes, the price level of the S&P 500 is approaching an area of attractive risk/reward. This dovetails with the first graph in this note above where we are entering the “fear range.” Ned Davis Research compiled the statistical data table going all the way back to 1938. It selected periods like today and the returns after this Q3. As can be seen, periods following seem quite consistent:
A mean return at the end of the year of almost 10% would be quite welcome, and particularly good when the consistency of this has had a high probability as seen above! Of course, as the disclaimer says, past experience is no guarantee of future performance, but just as the rally was long in the tooth in late July, the bloom has clearly come off the rose here into the beginning of October. In Ari Wald’s weekend comments, this past weekend, he feels we are entering a period of S&P 500 buying opportunity. His bullet points were as follows:
- The S&P 500 is still in an uptrend off the October lows of 2022.
- The internals (as shown above) are in oversold territory.
- Seasonal headwinds are turning into what could become a tailwind.
As shown above, the market, as measured by the S&P 500 index, is now 11 months removed from the October 2022 low, and if history (going back to 1932) should prove to be a precedent, the expectation is that sectors / indexes with a high degree of momentum could be accumulated into the next few weeks and have historically led the market higher into the end of the year. As can be seen below, the low on the thick blue line is consistent with October of 2022, and the dotted grey line shows what has happened before with a fairly high degree of consistency.
If we are to put together this picture, with the Presidential Election Cycle that I included last week, and then get really granular and say “what happens when the market rallies from the beginning of the year into August, digests from August into the beginning of October, then what happens?” This is the table above of the August pullback. All combined, in past years the reason for the rally or the decline has always been different, but the outcomes seem to be pretty darn consistent. Of course, I say once again, these results cannot and should not be viewed as an indicator of future performance.
The one thing that I can promise you is that we will be here paying attention and adjusting our thoughts based on what we are seeing as fact not media hype or confusion. If you have any questions, please don’t hesitate to reach out. We are all here ready to answer your call and answer your questions.
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