If one were to look at the S&P 500 from January 1 of this year till last Friday, the returns have been quite impressive. Given that the annual return since 1900 on the S&P is a little over 10% per year, the 18% return this year (and it ain't over) is really pretty respectable. Considering the returns from international and bonds, they appear even more impressive. But, in my opinion, the difficulty this year has been down to the fact that the market has simply been more range bound in 2023 and experienced several sharp reversals. While I guess this kind of environment is at least partially related to the more mixed breadth, the broad market has just not had the sustained trends that it enjoyed for many of the past few years. I want to be clear; I don't write these missives to "wish" the markets up or down, but rather to give some level of transparency to what I am seeing really going on rather than regurgitate what happened by simply giving benign facts. I also intend to provide a level of spatiality. I want to take into account that yes, things have been good, but how good is too good? And when is it time for digestion? Given how strong the markets have been since the end of October, we are getting to a point where I'd like to see another push higher above the July peak or quite possibly a short breather might be in the cards. What it appears we might experience into yearend I have here:
In any event, any corrective move could be a great opportunity to load the boat once more, if the above market action proves to be correct. Seeing the S&P 500 move above its July highs, as the NASDAQ 100 already has, would be a good confirmation. Bloomberg reported that November of 2023 was the second-best November since 1980 and the best month for a balanced portfolio since 1991. Clearly, those waiting for Santa Claus to come to town are hoping for a continuation of last month's advance, but things are beginning to appear a bit fatigued right at this moment. While the 18% return seen so far in 2023 looks great on the surface, the market has not been as consistently strong as that number implies. When we take a closer look at the path of the index this year, it was really only in January and June-July when any real progress was made, followed by four months of churn after each of these periods of appreciation. This means that in 8 out of 11 months the index just either went sideways or declined from a previous move. See the picture below:
I am often reminded of how high the markets were in November of 2021, and that it seems like the indexes have been fighting their way back since that high point was achieved. Given that since that time earnings, revenues and efficiencies have improved quite a bit, today virtually everything is less expensive than it was in 2021. Therefore if inflation were to decline and interest rates were to back off, the markets could quite comfortably move to higher levels. This period of decline has been quite sobering to be sure! With the NASDAQ breaking out above its July high recently, taking a shot at 2021 high looks quite possible. However, it also makes one wonder how much it might have left in the tank given that it's going to require about a 60% rise in a little over a year to accomplish this feat. See the picture below showing this rally in 2021 and what has happened since:
Last week I went over what I thought might be necessary for the market fuel to accomplish the breakout mentioned above. I went into detail about inflation measures, interest rates and the increase in the number of companies joining the party. Speaking of the new companies joining the party, the one index that really was acting as an anchor and is now showing that it wants to participate is the smaller company index, the Russell 2000. Given that this index had been hibernating versus its large cap brethren (especially the Elite Eight), this index really doesn't need to take a well-deserved breather. Instead, it could quite comfortably move higher without adding to the froth of the bigger companies. See a picture of what I am referring to below:
While the performance of the "Elite Eight" has become a popular talking point this year, it's actually not uncommon to have a small number of stocks be responsible for most or all of the market's gain. In looking at the extensive advance from 1989-2015, only 20% of stocks accounted for all of the gains that were made. The bottom 80% collectively had a total return of 0%! This is one reason why stock selection is so key for those of us who do pick stocks. Holding the wrong stocks over even a long time period does not often create gains. Eric Crittenden, formerly of Longboard Funds put together the chart below that illustrates this:
Given these market related points, the question would logically be, what could need to happen to provide the fuel for the breakout rally that is being hoped for this month and into 2024? There seems to be a subtle balance between growth in the economy, yet not enough growth to be inflationary. Also, with interest rates dropping, this tends to infer a recession around the corner, which could suck the oxygen out of the earnings progression. One indicator that I have been watching closely is the Leading Economic Index. It keeps heading lower. The Conference Board's LEI has been falling now for 19 consecutive months. Historically, declines such as this one have always resulted in recessions soon afterward, but in this case the economy has not cooperated. That's another reason why this year has been so difficult since the strength in stocks doesn't seem to make much economic / fundamental sense. But there is one issue that I haven't seen discussed that I believe explains the current phenomenon. If there is not a constant amount of capital since the Great Financial Crisis and instead the economy has had $5 1/2 Trillion dumped on it, then there is essentially an unquenchable appetite for purchases. So much in fact, that interest rate hikes, labor issues and inflation can't really put a dent in the amount of cash sloshing around. See the chart of the Conference Board Leading Economic Index below. Notice that every significant decline was capped with a recession (grey vertical line). This time we just aren't getting the same effect:
I have thought about what would show when all this cash loses its strength. I see this by paying attention to the delinquencies in debt that really need to be seen in consumer purchases, real estate, and commercial real estate. What we have noticed is even though mortgage rates have gone from 3% to 8% and credit cards are charging upwards of 30%, delinquency rates for most loan categories are pretty benign.
- Total delinquency rate rose 7 basis points in Q3 to 1.33% just above the record low of 1.19% recorded in Q4 of 2022- still insignificant.
- Most loan categories were pretty benign. Commercial and Industrial climbed 11 basis points, to their highest level since Q3 2020- still under 3%.
- The consumer delinquency rate jumped 16 basis points, the most since 2009, to 2.53%. Clearly some consumers are struggling- but still below the historical mean of 3.07%.
- Credit cards have been experiencing the highest delinquency rate, up 21 basis points to nearly 3%, the most since 2012- also still below the mean of 3.74%. and the rate of increasing is slowing.
In sum, rising delinquencies are a problem at the margin for consumer spending but not enough to derail the economy. Even though commercial real estate loans are expected to deteriorate more. In the November 27th issue of Barron's there was an article titled, "Rate Hikes Haven't Hurt Main Street. How That Could Change." This article goes into greater detail on this issue of debt cost affecting not just our Federal Government but also the person on the street. Yet, even with Leading Economic Indicators falling for 19 months, corporate America seems to have figured out how to manage through these economic problems.
It is December. We really don't think that the Fed has what it needs to raise interest rates at its December 13th meeting. The markets have remained strong. The last statistic I will leave you with is that if November is up over 5%, and the first five days of December are up over 1% cumulatively, 80% of the time December finishes strong. As you can clearly tell, I will be paying close attention and next week I'll provide greater insights into this final month of 2023 is shaping up. As always, if you have any individual questions, please don't hesitate to call and chat. We are always here for you. Ho Ho Ho!
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The Standard & Poor's 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.
The Nasdaq-100 is a large-cap growth index. It includes 100 of the largest domestic and international non-financial companies listed on the Nasdaq Stock Market based on market capitalization.
The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.
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