Before starting this week's note, I wanted to take a moment and recognize all those that suffered during last week's weather in the southeast. Many lost homes, valuables and went without power for some time. Our deepest sympathies are with you.
Last week’s data on manufacturing, services, and jobs should provide near-term fuel for further market gains. Where the markets go from here is really anyone's guess, but not only are we at the tail end of seasonal weakness, but the 1/2% rate cut by the Fed is a huge scoop of fuel for the market's fire. This September was truly different as it is the first September ever when after being down for the first four trading days it closed positive for the month.
October, like September, carries its own history of challenging bullish sentiment. We remain positive on equities and maintain still higher year-end price targets for the S&P 500. The Fed’s recent rate cut and expectations for further cuts should provide some support for the bullish outlook to be nurtured. Even this was challenged though by Powell’s comments Monday when he said that even though he cut by a half, he wasn’t convinced that more cuts are necessary. That said, beyond this week’s brace of data points and the turn of the page in the calendar investors will be looking ahead to October 11 when the big US banks begin to report Q3 results for clues as to the direction the markets are likely to take headed into the election in November.
The US equity, and even the international equity markets, had a good month of September- far different than what many were expecting. Strong price action takes precedence in our work over the fact that the S&P has averaged negative returns in October during a presidential election year since 1929. Seasonal tendencies tend to be secondary to the fact that October normally marks the end of the seasonal pullback in the election year road map. I caution you to be careful in depending too much on seasonal history, but this year has been quite true to form! Based on the last 20 years, equities tend to struggle into the end of September and beginning of October before rallying into the end of the year. Obviously, this overly contentious election remains a wildcard, but here is the 1 week, 1 month, and 3 months probabilities of positive returns:
And for the average for the past 20 years, I find it quite consistent as to why many are looking for the October bottom and possibly why the market moves have been so sporadic:
I also find it valuable for you to keep the following timeline close at hand as we move into the last 4 weeks up to the election. Statistically, it can be seen what the "implied levels of volatility" are for each announcement I have listed. I find this important as it gives some perspective to the amount of fluctuation in index prices that could be seen as a result of each economic indicator and then ultimately how large these probabilities are compared to the expectation for election day itself.
Given that we are now entering a new environment of economic transitioning, a normalization process for rates and a watershed-like period of innovation in the current economic cycle and the secular (longer term) period ahead, I find it important to recognize what is working, how the year has progressed, and ultimately an update on Ari Wald’s Election Cycle charts. Notwithstanding election year nervousness on policies intimated by either Presidential candidate as well as heightened geopolitical risk in the Middle East the S&P 500’s closing price last Friday of 5738.64 suggests to us a market bolstered by economic resilience and wanting to go higher. How have growth companies fared relative to value companies? This is something that I follow closely as our portfolios tend to be US equity concentrated. Below is a comparative chart of this year’s action. Aside from the breather growth companies have experienced for the past few weeks, it is clear that growth has been the place to be:
Looking at the S&P 500 for the year so far, we have just completed what is termed a “head and shoulders bottom.” This is when the market has reached a top (as it did July 16th), then it corrects (July 25th), tries to go back up, can’t and goes to a lower low (ultimate August 5th low), rallies aggressively (into August 30th), experiencing profit taking once more (into September 6th), and then ultimately breaks above all previous highs to an all-time high (as it has done this last week).
Being that there are so many unforeseen and unmeasurable conflicts currently in play across the globe, it is no wonder that consumer confidence and overall sentiment indicators are on the decline. I must add that this is very uncommon for a market to be going to all-time highs and confidence and sentiment to be poor, see below:
A logical question that I have then asked myself is how could this be? How could Consumer Confidence and market Sentiment Indicators be declining, and the equity markets be at all-time highs? To answer this, I think that there are several measures that are providing much more catalyst fuel to the market’s advance. To begin with, as seen in the PCE Deflator Measure of Inflation, it is clear how high inflation was at the beginning of 2023, and how it is accelerating to the downside now and is now almost at the Fed’s desired 2% level. Since it has accelerated so quickly to the downside, this is part of what is giving Fed Chairman Powell the ability to start with an aggressive .5% cut, and might possibly give him room for some more before year end:
As a result of the PCE falling and the Fed cutting, home buyers are cheering with falling mortgage rates. This gives the consumer breathing room to have more to spend discretionarily if they are spending less on monthly mortgage payments:
The last positive is the price of oil. Since a majority of a worker’s disposable income is spent on fuel to drive to and from work, falling oil prices makes gasoline immediately cheaper, and this also provides more money for spending elsewhere in the economy:
All told, these are all combining to help what was beginning to look like a tired-out consumer. Now, lower inflation- leading to even lower interest rates (good for both business and consumers), lower mortgage rates (heats real estate activity back up), and lower crude oil (making gas prices lower) are all combining to what could be a good lift off into year-end.
So, this brings me to Ari’s US Presidential Cycle work. As can be seen, election years tend to be good after they tend to stub their toe in September / October before the final push:
To give exact numbers of what has been experienced going all the way back to 1929 and up to the last election in 2020, this is what has been seen:
Where We Stand Now
We remain positive on equities. The broad rotation which began in the rally from last year’s S&P 500 low on October 27, 2023, has deflected volatility repeatedly evidenced on a day-to-day basis since the lows in early August. Pull-backs experienced thus far this year have mostly looked like “trims” and “haircuts” for the S&P 500. Whenever bears, skeptics, and nervous investors have found a catalyst to take near-term profits without FOMO (fear of missing out) midst what appears to us like a very much intact bull market.
Drivers of the bull market that in our view have provided resilience in the intermittent downdrafts that have occurred this year include:
- The success the Fed has had over the course of 20 FOMC meetings along with resilient earnings has provided support for the US economy and the markets thus far this year.
- Consumer activity and job postings— notwithstanding the revisions in the monthly jobs numbers—have added support as well to the case for a soft landing this cycle.
- Even with the Fed having taken its benchmark interest rate from a band of 0–0.25% to a band of 5.25–5.50% from March of 2022 the economy has not so far dipped into recession.
- With the unemployment rate having inched up to the higher end of a band of 3–4%, the Fed Chair has said the Fed is focusing on the full employment mandate part of its dual mandate while remaining cognizant of the need to avoid a blow back in inflation should it begin to cut rates at too fast a pace.
- The 50bps rate cut rather than a 25bps cut on September 18 in some part appeared to us designed to address the Fed’s mandate and keep the employment factor from softening too much.
- Technology deeply embedded in the lives of business and the consumer creating greater efficiencies of execution has contributed significantly this cycle to the degree of economic resilience stateside that exists to date notwithstanding the effects of tighter monetary policy since March of 2022. We persist in thinking that technology today (including AI) is likely parallel to the automobile in the early 20th century after Henry Ford had mechanized the assembly line and reduced the cost of the automobile while raising the overall quality and levels of production resulting in a change in the way business could execute and consumers could manage their lives.
The Presidential election certainly looks to be a close one. We expect markets to continue to experience upside and downside risk leading up to the election on day-to-day news flow. After the election? While we favor equities over fixed income, we continue to find fixed income to be complementary to equities and other asset classes in diversified portfolios when matched to investor goals, objectives, and tolerances to risk. We suggest investors look for “babies that get thrown out with the bathwater” when market downdrafts occur.
Given this rather abnormal desire to have fixed income in a portfolio, I think it would behoove you to read this past weekend’s note from the Saturday Wall Street Journal. The column by Jason Zweig, “The Intelligent Investor,” addresses how people simply have forgotten to pay attention to their cash balances in their accounts, as has he titled his article, “Your Favorite Financial Columnist Messed Up.” Truly a good read.
The election is still almost 40 days out and there is still a lot going on to pay attention to. Don’t become complacent! Opportunities could present themselves as well as some dangers.
- Ken South, Newport Beach Financial Advisor
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