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2022 put the Wall Street cliche' "It's always a bull market somewhere" to the test for sure. For the first time on record both stocks and bonds fell. In 2023 the decline in bond market prices has continued for a third consecutive year! Again, a situation that has never been experienced. Yet, the first five days of this year the S&P 500 was up, followed by numerous other measures of time suggesting that this year could be quite a good one. Besides these statistical outcomes that I have brought up numerous times, there are also many seasonal factors at work that are probabilities that the market should finish the year strong. In speaking with clients, I have been given the retort of, “hey there are teams that win the world series for the first time in 54 years and statistically they shouldn't have even made the playoffs!”
If one just looked at the S&P 500 (without paying attention to the news), their conclusion would be that 2023 is a much better year. The index is up 15% year to date. However, few other asset classes have come along for the ride. And without question this equity rally has truly been narrow. Only 32.5% of stocks in the entire index have outperformed the index over the last three months. In looking at the earnings progression for the year, most companies (exclusive of the oil sector) have done exceptionally well, and actually way better than what was expected for them. As seen in the LPL earnings dashboard below, for the third quarter, with only around 50 companies of 500 S&P Index companies left to report, 80% have beat their expectations and done so by over 7%. 7% might not seem like much, but when we see that over 80% have bested expectations, this is really quite impressive.
Year-over-year, the earnings are up over 5%, and if we take out energy companies, the earnings are tracking a 10% increase year-over-year. Also, earnings growth more than doubled sales growth, which corresponds to margins widening impressively. Doesn't smell like a recession in the making to me, yet the next 12 months S&P 500 EPS estimates are now 1.5% below what was forecasted back on September 30th. Looks like many analysts are still expecting a recession, yet the resiliency of US companies should not be underestimated. I mean for them to increase earnings by 10% in the face of a massive increase in the cost of capital, bank failures, two wars and domestic political friction is very impressive. Before I leave the concept of earnings, I want to give you two tables that I found extremely illustrative of our current earnings season. The first one gives the progression of each quarter since Q3 of 2022 and then the forecasts to Q3 of 2024. The next one gives a breakdown of the earnings reported thus far for the quarter separated by sector. It should be no wonder that energy companies highly underperformed this year while consumer discretionary and technology have greatly outperformed.
Several weeks back I mentioned that the typical market advance tended to depend on the performance of 10% or less of the index’s companies. It seems that these certain few leaders tend to pull the broad indexes up with them. I found the following chart from NDR research a very interesting depiction of what we have experienced this year. If we were to simply look at what they term the "Elite Eight" companies, it is extremely graphic how important it would have been to own these if it one was to have outperformance to the broad markets. I have highlighted in the table at the bottom that if one were to examine these eight companies, and combined their returns cumulatively, to-date the return has been a whopping 67.36%. If they were removed from the broad S&P 500's performance, the index's year to date return would drop from 15% to 1.7%. I took the liberty to include the picture of the year's progression as well as it can be seen pictorially as well.
The last point that I wanted to discuss this week is the action of the markets since late July. The market rise was quite ferocious in the face of rising interest rates and fear of runaway inflation. Then July ended, and the air came out of the balloon quite quickly. I took the time to show a picture of the three wave decline last week, and this week I wanted to add on the two weeks since October 27th to show how aggressive the bounce has been. I focused this chart on the NASDAQ as it tends to house the companies that have been most positive for the year.
I highlighted the three waves of decline and then the action of October where last Friday the index jumped above the previous October high. Below I focused purely on October itself to show how the index moved up for the last two weeks to the old October high, sort of caught its breath there and then broke out above it last Friday. I have circled the breakout to illustrate how truly impressive Friday’s one day move was.
Is this the beginning of the year-end rally that was being hoped for, or simply a trap to suck in investors before another leg lower? If the price of oil, the rollover in interest rates and comments from Goldman Sachs macro economists are any indication, not only is the complexion of the markets changing, but interest rates, inflation and oil are also changing direction. All of these tend to precipitate a lessening of inflation expectations but not necessarily a slowdown that could be recessionary. According to Goldman, AI coupled with corporate efficiencies have added to additional levels of disinflation which could very likely cause inflation to back off to 2-2 1/2% by the end of next year. Talk about a Goldilocks scenario!
Whatever you do, don't forget to get your Thanksgiving fixins. The bird will take some time to thaw, and the best Bloody Mary mix might be gone! For us, the weather is usually beautiful at the beach, and after a morning surf it is one of our favorite times to enjoy family and friends.
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