Market Perspective- November 2023

Patience

• October’s consumer price index (CPI) was flat from the previous month but still represented an increase of 3.2% over last year.

• Excluding volatile food and energy prices, core CPI rose 0.2% and 4%, the smallest increase since September 2021.

• Real gross domestic product (GDP) increased at an annual rate of 4.9% in the third quarter of 2023. This third quarter’s growth reflected improving consumer spending and inventory investment.

• The favorable outlook on declining inflation trends has tempered expectations for further hikes through the rest of this year and next.

• On the heels of recent inflation news, investors bid markets back above September and October’s doldrum levels over the past 15 trading days; the S&P 500 was up 9.6%, and the Nasdaq composite was up 11.7%.

• Some relief is expected in food prices this Thanksgiving. According to the American Farm Bureau Federation, a traditional Thanksgiving feast will cost 4.5% less than last year, but still 25% higher than 2019, before the Covid-19 pandemic.

A Market Back on Track

October is in the rearview mirror, and to date, the highly anticipated and forecasted recession has yet to appear. Not wishing to tempt fate—at least for now—a number of economic signals are moving further into the plus column. Undoubtedly, the Fed’s prior 11 rate hikes continue to percolate through the economy, likely causing further belt tightening for consumers and businesses alike. Now halfway through the final quarter of 2023, the Fed has backed away from further recession forecasting, at least this year. Expectations for next year, however, do include its forecast for a soft landing. If you have faith in the futures markets, expect one or two rate cuts later in 2024.

Beyond recent inflation-positive news, quite a few economic headwinds still blow. These economic “squalls,” including wars in Ukraine and now the Middle East, have buffeted the markets this year. Higher interest rates, tighter credit, a lackluster global economy, and the restart of student loan payments have also pummeled financial markets. Despite these speedbumps (including an apparent dysfunctional  Congress), the U.S. economy still managed to post an annualized GDP growth of 4.9% this third quarter—the fastest pace in nearly two years.

Job markets have also weathered staff reductions across a number of industries, and yet overall employment trends have remained relatively healthy. With unemployment at 3.9%, job growth averaging 258,000 per month over the past year, and average hourly earnings rising 4.1%, the labor markets are on par with pre-pandemic levels. This strong labor market and the accompanying rising wage levels have also bolstered consumer spending, which, while countering retailer fears, have added to this year’s inflation concerns.

These economic snippets of positive jobs and wages added to diminishing inflation news did not make it into the recent Conference Board’s Consumer Survey nor the University of Michigan’s Consumer Sentiment Survey. In both instances, respondents still expressed worries about rising interest rates, the political situation and spreading overseas conflicts. November’s Michigan’s Index dropped for the fourth consecutive month, falling 5% from the prior month alone. The Conference Board’s Index was likewise down for the third consecutive month as respondents mirrored the same concerns with the broad economic outlook.  More interesting, perhaps in this survey, respondents who were not confident in the overall outlook were generally positive about their own financial situation, a consideration not lost in recent retail sales data.

While October’s retail sales were nominally negative for the month, backing out the impact of auto sales pushed up growth for the month to a positive 0.1%. On a year-over-year basis, this resulted in a positive 2.5% growth rate over last year. Beneficiaries of consumer spending were categories such as health and personal care, up 9.60% over last year; bars & restaurants, up 8.6%; and online sales, up 7.60% over last year. Three large detractors from the prior year’s comparison were gas stations down 7.5% (falling gas prices), building materials down 5.6%, and furniture down 11.82% (both functions of the current housing market and the earlier consumer lockdown shopping spree).

Somewhat of a surprise in last month’s data were the downturns in both the ISM Manufacturing and Services Indexes. The Manufacturing Index still sits in contraction territory, dropping by 2.3 points from last month’s 49 reading (above 50 is considered expansion). Industries witnessing growth last month included food, beverage & tobacco products, and plastics & rubber products. Data underlying the Manufacturing PMI trend may reverse next month because a significant component dampening the index level was the auto-related labor strike, reflecting a decline of 33,000 employees now largely resolved by the recently settled strike. While off 1.8 percentage points below last month, the services industry remains in expansion territory, having continued to grow for 40 over the past 42 months.

The Inflation Hurdle

October’s inflation report might also be a game changer for the markets—at least that is how the news was treated last week. Headline CPI rose by 3.2% in October, a slower pace than in September, while core inflation (excluding volatile food and energy) increased an annualized 4%, the smallest change since September 2021. Significantly, energy prices were down year-over-year by 4.5% from October 2022, including declines of 21% in fuel oil, 16% in natural gas and 5% in gasoline.

Other notable inflation decreases were major appliances (down 10% from October 2022), air travel down 10%, and eggs down 22%. Categories on the rise included sports tickets, up 25%, and auto insurance and car repairs, up 19% and 15%, respectively. These numbers do not include the latest auto workers’ wage contracts; there are more inflation surprises ahead.

Overall, this month’s report confirms that CPI inflation should continue trending lower through the balance of 2023 and into 2024 without further rate hikes. Wholesale costs (PPI) fell by 0.5% in October from the prior month. On a year-over-year basis, prices are still up by 1.3% but are still a sharp drop from September’s 2.2% growth. The next CPI report is scheduled to be released in tandem with the Fed meeting on December 12^th and 13^th. The report, hopefully, will provide assurances to Fed Chair Powell and his team that inflation easing continues and further pauses in rate tightening are warranted.

For investors, these factors should also provide further assurance that steady declines in inflation will continue. Although they are not likely to hasten Fed rate cuts, they should allow long-term interest rates to decline further, providing support for financial assets such as stocks and bonds. More importantly, some insight into the central bank’s probable policy moves will remove one critical level of investor uncertainty.

An Enthused Market (for Now)

Through this past week’s close (November 17), the markets were once again in positive territory. They are still, however, bifurcated between the darling growth stocks (Facebook, Netflix, Apple, Nvidia, Telsa, Microsoft, Amazon and Alphabet) and everything else. Even so, indications exist that performance gaps may be narrowing. At this writing, the Nasdaq Composite is clearly in the lead (+36%), with the S&P following in a distant second (19%) and the Dow Jones in a very distant third place (+7%). On a year-to-date basis, a few sectors remain in negative territory (utilities, health care, consumer staples and energy). These sectors are comprised mostly of dividend paying companies, which, unfortunately, have not had much traction this year. As a group, dividend stocks are generally down by at least 6% this year.

The broad market rally (and a more friendly dollar) also helped the global markets, with a number of international ETFs up more than 3% last week. There were a few exceptions, though, with Germany (EWG) posting a week’s return of 6% and Mexico (EWW) and Spain (EWP) both up over 5%. Since the markets pushed back up from the October 27 lows, commodities have not been our friend, as the oil sector fell nearly 10% over those 15 trading days, with natural gas off 14%. From a consumer perspective, however, these selloffs represent lower fuel prices at home and at the gas station.

In the past three weeks, the S&P 500 has recovered nearly 10% from its October 27^th lows, placing the index at its first “higher-high” since July—a technical signal not lost on investors. The S&P has rallied above its 50-day and 100-day moving averages, a first since September’s sell-off. Today (November 17), nearly 71% of the S&P 500 stock constituents exceed their 50-day moving average. On October 27^th, the number was 10%.

Meanwhile, in mid-November, 94% of the S&P 500 companies reported earnings for the quarter just passed. Surprisingly, 82% of those companies are reporting positive earnings growth, with 62% of those reporting also reflecting positive revenue growth. Of the 11 sectors, only three have reported negative growth for the quarter: Energy, with earnings decline on a year-over-year of -37%; the materials sector, with a comparable decline of -20.3%; and healthcare, off 20.1%. As expected, earnings growth on a year-over-year basis was reported by the communications sector, up 42.4%; consumer discretionary, up 41.8%; and financials, up 18%.

Today’s forward S&P 500 P/E multiple is trading in a competitive range, sitting at 18.6, slightly below the 5-year average of 18.8 times earnings but a few notches above the 10-year average of 17.6 times earnings. The good news is that for the calendar year 2024, analysts are expecting returns to earnings growth of 11.6% and revenue growth of 5.4%. Given the expected continuing dispersion around sector-specific and stock-specific valuations, as well as momentum next year, active management will be key again.

Market segments, such as small cap stocks, are beginning to look attractive, but there have already been a few false starts this year. With the small cap (Russell 2000) off nearly 26% from its high in 2021, the price-to-book ratio for the index was in the bottom 20% of all readings since 1995. At this point, nearly 60% of the financial stocks are trading below book value. Perhaps pointing to some pent-up demand away from the “growth darlings,” at last month’s October 27^th lows, both the S&P and the Russell 2000 (IWM) rallied by nearly 10%.

One last commentary on investor reaction over the past several weeks is worth noting. Over nearly a three-month period ending in October, the S&P market value dropped by nearly 9%. During the month of October, Bespoke Research data noted that investors withdrew nearly $23.5 billion from equity funds and $17 billion from fixed income funds. Although this period from August through October were rather volatile months, investors left the markets having already endured the summer sell-off.

The timing was premature, reflecting investor nervousness in this volatile market environment. Over the same frame, the AAII sentiment index nearly doubled over a two-week period, rising to an index level of 43.8%, the highest “bullish” reading from the Association of Individual Investors since August 9^th. Essentially, investors voted their sentiment in the survey but “banked” their investments; as is often the case, casual investors also lack the patience required for long term investing.

Counting Down the Days (Thanksgiving and Year-end)

The markets have experienced a number of distractions and unsettling events that have impacted investor confidence, corporate earnings, and more importantly, disrupted lives.

• The war between Hamas and Israel has the potential to be both unpredictable and destabilizing. At this point, however, regional oil producers have not responded in a way that would disrupt global oil supplies.
• Strikes that have disrupted the entertainment business (writers and actors) have been settled; the autoworkers’ union strike has also been settled. Inflationary wage pressure won’t be far behind, but the overall impact on the economy is muted by the size of the union workforce.
• Congress has successfully “kicked the budget can” further down the road; as a consequence, the risk of a year-end government shutdown has been mitigated until early next year.
• Employment indicators are not softening, and the job markets appear to be strong.
• Retail sales are likely to continue softening as rate hikes continue to percolate through the economic channels. The impact will likely be muted, given the job growth already experienced this year, coupled with the annualized 4.1% wage growth. There have already been layoffs across a range of industries, but assuming inflationary pressures subside, the trend will likely slow down as well.
• The Fed will continue to preach “higher rates for longer,” but the likelihood of another rate hike is not in the cards at this point. And despite the current futures market reading, a rate cut in the near future is also not likely. All of this, of course, will depend on future data.
• The next two months are typically positive market months, and up until now, November 2023 will not be the exception. As of last Friday, the S&P 500 was up 6.52% from November 1^st, while the Nasdaq composite was up 8.15%. Assuming inflation data continues its downward drift (and retail shoppers make this a great gift giving season), I would expect good market news to continue throughout the holidays. I would also keep an eye on the small cap market because, throughout the years, these smaller companies have occasionally provided early rallying indicators.
• The presidential election is only a year away. According to Bespoke Research, over the past 80 years, the year leading up to the election posted gains 18 out of 20 times. Consumer discretionary stocks historically averaged the strongest gains (up 12%, while the materials sector posted the smallest gain of +1.4%).

 

Three-Month Look Back / Hard Landing vs. Soft Landing*
                                       Current    Prior Month   Three Months Prior   Status

ISM Manufacturing            46.7           49.0                  46.4                 Hard Landing
ISM Services                    51.8           53.6                  52.7                  Soft Landing
Job Adds                    150,000       297,000            236,000                Soft Landing
Jobless Claims **        212,000      207,000             232,000               Soft Landing
Retail Sales                   $612 B       $613 B               $604 B               Soft Landing

*Data aggregated by Kinsale Trading **Four-Week Moving Average

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