Markets attempt breakout on technical factors

Thoughts

• Equity markets saw their third gain in four weeks, as hopes for a Fed pivot on the pace of rate hikes in December emerge. The market is trying to break out to the upside, with the S&P 500® Index touching the highest level in a month and 9% in two weeks, the best stretch since November 2020. Substantial dispersion was seen, with value substantially outperforming growth, and small caps handily beating large caps. October is heading for a gain of roughly 9%, which has historically been a good omen for market momentum. The S&P 500 has gained 8% in October six times in history. On each occasion, the following year was positive, by an average of 20%.
• The tone of the market is shifting, with investor sentiment and momentum showing significant improvement, and the market higher in three of the past four weeks. While the fundamental picture remains challenged, technical rebounds almost always predate a fundamental turnaround, as investors realize that too much negativity is priced into markets. Through Friday, the Index has gained in 10 of the 22 sessions, with each gain exceeding 1% (seven >2%), reflecting the willingness of institutional investors to “dip their toe in the water” after historic levels of cash holdings. This is echoed by improving investor sentiment and risk metrics, with the CNN Fear & Greed Index above 60 for the first time since January. Goldman Sachs notes that there is now $20 billion in daily “buying power,” including $12 billion in institutional, $5 billion in company buybacks, and $3 billion in retail.
• We are seeing some recent, optimistic signs in the market. Notably, this has been the best two-week period since November 2020 and historically, a positive October for the markets is a good omen for the following year. While the current rally is promising due to improving technical factors, better investor sentiment, seasonal tailwind and post-midterm strength, we still need to judge its durability. If correct, I expect we are heading to a sustained rally for at least 3 – 6 months.

News

• Earnings season is more than half complete, with more than one-third of the S&P 500 companies reporting last week. Growth is trending towards 2%, which would be the weakest pace in two years. Over 70% of companies are beating estimates, though the degree of beat is well below the historic average, and the stock prices for those are rising just 1%, versus an 8% loss for misses. Four of 11 sectors are seeing growth (energy, real estate, industrials, and consumer discretionary), while seven experiencing declines. The S&P 500 is heading for its fifth-straight quarter of margin compression, though the current consensus expects the next three quarters to each show improvement. Cautious commentary is bringing down the estimate for 2023, which is now expected to see 6% growth, down from 8% a month ago.
• Investors got a rare positive surprise on inflation Friday, with headline and core PCE (inflation metric favored by the Fed) coming in below expectations. Personal income and spending both modestly surpassed expectations, with real income flat from August. Real GDP grew a surprising 2.6% in the third quarter, exceeding the 2.3% estimate and the first increase this year. Consumer spending continues to shift to services over goods, with spending on services up 2.8% and goods dropping 1.2%. Skeptics of the report note the strong contribution of net exports, driven by declining imports, and unlikely to persist in coming quarters. Notable in the release was the 26% contraction in the housing market, the sharpest decline since 2007.
• Expectations for Fed hawkishness are beginning to ease, as the Fed Futures curve implies a 60% chance that the Fed does not do back-to-back 0.75% hikes in November and December. Additionally, the terminal rate is expected to be 4.8% by next May, down from 5.0% last week. San Francisco Fed President Daly highlighted concern about overtightening just ahead of a blackout period that will go through Wednesday’s meeting. A Bloomberg Economics model puts the odds of a recession over the next year at 100%. A survey of economists showed 75% believe a recession is on the way, with an additional 20% expecting a hard landing without an official recession. Global central banks are also signaling a pivot, with the ECB saying on Thursday that it has made “substantial progress in withdrawing monetary policy accommodation.” The Bank of Canada surprised the market by only hiking rates by 0.50% on recession concerns.

What to Watch

• Earnings will remain a driver of activity this week in the last major week of the season. The FOMC meeting is Wednesday, with a likely 0.75% hike. Economic data include JOLTS job openings and PMI data on Tuesday, durable goods on Thursday, and the monthly payroll report on Friday.