11/18/2024 Market Strategy
What’s Going On?
Last Week’s Sell-Off We Think Is the Pause that Refreshes
Key Takeaways
- With 462 or 92% of the firms in the S&P 500 index having reported earnings thus far, results are showing a robust third quarter. Profits in Q3 overall were up 6.8% from a year earlier on 5% revenue growth.
- Eight of the 11 sectors have positive earnings growth, with four at double-digit rates. Three sectors are showing declining earnings, with one (energy) falling at double-digit rates.
- Last week’s consumer price indexes showed scant progress on further reducing inflation towards the Fed’s 2% target while retail sales data showed resilient consumer demand in October.
- This week brings reports on housing starts and the Michigan survey of consumer sentiment. Another 14 firms are due to state earnings as the Q3 reporting season winds down.
Mixed messages extrapolated from economic data released last week and from mixed messages delivered in guidance proffered from management in earnings calls over the course of an overall positive Q3 earnings season for the S&P 500 lead to what looks to us to be a healthy and normal pause in the market’s recent upward trajectory that has carried stocks and sectors higher in a broad and powerful rally from this summer’s low reached on August 5.
On one hand a drop in bond prices orchestrated by negative bond market sentiment and some investors’ questioning the effectiveness of Federal Reserve monetary policy and the central bank’s ability to cut its benchmark rate further in the near term seems to be at the heart of last week’s price action.
With the S&P 500 having achieved something like 50 record highs this year and the natural uncertainty that comes from the course of daily news and data flow—along with a change in Administration now taking place in Washington—it would seem quite natural for the moment to present opportunity for bears, skeptics, and nervous investors among others to find a catalyst to take some profits without FOMO (fear of missing out) midst an amazing run-up in stock prices this year and last year driven by a bull market supported by improving fundamentals and prospects for rate cuts by the Fed as the pace of inflation has slowed.
Markets don’t like uncertainty
When prices of asset classes pause or pull back we often hear the phrase “markets don’t like uncertainty.” Perhaps they don’t like uncertainty at first glance but in our experience the emergence of uncertainty that captures the attention of investors often has resulted in hindsight ushering in opportunity for intermediate and long-term investors to find “babies that get thrown out with the bath water” (good stocks, bonds or other assets that get caught in a near term downdraft).
We want the world, and we want it now not the best approach
Ironically markets were jostled somewhat last week by contradictive data as oil prices fell on economic growth concerns while interest rates moved higher on expectations that a healthier than expected consumer -- along with stickier than expected inflation in some of the CPI data -- could keep the Fed from cutting rates as fast and deep as some investors would like to see.
Among the concerns reflected in last week’s stock and bond market action we’d include: the concerns expressed over economic data, future earnings growth prospects and the questions around at what pace and to what levels the Fed will cut rates in the months ahead appearing the loudest among the market din and the more likely the easiest to be digested by the markets over the near term.
In our view the inflation data released last week showed that while the Fed has made progress in bringing down the pace of inflation since it peaked this cycle in March of 2022, their 2% inflation target remains elusive. This is not surprising to many of us who experienced the sticky nature of inflation in prior inflation/rate hike cycles and how long it can take the central bank to put inflation in check. Patience is likely the best discipline for dealing with this rather than overreacting to news that merely suggests a process is in place that will continue to take somewhat longer than many would like to see.
Bloomberg reported over the weekend that Wall Street analysts are “scaling back” their forecasts for US corporate growth over the year ahead. We aren’t surprised by the news after the better than expected results through much of this year. That said, it is not uncommon for Wall Street analysts “to pull in their horns,” particularly when company management guidance has been as cautious as it has become for the most part this earnings season as well as throughout much of the years since the Great Financial Crisis of 2008 and the pandemic. The good news? So far S&P 500 corporate managements have done well in navigating challenging times from the low of March 2009 through last Friday.
Ultimately the stock market focuses on the health of the economy, revenue, and earnings growth, the potential for innovation to drive earnings and the effect of monetary policy on the economy (particularly on business and the consumer).
With the Fed having begun the process of cutting its benchmark rate, equities appear well positioned to benefit as interest rates likely move somewhat if not much lower over the months ahead.
We remain positive on equities and look for opportunities within the asset class across sectors, market capitalization, style and those areas that offer the potential for good total returns (capital appreciation and dividend income).
As Q3 S&P 500 earnings season nears a close large cap stocks have continued to show the ability to exceed consensus expectations with results. (See page 10 in this report for details in our Earnings Scorecard). As prospects persist for the Fed to continue the process of rate cuts (if not as dramatically as some might expect or want) we look for midcap and small-cap stocks to gather increased investor attention.
Current yields in fixed income suggest to us an environment where bond issuers once again are having to pay for the privilege of borrowing money providing bond buyers an opportunity to get something in return in the form of attractive yields compared to the last decade. The path to interest rate normalization currently being orchestrated by the Federal Reserve in our view offers additional opportunity for investors looking for further diversification of their investment portfolios.
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