Investors came into October hoping that the start of the fourth quarter would bring them some seasonal cheer, but last month proved to be another tough one for markets.
The Hamas attacks on Israel in early October and Israel’s response did little to minimize the market’s uneasiness even as investors have become accustomed to shrugging off geopolitical events in recent years.
Economic data continued to offer something for everyone with pending home sales remaining weak, but job growth remaining relatively robust. Inflation has shown progress in moderating, but the bond market is now contending with a supply and demand problem fueled by massive deficits and debt. Furthermore, the bear steepening has continued, which has moved the yield curve closer to positive territory.
On the positive side, companies have beaten tepid earnings expectations. Through the end of October, S&P 500 firms have beaten EPS estimates by 7.86% on average on year-over-year growth of 2.60%. However, revenue growth has been harder to come by with topline only increasing 1.62% in a sign that companies are having a tougher time in an uneasy operating environment.
In light of these developments, Bank of America Research highlighted how earnings beats have been rewarded with average gains of 1.00% in the last week of October, a meaningful improvement compared to 0.20% in the weeks prior , but are below historical average of 1.50%, indicating crowded positioning in companies posting beats. Simply put, it’s gotten harder for investors to win even if they pick the right companies.
Major averages and well followed companies like Apple dipped below their 200-day moving averages. The S&P 500 briefly fell below a key level of 4,200, which we noted as a bearish signal last month. This action reinforces the fat and flat trading environment we have experienced since 2021. A 50% Fibonacci retracement now stands at 4,053.
Fat and Flat Staying Fat and Flat
Source: Bloomberg, as of October 31, 2023.
Seasonality suggests that with a negative August, September, and October, markets may be poised for a bounce in the final two months of 2023. However, we believe that investors should prepare for more of the same – conflicting economic data, steepening yield curve, and limited equity market leadership. In other words, nothing has changed to disrupt the fat and flat environment.
For now, we believe that the Magnificent Seven stocks will remain a pocket of perceived safety for investors. If you exclude them from the S&P 500, the market would actually be negative on the year. The seven tech giants have offered growth in an otherwise challenging environment. A valid concern is valuation – the Magnificent Seven are trading at high P/Es and it is becoming more difficult to make an argument that they will continue to outperform at the same pace.
Looking further out, investors will likely seek out traditional safe havens, particularly Dividend growers. Dividend growth companies like the Dividend Monarchs (or Dividend Kings) offer high quality exposure and trade at attractive price multiples. Considering they have raised their dividends for 50+ consecutive years, they have demonstrated the ability to reward shareholders through good times and bad. If you believe winter is coming then it may be time to take some profits on the Magnificent Seven and reposition toward the Monarchs.
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