Markets rebound following a difficult three-month stretch

11/06/2023 — Equity markets staged an impressive rally following a difficult three-month period, with the S&P 500® Index delivering the best week in nearly a year and the Russell 2000® Growth Index showing the best week since February 2021. Investors reacted to a substantial pullback in interest rates, an easing of the dollar, and a dovish interpretation of the FOMC meeting. Interest rates fell sharply, with the 10-year Treasury yield down to 4.57% after breaching the 5% level last week. Following the first three-month losing streak for the S&P 500 since the beginning of the pandemic, we move to the seasonally strongest two-month stretch on the calendar, with an average gain of 3.0% and positive performance 75% of the time.

Markets saw a relief rally this week, as several major headwinds from recent weeks eased. Markets entered the week severely oversold following declines in six of the previous eight weeks, with the S&P 500 more than two standard deviations below the 50-day moving average, setting the stage for a bounce. The Russell 2000® Growth Index exited oversold territory on Thursday following a 34-day stretch at one or more standard deviations below the 50-day moving average, the fourth-longest stretch in the 44-year history of the index. Financial conditions had been at the tightest level in a year, but conditions improved through the week on strong equity and bond market returns. Bank of America’s Bull and Bear Index fell to the lowest level in a year, providing a contrarian "buy" signal for the third straight week. Also, the Sell Side Indicator saw the largest drop in equity allocations since last October, historically consistent with a 16% return over the next year.

There are notable echoes of the market bottom from a year ago, with extreme weakness in momentum and emotion dictating the market. Though we may see more volatility with a slow economic news week ahead, we believe this is setting the stage for an inflection point, leading to a relief rally that should sustain through the seasonally strong 4th quarter.

News

Non-farm payrolls rose just 150,000 in October, below the 180,000 estimate and the downwardly revised 297,000 in September. The unemployment rate rose to 3.9%, the highest level since the beginning of 2022, despite participation ticking down for the first time in a year. Average hourly earnings eased to 4.1% from a year ago, below the estimate and at the lowest level since June 2021. Fed Chair Powell noted easing labor industry pressure during his post-meeting press conference, hinting that this eases pressure on the Fed. Investors took the news with a "Goldilocks" lens, with rates falling sharply and equity markets rallying. This news contradicted the JOLTS report from Wednesday, showing the strongest level of openings since May and still at 1.5 times the level of unemployed.

Earnings season had its crescendo this week, with nearly one-third of S&P 500 companies reporting. Earnings are on pace to grow by 4% on 2% sales growth, the first positive quarter in four and the first quarter with positive operating leverage (earnings growth exceeding revenue growth) since 2021. This is expected to continue, with steadily improving earnings growth and margin expansion through 2024. Themes from the quarter included a resilient but potentially slowing consumer, margin headwinds from wage inflation, higher interest rates, fading pricing power, and the impact of the strong dollar. Domestically focused sectors are strong (communication services +42%, consumer discretionary +41%, and financials +18%), while globally-focused sectors are struggling (energy -38%, health care -21%, and materials -20%).

The FOMC met last week, and as expected, unanimously agreed to keep the Federal Funds target rate unchanged at 5.25-5.50%. This was the second "skip" following hikes at 11 straight meetings. The tone of the statement and press conference was generally viewed as balanced despite economic growth above the long-term sustainable rate and inflation still well above the 2% target. "The process of getting inflation sustainably down to 2% has a long way to go," Fed Chair Jerome Powell said at the press conference. He also noted that the FOMC is not considering or even discussing rate reductions at this time. The market disagrees, with just a 15% chance of any additional rate hike this cycle priced into the curve, and between four and five cuts by January 2025.

What to watch

With earnings season largely complete and the FOMC meeting behind us, the intensity of catalysts fades. Economic data include consumer credit on Tuesday, the NFIB Small Business Index on Thursday, and the University of Michigan’s consumer sentiment on Friday.