Within a matter of weeks, the SP500 has bounced 10% higher from the October 27 lows. A rally this strong makes it is easy and perhaps convenient to believe that the worst is over. However, investor sentiment can be fickle and to use it as one’s guiding star may be ill-advised.
That same investor sentiment that appears giddy was the exact opposite just a few weeks ago with many investors contemplating throwing in the towel. Bank of America’s AAII Bull-Bear indicator and CNN’s Fear & Greed Indicator signaled extreme fear and distaste for stocks. In hindsight, the contrarian nature of markets often prove that these extreme readings actually occur near the bottom. This makes it that much more difficult to use how one “feels” to dictate investment action.
Feelings can be deceiving. The 10% correction that was experienced from August to October may have felt worse than it actually was. Afterall, this correction coincided with a relatively low VIX score (Volatility Index), barely closing above 20. In comparison, similar pullbacks over the last decade would typically register a close over 30. Hence, one could argue that this most recent correction was in fact quite orderly without significant panic.
It is difficult to be certain that the worst is over, however, such a determination should not be made through sentiment alone. Rather, to answer that question we attempt to look at market fundamentals, key index levels, and the price action from the market.
Looking at the fundamentals, at the minimum, it appears safe to declare that the worst in inflation is over. Since hitting the inflationary highs of 9.1% in June 2022, the most recent October headline CPI print was 3.2%. This is convincingly lower and reasonable to believe inflation will not return to those previous highs.
If the worst in inflation is over, it could also be reasonable to believe that the worst of the interest hiking cycle is over. In other words, the frequency, speed and magnitude of future rate hikes should be limited with the Fed increasingly satisfied with cooling prices. The next order of reasoning could further argue that the worst may be over in the severity of any potential economic recession. Although one cannot count out a recession in 2024, the absence of large future rate hikes reduces the likelihood of the Fed inducing a hard landing due to an extreme level of rates. And finally, should this be the case, one could suppose that corporate earnings will benefit from more macro stability, which can improve future earnings guidance. Already, Q3 earnings season has returned to growth mode, breaking the trend of 3 consecutive quarters of negative earnings growth. Altogether, the market and macro fundamentals appear to be on track towards turning the page to a new cycle.
The price action of the latest 3 month correction is also worth noting. Although the scorecard is marked with declines, the buyers did attempt to punch back near the end of every month. Although the buyers were unsuccessful, the idea that investors continue to “buy the dip” is the ultimate takeaway. Surely, part of the reason for this appetite is the overwhelming figure of $6 trillion that is held in money market funds. With yields seemingly peaking and fundamentals improving, investors are enticed to look longer term to add back equity exposure. This further endorses the notion that the market should find support on future pullbacks.
When thinking about the “worst”, we believe there are key index levels to watch. The recent correction could be considered a “productive” one, as it allowed the market to re-test and revisit the 4100-4200 levels of the SP500. This was the level that the market broke through in late spring when the market narrative pivoted to reflect lowered recession risk. The market’s ability to hold their ground and bounce back higher from these more recent local lows should be seen as very constructive. Investors should also take note that the bear market lows were reach on October 13, 2022. This low was more than 13 months ago and marked an environment where CPI inflation was still at 7% and the Fed still having 9 more rate hikes to go (2.25%). With the improved market and macro fundamentals we believe a trip back to these“worst” levels are unlikely.
Nevertheless, investors should restrain themselves from feeling overconfident. The final stages of getting inflation lower from 3.2% to the 2% target could prove to take longer than expected. With continued economic resiliency, the Fed may also feel comfortable leaving interest rates at a high level for longer. Consequently, perhaps the Fed only provides one ceremonial rate cut to signal their satisfaction with their progress, rather than the multiple rate cuts that the market has priced in. And finally, perhaps corporate earnings growth will prove to be overestimated as businesses find it more difficult to pass on higher prices amidst a more price conscious consumer. Any of these reasons could bring upon a buyer’s strike or a pause to any dip buying.Overall, it is unlikely that the worst in market volatility has been seen. This is especially so considering we have continued geo-political conflicts and an upcoming Presidential election in 2024.
Volatility will persist, yet this will provide opportunities for long term investors. Speak to one of our advisors to determine the ideal positioning for your portfolio as we turn the page to a new year in this wavering recovery cycle.