By William Watts
Barring a sudden bout of post-Thanksgiving indigestion, the U.S. stock market looks poised for a healthy rebound in November. And while there are certainly no guarantees, history says momentum is likely to build through the end of the year.
โI think the market is primed for a strong final six weeks of 2023 and I would expect it to ride that momentum into the end of the year,โ Michael Arone, chief investment strategist at State Street, said in a phone interview.
Driving factors include an economy that continues to expand, improving earnings, a resilient consumer, moderate inflation and expectations that the Federal Reserve will no longer raise interest rates.
Arone and others acknowledge that the market is technically overbought, which could set the stage for some consolidation in the near term, but the overall situation is encouraging.
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In terms of momentum, the S&P 500 SPX is up more than 18% so far this year. In years where the large-cap benchmark has gained at least 15% through November, the benchmark rose 76.7% of the time in December, with an average gain of 2%, according to Ned Davis Research.
Needless to say, the 2023 rally has some peculiar aspects. First and foremost, it has been a story of very narrow leadership, with mega-cap tech stocks (the so-called Magnificent Seven and a few others) accounting for much of the gains, leaving other stocks in the dust.
Of the 500 stocks in the S&P 500, only 272 rose in the year through Friday's close, according to Dow Jones Market Data.
Market breadth is the lowest in a year that has seen a gain of more than 15%, while the dominance of US stocks in global indices has hit new highs, said a team of analysts led by Manish Kabra of Sociรฉtรฉ Gรฉnรฉrale, in a note last week.
US stocks are now "overly reliant" on large-cap technology, with the sector's top 10 stocks now accounting for 35% of the S&P 500's market capitalization, they said.
Even there, investors find some reasons to be optimistic about the end of the year. The year's top stocks appear to benefit from the year-end showcase by active fund managers who want to show off companies like Nvidia Corp. (NVDA) and other heavyweights in their portfolio.
That said, it's difficult to make a compelling case for investors to chase large-cap winners at their current lofty valuations, Patrick McDonough, portfolio manager at PGIM Quantitative Solutions, said in a phone interview.
Instead, he is encouraged by November's rally that shows signs of life for parts of the market that lagged behind.
The iShares MSCI EAFE ETF EFA, which tracks a range of companies in Europe, Australia, Asia and the Far East, rose 8.4% in November, almost keeping pace with the S&P 500's 8.7% gain, while the iShares MSCI Emerging Market ETF EEM is up 1.7%.
And small caps, which have greatly underperformed in 2023, have shown signs of life. The Russell 2000 RUT benchmark keeps pace with the S&P 500 in November.
That indicates investors are being a bit opportunistic, McDonough said. "It gives me some significant optimism that the overall stock market is not about to crash," he said.
Stocks ended a holiday-shortened session and week with gains on Friday. The S&P 500 finished just 0.7% below its 2023 closing high of 4,588.96 set on July 31 and less than 5% from its all-time high of 4,796.56 set on January 2, 2022. The Dow Jones Industrial Average DJIA rose 1.3% last week. , while the Nasdaq Composite COMP recorded a gain of 0.9%.
Stocks had stumbled toward the end of the summer and fall as Treasury yields rose, pushing the rate on the 10-year Treasury bond BX:TMUBMUSD10Y briefly above 5% last month for the first time since 2007. Since So, yields have fallen, and 10-year bonds have an interest rate below 5%. Investors largely believe the Federal Reserve is done raising rates and has begun pricing in a series of rate cuts starting next spring.
That change has helped push the stock higher. Anything that causes those expectations to crumble could derail the market. The more likely danger is that investors will begin to fear that the so-called soft landing, in which inflation continues to moderate and the labor market cools but does not fall off a cliff, will not materialize and instead prepare for a sharp downturn. deceleration.
But with economic data proving resilient, that kind of change seems unlikely between now and the end of the year, Arone said. He noted that the Atlanta Fed's GDPNow model still points to 2.1% annualized economic growth in the fourth quarter.
Arone argued that the path to stock market gains will become more difficult once the calendar changes. While the Federal Reserve may have finished raising rates, the economy likely has not yet felt the famous lagged effects of the previous tightening. The boost from fiscal stimulus will also fade.
Meanwhile, the market's reaction to better-than-expected results in the just-concluded third-quarter earnings season indicates investors are raising the bar.
Companies that beat their earnings and revenue saw, on average, an increase of around 2.5% in the following days. This time, there was an increase of between 1.2% and 1.3%, Arone noted. And companies that fell short on revenue and results fell by about 7% or more, compared with a typical decline of about 3.5%.
That indicates that expectations have changed, as investors ignore results that exceed expectations and punish more harshly those that fall short. With analysts expecting S&P 500 earnings in 2024 to grow around 12%, according to FactSet, the bar may be set high to satisfy investors.
Read: RBC and BofA predict the S&P 500 will head to 5,000 in 2024, but here are 10 reasons why investors should continue to tread carefully
-William Watts
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11-26-23 1201ET
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