The U.S. stock market had an exceptional week, marking the best performance of 2023 as Treasury yields took a tumble, sparking hopes for an early “Santa rally” to close the year. However, while many investors are optimistic, some remain skeptical about the sustainability of this rebound.
Jason Hsu, Chief Investment Officer at Rayliant, expressed his reservations about the recent stock market surge, stating, “I don’t believe in this rebound, and I don’t think we’ll see a year-end rally.”
A Full-Blown Economic Slowdown
The doubters’ concerns stem from early signs of a cooling labor market, which currently reinforces the market’s expectation that the Federal Reserve has finished raising interest rates. They worry that this trend may evolve into a full-blown economic slowdown, negatively affecting consumer spending and corporate earnings in the coming quarters.
On the flip side, the optimists argue that consumers are holding up well, supported by robust third-quarter gross domestic product (GDP) growth that defied economists’ predictions of a recession. Consumer spending has remained strong, rising by 4% from July to September.
Concerned about Consumer Credit
However, bearish investors are concerned about consumer credit. Data indicates that consumers, previously buoyed by pandemic stimulus payments, have become increasingly reliant on credit cards to fuel their spending. While revolving credit as a percentage of personal spending remains below pre-COVID levels, the trend is concerning. Michael Reid, U.S. economist at RBC Capital Markets, noted that personal interest payments as a percentage of disposable income reached 2.7% in September and will continue to rise as federal student loan payments resume. As monthly interest payments increase, consumers may need to dip further into their savings to sustain current spending levels.
Economists are closely watching the Federal Reserve’s November 7 consumer credit report for September to gauge the situation.
Low Earnings-Per-Share Estimates
While the bulk of the third-quarter earnings reporting season is over, downbeat investors are focused on the weak guidance regarding a potentially slower economy. In October, analysts significantly lowered earnings-per-share estimates for the fourth quarter, with the decline being more pronounced than usual, according to John Butters, senior earnings analyst at FactSet. Butters highlighted that bottom-up fourth-quarter earnings-per-share estimates fell by 3.9% between September 30 and October 31, a more aggressive reduction than historical averages. This suggests that a challenging economic environment may be in store in the coming quarters, which could disappoint investors.
So, what led to the recent stellar performance of stocks? A significant factor was the sharp decline in long-term Treasury yields, which provided equities with room to recover. The 10-year Treasury yield, after briefly exceeding 5% last week for the first time since 2007, dropped 28.9 basis points during the week, marking its most substantial weekly decline since March 17.
Bond bulls found several positive catalysts during the week. The U.S. Treasury announced plans for less debt issuance on the long end of the yield curve than initially anticipated, and jobs data, particularly the Friday jobs report, showed early signs of a cooling jobs market.
Interest rates are squarely causing the stock market to go down, says Cerity’s Jim Lebenthal
The Pivotal Moment
The pivotal moment occurred when the Federal Reserve, as expected, left interest rates unchanged during a meeting in early November. While Fed Chair Jerome Powell hinted at the possibility of another rate hike, he didn’t commit to it, leading investors to conclude that the Fed might be done raising rates. Some investors believe this assumption may be premature, considering potential future developments.
This backdrop allowed stocks to stage a remarkable rebound just a week after both the S&P 500 and Nasdaq Composite had experienced corrections, with declines of 10% from their 2023 highs. The Dow Jones Industrial Average surged by 5.1% last week, the S&P 500 rose by 5.5%, and the Nasdaq advanced by 6.6%, marking their most significant weekly gains since November 2022.
With November and December historically being the best two-month period for stocks, many now see a clear path for a year-end rally. Optimism is fueled by the resilient macroeconomic backdrop, strong seasonality, and improved valuations.
While technical analysts view the recent stock market bounce as a positive development, there’s still work to be done to dispel the uncertainty. For a genuine reversal of the emerging downtrend, the S&P 500 needs to close above 4,400. Stock market breadth remains underwhelming, with less than half of the stocks in the S&P 500 trading above their 200-day moving average.
As the stock market continues to grapple with conflicting signals and uncertainties, investors are advised to exercise caution and closely monitor economic developments and central bank policies to make informed decisions in this dynamic environment.
