We are rounding the corner into Halloween and closing in on the Presidential election. With so many different frictional issues both domestically and internationally, it seems almost uncanny that the US equity markets have been on a tear to the upside. Through the end of last week, they have been up for six weeks straight! Barron's this past weekend, in their Up & Down Wall Street column was titled, " Hot, Hot, Hot: The Everything Rally Is A Little Too Sizzling." I read this, and I can see why he says this, but I don't believe it to be the case. It seems to me that there simply are not enough people paying attention to the reaction of the currency market, the longer-term interest rate market, the precious metals market, and most recently how the third quarter earnings are coming out.
For several weeks, I have been putting in the chart of the amount of money sitting in Money Market accounts. For many money market investors, they are happy with earning around 5% on their liquid funds with no risk. But eventually this money needs a stickier place to be, and of all options available, the large-cap, growth market continues to show the greatest relative outperformance. Since earnings have begun being released, over 79% of companies that have reported have beaten the estimates and done so by an average of 6.1%. This is actually an acceleration from the last quarter when many were expecting that Q3 would be less robust.
The larger backdrop for earnings remains positive. We are still early in the 3Q24 earnings season, and it has been very good, in our view. The standout is that revenue growth is tracking +5%, consistent with 4% to 6% growth for each of the past 5 quarters. This is notable because “core inflation” has fallen like a rock from 7% in 3Q22 to 3% 3Q24. The fact that revenue growth has held steady despite this decline means that “real” revenue growth – S&P 500 revenues less core CPI – is accelerating. To me, this constitutes a positive surprise. See the progression below:
It should then be no surprise that even though China is in an aggressive slow down, and developed Europe is showing little sign of growth, that the US market is far from a "landing" in its economy. The proof of this is twofold. First, three weeks ago the 10-year US Treasury yield was 3.6% and this week it has ticked over 4.2%. This is a 17% increase in the rate in a little less than a month. There is very little reason for these rates to go up for any other reason than economic growth expectations. It is as though cutting rates by 1/2% instead of 1/4% seems to have almost reignited the inflation mantra. So as a result, the US Dollar has continued to strengthen at the same time. The world recognizes this and finds our Treasury rates and currency security quite attractive as well. Last week's Treasury note auction attracted $511 Billion of foreign buying, equal to 32% of the net issuance, according to data released last Thursday.
But the real story is the continued ascent of the US equity markets since late 2022. The bull cycle that started on October 13, 2022 (SPX=3,491) reached its two-year anniversary last week. The S&P 500 is up 63% on a closing basis (+68% intra-day) over this period, on par with historical returns through the first two years of a bull cycle. It’s not surprising that year-3 returns have been dependent on the continuation, or end, of the cycle. Bull cycles that lasted more than three years averaged a 13% return in year-3, and only half of the six cycles that topped in year-3 posted a gain. Overall, the bull cycle is not yet on borrowed time, but signs of weakness should be treated with increasing prudence over next 12-plus months. To give some perspective on how this 2-year run has done relative to past uptrends, this is a chart of exactly where this one lies:
Global breadth is currently confirming our bull market. I bring this up as divergences tend to lead market peaks. A divergence occurs when other markets peak out and begin trending lower. This often happens prior to a rollover in our markets. Therefore, worsening global breadth would be a bear market warning- but as yet unseen. We will continue to monitor for continued global participation. According to Mark Newton, Chief Market Technician, FundStrat, November could be quite a difficult month. Based on his cycle work below, the S&P could have a difficult time around now and into the second week of November. This week of the year has historically been the worst week of the year for the markets. It seems to be starting this way, but we will not make drastic changes unless we see breakdowns occurring.
Gold has been quite strong this year. It is also mimicking inflation fears as it has continued to move higher and has topped $2,700 an ounce, a new all-time high. Gold rising has in the past been a sign of a flight to safety during a currency dislocation, but there has clearly been no currency dislocation as far as the US Dollar is concerned. Therefore, I believe this is a further statement about the direction of inflation. I don't say this to mean that we are in a period of runaway inflation, but rather that inflation is not going away, and economic growth, interest rates, and precious metals are attesting to this. The great thing is that the combination of the Fed cutting short-term rates while the economy continues on its no-landing flight is a formula for higher asset prices, and not just equities.
Consumption represents the largest percentage of US GDP, and with oil prices down around $70 a barrel, the percentage of a worker's capital that needs to be spent on transportation has been declining, this provides more funds available for discretionary spending. This was also addressed in Barron's with it being stated that the estimate for holiday sales this year is up as much as 3.5% from last year to $989 Billion. This is far from an economic landing or declining and recessionary spending. The last and most obvious issue is the spike in 10-year interest rates, which although positive from an economic standpoint, can be a negative to equity price advances.
In closing…
For most investors, there might seem to be little reason to look at anything other than the U.S. market. That would be a mistake. Decisive and sustainable trends are global in scope. And that’s the case right now. The vast majority of major & emerging component markets are above their 200-day moving averages, and almost all of the smoothings are rising. But while seasonal and cyclical tendencies support the prospects for continued rallying into year-end, global breadth should not be ignored. Charts show that global participation started to diverge before the 2020 bear market got started. And the divergence was especially pronounced in 2021, ahead of the 2022 bear market. Among the 16 global bull markets since 1970, the median bull has lasted close to two years, a median now surpassed by the current US bull. Global divergences would warn that the bull is at risk. And the more pronounced the diverges, the more significant the warning
However, after 40 years of observing markets, it is my opinion that the market knows something that you, I and the media pundits clearly do not. What it is in each case I cannot be clear until after the facts are known. I can make a guess; however, and these are the facts that I have presented to you above. For now, suffice it to say that the trend is up and those "animal spirits" seem to remain in their place even if they have caused the broad market to get a bit extended, as Randall Forsyth stated in his Up & Down Wall Street column. I keep on presenting statistical data about how late October- into the election could be a difficult time for the markets to stay strong, but as of yet, even this period of unknowns doesn't seem to be shaking the advance.
- Ken South, Newport Beach Financial Advisor
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