- The S&P 500 has traded sideways since November 10.
- Bulls are battling bears for control, and a winner is uncertain, despite seasonal strength.
- The index is at a critical technical juncture, and valuation isn't the tailwind it was a few weeks ago.
Although the stock market rally from October’s low has impressed, it’s important to note that the S&P 500 has made zero progress since its 5.5% spike on November 10th. The commonly viewed benchmark for stock action was trading a shade below 3942 this morning, below its 3956 close on the 10th.
The sideways action isn’t necessarily bad, but it suggests buyers and sellers are battling beneath the surface. Investors with gains since October’s lows and trapped investors who are reducing exposure are selling. Meanwhile, intermediate-and-long-haul investors who missed last month’s lows and overly-bearish short sellers are buying.
Who wins the field is a bit of a toss-up, given competing arguments appear equally valid.
A Stock Market Packed With Mixed Messages
The bullish argument is supported most by the Federal Reserve's potential downshift in tightening because of decelerating inflation. Seasonal probabilities are also bullish. For example, Thanksgiving week tends to be bullish, as does December, because of the Santa Claus rally. Additionally, the six months from November through April are the best-performing stretch of the year, and the pre-Presidential election year (2023) is the strongest performer of the four-year cycle, according to the Stock Trader’s Almanac.
Real Money Pro’s Carley Garner writes:
“The odds are sharply in favor of the bulls on the week of, and the week after, Thanksgiving…I've been following markets for more than I would care to admit, and I've seen the holiday season wreak havoc on unsuspecting bears…Although the rally happens almost every year, it manages to catch people off guard because it is accompanied by bearish headlines and complacency. The seasonal strength often extends into late December.”
Garner’s spot-on in recognizing that seasonal tendencies can catch fundamental investors off guard. In bear markets, there’s plenty of reason to expect poor economic, revenue, and earnings news, thus lowering share prices. It doesn’t take much to spark a rally when everyone is betting on lower prices.
Nevertheless, there are examples of negative returns in seasonally strong periods during bear markets, including lousy performances in the fourth quarters of 2000, 2008, and 2018.
For this reason, Real Money’s James DePorre reminds us to keep seasonality in perspective. He writes:
“It is important to remember that this sort of seasonality is an inclination, not a certainty. This year we are at the jaws of an ugly bear market that will influence these tendencies to some degree…Holiday trading may be a nice distraction this week, but there is a bigger battle out there that is still raging… There are two market adages that are doing battle with each other. One is 'don't fight the trend,' and the other is 'don't fight the Fed.'... The trend is more important in the short term, but the Fed is far more important in the long term. All year we have seen how the Fed can quickly kill a bounce. Just as market participants start to hope that the bear market is over, the Fed reminds them of all the economic problems that are still unresolved, and back down we go.”
DePorre isn’t alone in discounting seasonality this year. Real Money Pro’s Doug Kass puts it bluntly, writing:
“On Thursday, I suggested that it appeared that almost every "talking head" in the business media, when asked about the near-term outlook for equities, reached to the argument of and gives weight to the notion of seasonal market strength…But I really wanted to say that this particular part of the bullish short-term argument for stocks, especially in the face of a turn lower in the profits cycle (Target TGT, Micron MU, etc., and these uncertain and volatile times) is totally B.S…Like other shibboleths (like Sell In May and Go Away) - putting any serious weight on seasonality is nonsensical and non-rigorous…Seasonality is important to know, ridiculous to trade by.”
Certainly, stocks may perform well from here, but it’s more likely that if they do, it will be because more data strengthens the argument that we’re closing in on a Federal Reserve pivot to neutral.
As Action Alerts PLUS co-Portfolio Managers Bob Lang and Chris Versace write, “Does the new order activity support the GDPNow Model? What does the Flash November PMI report indicate about inflation vs. October? The answers to those and other questions will factor into the latest thinking about what the Fed is likely to do in the coming weeks but also the first few months of 2023 [emphasis mine].”
Currently, optimism is high that inflation is cooling because the headline CPI of 7.7% in October was well south of June’s 9.1% level. That’s good news, but the Fed’s preferred inflation gauge is the PCE. It’s the one that could move the needle in their thinking.
The Bureau of Economic Analysis will release October’s PCE on December 1. In September, headline PCE was 6.2%, down from 7% in June. The Cleveland Fed’s Nowcasting model forecasts 6.03% for October. It also expects Core PCE ex-energy and food to be 5.02%. In September, it was 5.1% – a six-month high.
It’s more likely that the market's performance will depend on whether we’re above or below those estimates rather than seasonal tendencies.
The Smart Play
Seasonality is a key component in the seven-factor stock scoring model I’ve been using since 2003. However, we should also recognize that probabilities aren’t guaranteed, especially in bear markets. For this reason, we need to rely on other evidence to add conviction, such as technicals and valuation. Unfortunately, they’re not overly helpful right now, either.
As I previously wrote, long-time chart expert Helene Meisler has noted that the market is making fewer highs than two weeks ago, potentially concerning, and her intermediate-term market oscillator is likely to be overbought this week or next.
Carley Garner writes, “The weekly E-Mini S&P 500 chart defines a bull and bear market by a long-dated trendline that comes in at 4050 to 4080 in the S&P. This week's rally touched it and failed. That is bearish. Obviously, this is at odds with seasonality.”
Valuation helped support the rally last month as lower prices resulted in lower P/E and P/S ratios, but that tailwind is fading.
Real Money Pro’s Guy Ortmann notes, “The forward 12-month consensus earnings estimate from Bloomberg for the S&P 500 is unchanged at $225.16 per share. As such, its forward P/E multiple is...at a premium to the "rule of 20" ballpark fair value of 16.2x.”
Real Money’s Stephen Guilfoyle writes, “According to FactSet, the S&P 500 now trades at 17.2 times forward-looking earnings…This ratio remains significantly below the S&P 500's five-year average of 18.5 times but now enters the new week having caught up to and surpassed its ten-year average of 17.1 times.”
FactSet adds, “It [Forward P/E of 17.2] is also above the forward P/E ratio of 15.2 recorded at the end of the third quarter (September 30), as the price of the index has increased while the forward 12-month EPS estimate has decreased since September 30.”
The takeaway? Stocks aren’t as big of a bargain as they were a few weeks ago, particularly given that recessionary headwinds could mean forward earnings estimates for 2023 keep falling, putting more pressure on the index’s P/E ratio.
So, where does that leave us? If you’re a shorter-term investor, it suggests being quicker than usual to book your gains, and if you’re a swing trader, it means a murky market potentially too risky to buy OR sell.
Doug Kass wrote today in his trading diary, “I am willing to be patient and wait for the right pitch.”
That’s good advice, given lower trading volume during the holiday-shortened week could contribute to volatility that disappoints everybody.