We hope you have weathered the volatile and negative stock (and bond) markets. We have described the negative cycle trends that can and do often take place in September-October. 2023 has certainly been amplified.

As all of us are traveling to The Money Show in Orlando, this will be a shortened outlook for this week. We hope that maybe you will be attending The Money Show this weekend through Tuesday, and we may even get a chance to visit. If you are at the show, please track us down. Mish is also speaking at several panels, workshops, and presentations.

As scary as Halloween can be, there is a lot going on around the world that may be scarier, including the economic uncertainty that plagues the United States at this time. October has exceeded the scary expectations many pundits had about the potential downdraft of this historically weak and negative season.

So far in October, the major indices are down more than 3% month-to-date, with the Dow Jones down the least (-3.2%), and the Nasdaq 100 (-3.6%) heavily influenced by the mega-cap technology stocks (otherwise referred to as the Magnificent 7), who so far have reported better-than-expected earnings, except Tesla and Alphabet, which had mixed results.

The S&P is down 3.9%, influenced by the 35% cap weighting of those same seven stocks. The Russell 2000, the small-cap index (IWM), is down over 8%, heavily influenced by the effect rising interest rates will likely have on these businesses, which are more dependent on financing and are more heavily leveraged than the mega-caps.

Interest Rates' Most Dramatic Effect is on Smaller Companies

Last week we went into detail about the rise in interest rates and its potential effect on Price-Earnings ratios of the market and, more specifically, how analysts have to readjust their earnings expectations on companies, including cost of financing debt, inventory, and reducing the leverage on their balance sheet as a result of higher interest rates.

During much of 2022, and now since July 2023, the negative pressure on the stock markets has been the rapid rise of interest rates (earlier this week the 10-year touched 5.0%) and the strong dollar as investors around the world chase the high interest rate returns of money market funds and short duration bonds.

It should be noted that money market funds with assets well over $6 trillion continue to see huge inflows. See the 10-year rate rise as well as the US dollar (UUP) increase in the graph below:

There is a very distinct and clear (negative) correlation between a strong and rising US dollar and the sell-off in the stock market. See chart below:

Nowhere has this been felt more dramatically than small-cap stocks, which are underwater year-to-date by 7% or more. The IWM small-cap index is down 6.9% year-to-date. Let’s take a look at a few Russell 2000 small-cap stock graphs:

So far, over the past five years, small-cap stocks have produced an alarming 0 return. See graph below:

Large-Cap vs. Small-Cap Stocks 

As noted above, there is a wide divergence between large-cap and small-cap stocks. In her brilliant assessment of the inner workings of the markets, Mish often points out that without participation of the Russell 2000, it is hard for the markets to stay positive. This could not be clearer than what can be seen in the recent collapse of small-cap stocks and their large-cap counterparts. This is one of the biggest divergences in a few years. See the charts below:

Tech Stocks Have Held Up Better Than the Rest of the Market 

Of course, the Nasdaq 100 lost more than any other part of the market last year (2022), so it would likely seem probable that it would snap back the most. Early 2023 gains were also amplified when the excitement of AI came out.

Many of the magnificent 7 are those companies that are already using AI in their businesses, and prospects for future growth remain elevated. Nonetheless, the Nasdaq 100 has gotten hit pretty hard lately. Right now, very few stocks are above their 100-day moving averages. See graph below:

A Look at The S&P 500 Index

The cap-weighted index made up of the largest 500 stocks has been falling since the last high on July 31. It has now fallen 10.3%, and is now officially in correction mode. The small-cap IWM is now down 18.3% and appears close to signaling a bear market. To look at the drawdowns that have taken place in the S&P 500 so far this year, take a look at the following graph:

What is perhaps even more interesting is the disparity between the equal-weighted S&P 500 index and the effect of the Magnificent 7 Cap Weighted S&P 500 index below:

Another important aspect is the role that transportation stocks play in either confirming or denying the broad market’s health. This would include trucking, automobile, airlines, and other transportation-related companies.

Again, one of the oldest indicators used on Wall Street is the Dow Jones Theory, which says that transportation stocks have to confirm the Dow’s movement by closing at or near a high. The current health of the transportation sector is in question. See chart below:

Additionally, Mish often discusses the important 23-month business cycle moving average and the market.

For illustration purposes, I have provided two charts. The first is a monthly chart of the S&P 500, with the blue line the moving average of the 23-month business cycle. It is uncanny that we stopped right on it on Friday. The other chart displays the three-year moving average. Both tell the story that an imminent slowdown is forthcoming, likely accelerated by rising interest rates (even with a good positive GDP number for September). See charts below:

Some analysts view this correction as a positive sign of the bull market that started in October 2022. See graph below:

Will We Get the November Turn?

There is significant information to show that this October weakness historically comes to a halt, and early November will likely get the turn. We have no idea if this will in fact occur. But many of our favorite research firms, including our friend Jeff Hirsch at Traders Almanac and Ryan Detrick of the Carson Group, would like us to think so.

We offer the following charts to support the prospect that we may be getting ready for the best six months for stock market investing:

We hope that you have enjoyed reading this week’s outlook. Stay patient and vigilant for any true sign of a possible turn in the market. Happy Halloween.

Now, here are some further market factors to briefly mention.

Risk-On

• There weren't any significant risk-on conditions this week.

Risk-Off

• All major US indices made new multi-month lows this week. All 4 indices are also oversold on both price and momentum, and they may be subject for mean reversion next week.
• All 4 key indices have experienced worsening volume, with the Russell 2000 being the only index with any accumulation days seen over the past two weeks.
• Every major market sector was down this week, with the exception of utilities (XLU), which is a clear risk-off indication.
• Risk gauges have fallen from a weak neutral reading to a risk-off reading.
• Volatility continues to make new highs for the first time since August.
• Semiconductors (SMH) are holding up the best, while biotech (IBB), transportation (IYT), and the Russell 2000 all fell off a cliff this week.
• Soft commodities (DBA) put in a new October high and continued to significantly outperform relative to equities.
• There’s been a big surge for gold (GLD), as it has been following along with other commodities as a geopolitical hedge.

Neutral

• Despite the negative price action in the S&P 500 (SPY) and the Nasdaq Composite, the McClellan Oscillator remained relatively unbothered for both, indicating decent market internals.
• Although both value (VTV) and growth (VUG) continued to make new multi-month lows, growth is still holding on to its 200-day moving average as support on a closing basis.
• Foreign equities (EEM and EFA) are now outperforming the US on a relative basis in both the short- and long-term.

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