Hello Gaugers.  Hope that you have had a good week and are dealing with many of the ongoing distractions plaguing us all.

Freepik

I was on a long flight at the beginning of this week.  We hit a couple of rough patches of turbulence.  The pilot said that we faced some stiff headwinds as we were going east to west against a strong jet stream.  Reminded me a lot of the economic scenario right now and the accompanying market actions we have experienced since early September.

While this is typical seasonal action, it has also been mired with turbulent economic inputs, higher interest rates and enhanced geopolitical risks.

As you will soon review in the Big View offered below, RISK OFF was the theme of this past week.  However, underlying technical conditions may have held up enough to launch us into the positive seasonal effect that typically occur from late October until year-end.  But we certainly are not there yet.  The technical indicators are improving, ever so slightly.

So where is the turbulence coming from?

We could probably confine it to just a few major headwinds, which describe briefly below:

1. Geopolitical Risk. Several incursions overseas have pulled US attention and peripheral actions.  Whether it is the Mideast, Ukraine or Asia, the question remains on whether the US will find itself more engaged.  The market typically doesn’t like this type of uncertainty.  Interestingly the markets have held up well in past geopolitical uncertainty.  Also, the market is in the early stages of a new bull market that began 12 months ago.  All while the situation in the Ukraine had deteriorated.

2. A tick up in Inflation. We have now had 3 months of rising inflation numbers.  The September PPI and then CPI numbers were released this past week, and surprised with rising monthly numbers. Annualized rates of inflation on the CPI (3.8% yoy) have now increased since July.  This, after the big cooling off period that began in mid-2022.   More concerning perhaps is the forward expectations for inflation.  "1-year inflation expectations also jumped to 3.8%, the highest level since May. Five to 10-year expectations moved back up to 3%." See chart below:

3. Interest rates continue to stay high. With some of the recent geopolitical stress and indicators showing economic weakness, many believe the Fed is done hiking rates.  However, there is no doubt that interest rates will stay higher for longer.  Also, the futures markets that predict forward interest rates are not factoring in any type of interest rate cut until the second half of 2024.
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4. Credit has grown tight and corporate bankruptcies have spiked. There is no doubt we are in a credit crunch and most consumers are being hurt by higher interest rates.  Mortgage rates hit 8% this past week and indications are that mortgage applications have come to a screeching halt. Also, home foreclosures have been surging.  They are at their highest level since the start of the Pandemic.

There have also been 516 corporate bankruptcies already this year which has surpassed 2021 and 2022.   See chart below:

5. Poor Treasury Auctions hurt bond performance which affected stock prices (Thursday and Friday). The 30-year Treasury auction went off poorly.  The spike in rates (part of the auction process) immediately prompted a sell-off in stocks.
    
6. Significant reduction in consumer sentiment readings. "The headline consumer sentiment gauge plunged to 63.0 (67.1 exp) from 68.1, led by a big drop in expectations (from 66.0 to 60.7)." This will certainly affect retail sales and consumer discretionary purchases soon.  See chart below:

These factors and others are pushing volatility higher.  Also, remember October can be a mixed bag.  We started the new bull market 12 months ago and new bull markets are never without some uncertainty as well as enhanced volatility.

Sideways markets.

I reflect back to the many times that our own Mish Schneider went on multiple media appearances during late 2021 and 2022 and was unequivocal in her perspective that inflation was “sticky” and would stay higher longer.  Given her long experience dealing with economic cycles and living through the 70’s as a floor trader, Mish always has a prescient and accurate forecast.  During 2022 when she commented publicly that we would see enhanced volatility and that the markets would likely stay rangebound.

To illustrate the sideways market movement referenced above, we offer the following 3 charts showing the S&P 500 (SPX), the Dow and the small cap Russell 2000 index below.  (Notice the long-term moving average similarity to Mish’s 23-month business cycle):

And here is the Dow Jones Industrial Average (DIA) after a similar number of months:

And here is the Russell 2000 small-cap index (IWM) over the last few years:

Earnings Are The Key.

Numerous times over the past two years we have commented that the engine that powers the movement of the markets is earnings.  As long as earnings are continuing to grow and companies exceed their expectations, then analysts will factor in important growth measures into the market and increase the valuation expectations for stock prices.  This will help the market sentiment.

Of course, much of the recent noise of the markets is due to interest rates which make the same analysts “reprice” their earnings expectations based on such factors as consumer sentiment (see above chart), discretionary spending, labor costs, economic momentum, operating margins and company free cash flow to name just a few of the important factors that they look at.

Earnings Season just began.

It is early in earnings season but so far a small number of companies have reported earnings.  According to FactSet, 6% of S&P500 companies have reported their Q3 2023 results with 84% beating their earnings estimates and 66% reporting revenues above estimates.  On Friday several of the Big Banks reported a significant earnings beat which given higher interest rates and less commercial loans being issued, was a GOOD sign.

Here are a few charts that indicate earnings (and earnings surprises) may be favorable over the next 1-3 years.   Please note that the stock market is forward looking and will begin to price in these earnings expectations and surprises and much of this could begin over the next 1-5 months. This would coincide with a favorable seasonal period to be a stock investor.

Also, remember that areas of strength tend to be sectors that are being revised positive.  The below chart shows a few good sectors (likely areas like technology) while sub-par earnings in others.  It will be the small changes to the sub-par areas that investors will look to participate in.  During 2022 several of the MarketGauge strategies did well that had been out of favor the prior few years.  Energy, home builders and utilities to name a few.  See earnings revisions chart below:

Huge amount of assets are sitting in cash.

Another reason for our optimism (beyond seasonality factors) is that there is an abundance of cash sitting on the sidelines waiting to reenter the market.  According to the chart below there is approximately $6 trillion sitting in money market funds.

Often these investors may be “later to the game” as they sit it out until they are “sure” that the markets are on the right path upward.

If the market begins to turn up, watch for significant inflows to come in and likely move to the largest and most financially solid companies in the market.  This will fuel the large cap weighted market indices fastest. See chart on money market assets below:

Investment Advisors have become slightly more positive.

The NAAIM (National Association of Active Investment Managers) to which we are aligned with has become slightly more positive recently.  If the market begins to move up, there are assets guided by these managers that will also likely help fuel a more positive market.  See chart below:

Active managers increased exposure over the past week. NAAIM Exposure Index up to 45.8 from 36.2.

Our risk gauges are still positively biased:

Other positive signs of that the market may be bottoming out and ready to turn up:

I now turn it over to the all-important BIG VIEW summary points which amplify many of the above charts and include more detailed information about the technical aspects surrounding the stock and interest rate markets.

Have a good, prosperous week.  Thanks for reading!

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