With the holiday season approaching, we are entering the months where the stock market has historically performed the best.  Below is a chart of the S&P 500 Index average returns for each month dating back to 1928.  If you squeeze this timeline down to the last 53 years, November is actually the best month in the S&P 500 since 1970, closely followed by December.

(Source: Yardeni Research)

However, despite this favorable historical context, Wall Street strategists are adopting a more bearish stance. The Bank of America sell-side indicator, which measures the average strategist’s allocation to stocks and compares it against historical recommendations, indicates a growing bearish sentiment. Notably, the data since 1985 highlights a positive correlation between increased bearishness and improved stock performance.

Following three consecutive months of decline in the S&P 500, the sell-side indicator recorded its most significant shift this year, with average strategists recommending a 37 basis points reduction in stocks. Although the current level of pessimism has not yet reached extreme levels, it often acts as a reliable contrarian signal when strategists heavily favor one side of the market.

While higher rates have weighed on equity sentiment, we believe corporations and consumers may hold up better than expected as they have had time to adapt.  Notably, a key factor for this is that over 75% of S&P 500 debt is long term fixed (vs. <50% in 2008). 

Earnings Beat Expectations, Yet the Market Weighs Other Risks

Judging solely by the market’s performance, it would have been challenging to anticipate the robust Q3 earnings. With 49% of S&P 500 companies having disclosed their actual results for Q3 2023, an impressive 78% have reported positive earnings per share (EPS) surprises, and 62% have reported positive revenue surprises.

Despite this favorable earnings scenario, stocks have faced considerable challenges, chiefly stemming from the impact of higher interest rates, recent geopolitical events, and the cautious earnings guidance provided by these reporting companies. Looking ahead to Q4 2023, 28 S&P 500 companies have issued negative EPS guidance, while 14 have offered positive EPS guidance.

In an effort to provide a comprehensive picture, it’s important to consider the valuation aspects within the S&P 500. Notably, the forward 12-month price-to-earnings (P/E) ratio for the S&P 500 currently stands at 17.1, which is below both the 5-year average (18.7) and the 10-year average (17.5).

The Rationale Behind the 2% Inflation Target

In the face of heightened inflation concerns dominating the headlines, the methodology behind the Federal Reserve’s 2% inflation target has sparked intriguing discussions. Primarily, a mild inflation rate serves as a protective measure against deflation. If prices were anticipated to drop, it would hinder consumer spending due to the prospect of purchasing goods at a lower cost in the near future, ultimately impeding economic growth.

Another perspective lies in the correlation between the 2% inflation target and the performance of the stock and bond markets. The chart below illustrates the historical performance of stocks and bonds since 1976 across various inflation rates.

(Source: Capital Group)

Notably, the most optimal stock performance is observed within the 0-3% inflation range, while bonds tend to excel within the 3-4% inflation range. Inflation rates ranging from 0-6% have historically yielded positive returns in both markets, with struggles apparent when the inflation rates escalate beyond the moderate range. Conversely, deflation poses as a significant challenge for stocks due to its detrimental impact on the broader economy.Top of Form

Articles We’re Reading

High rates scaring of both homebuyers and sellers (CNBC)

Global central banks studying how prevent inflation breakouts like that of recent years (Bloomberg)

Saudi defense minister to visit Washington on Monday amid concerns about a wider regional war (Axios)

UAW announces a tentative deal with Stellantis but broadens strike against GM (CNBC)

Market Snapshot

For the Month Ending 10/31/2023 (Cumulative Returns)1   

1Source – Morningstar, Inc. Corporate Bonds is presented as the iShares iBoxx $ Investment Grade Corporate Bond ETF. Municipal Bonds is presented as the iShares National Municipal Bond ETF. High Yield Bonds is presented as the iShares iBoxx $ High Yield Corporate Bond ETF. 10 Year Treasury refers to the  valuation of a 10 Year Treasury Note, a debt obligation issued by the U.S. Department of the Treasury. Fed Funds Target represents upper limit of the federal  funds target range established by the Federal Open Market Committee. Inflation Rate provided for the purposes of this report by the U.S. Bureau of Labor  Statistics. Unemployment Rate calculated by the U.S. Bureau of Labor Statistics. WTI Crude Oil refers to the price of a barrel of West Texas Intermediate NYMEX) Crude Oil. Gold – Spot Price relates to the valuation of an ounce of gold, as traded on the NYSE Arca Exchange. U.S. Dollar refers to the U.S. Dollar  Index (DXY). All Returns are denominated in USD (United States Dollar), unless otherwise explicitly noted.

Did You Know?

Did you know that the concept of investing can be traced back to the 17th century during the Dutch Golden Age? In 1602, the Dutch East India Company became the first company to issue stocks and bonds to the general public, marking the birth of modern stock markets. This groundbreaking innovation allowed individuals to invest in the company’s voyages and share the profits, laying the groundwork for the development of today’s complex financial markets. This historical anecdote highlights the rich heritage of investing and underscores its vital role in the global economy, shaping the way individuals and businesses approach wealth generation and financial planning.

Presented by the Investment Committee of Lake Street, an SEC Registered Investment Adviser

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Diversification does not ensure a profit or guarantee against a loss. There is no assurance that any investment strategy will be successful. Investing involves risk and you may incur a profit or a loss.