It was mid-October 2022 when the stock market bottomed out following the tech recession. The stock market rallied +28% to the end of July 2023 before falling -10.14% to the end of October 2023. Since then, we have seen the market rally about +7.23% in 10 trading days.
For months now I have heard many market commentators and observers caution investors about the stock market. Their primary concern has been the US earnings seasons and the imminent earnings recessions. Didn't we already have that in 2022/2023? And didn't the stock market already price in the decline in profits during 2022? See chart below.
This is called recency bias - the tendency to overemphasize the importance of recent experience or the latest information in estimating future events. It causes people to rely on recent events, such as a steep drop in the stock market, and extrapolate these into the future.
Let me tell you how that's played out most recently. The earnings cycle continues to improve. With 406 of 500 companies reporting for Q3, 82% beat estimates by an average of +7.61%. That’s a typical pattern but supports the notion that earnings bottomed in Q2. Forward estimates continue to grow and are now up 5% year-over-year. Next time you hear someone talking about an earnings recession, just show them this chart
Although the RBA raised rates last week (IMO unnecessarily as I wrote here), the US Fed has kept rates unchanged for 4 months now (after over 500bps of hikes across 17 months), and with payrolls softening and inflation pressures waning, I think it’s safe to call it a pause. Here’s how the market has typically traded around Fed Pauses (and into rate cuts). The key questions is whether a recessions materialises in the next 6 months. If the answer is yes, the average decline in stocks is -14%. If however, the answer is no, we see an average rise of +22%. Historically we have seen +30% to -30% and everything in between.
Listen, the Fed has raised the federal funds rate aggressively by 525bps since March 2022 with the aim of tightening financial conditions to slow the economy and to raise the unemployment rate with the ultimate aim of bringing down price and wage inflation. Since then we have seen real GDP +4.9%, business output up, unemployment is stable, yet consumer and wage inflation has fallen from their 2022 peaks.
I'm not saying the economy is perfect. It's far from it. Trouble continues to brew in various parts of the economy. We are seeing a rise in newly delinquent loans. Retailers are expecting a slower season in holiday spending. Cost of capital is still rising from for small businesses. Bankruptcies are rising. Coverage ratios are declining for Investment Grade and High Yield. Having said all of this, the stock market seems to be holdings up just fine.
As hard as it is to believe, the year is coming to an end. With everything I've just point out above, the stock market is still sitting on a double-digit percentage gain for the calendar year. Interestingly, in all the years the stock market was up 10-20% YTD at this point of the year, no year ended the year up less than 10% - something to be positive about.
We are also now one year out from the 2024 US Presidential Election. Below is an updated look at the S&P’s four-year Presidential Election Cycle composite chart. The current Biden cycle has thus far played our very similar to the average path, with a strong year 1, a bad year 2, and a strong year 3. As you can see in the chart, year 4 isn’t quite as strong as year 3, but it has historically been a solid year as well. If history is anything to go by, investors might be in for a little surprise.
I'll wrap up on this final note. Given the above, I suggest investors continue to remain diversified. Diversified through equities - with a lower expectation for future returns. Diversified in fixed income, as no one knows where rates are going to go (although there seem to be a lot of experts on LinkedIn who seem to know where yields are going). Cash isn't a bad place to be any more for short-term money - no more TINA (There Is No Alternative). And if you have access, careful consideration to private markets - an ever-growing asset class.