The stock market seems to have a case of the summer doldrums.
The S&P 500 fell 2.0% during September. As of Monday, it was down 1.9% so far in October, and up only 4.0% ytd (Fig. 1 and Fig. 2). This listless performance may be frustrating, but it beats having a stock market meltdown, which for some reason tends to happen more often and be more vicious in the fall.
The actual monthly averages since 1928 show that the S&P 500 has been down more often in September (50 times out of 89 years) than any other month, with an average decline of 4.6% during the down years and the worst net decline of 1.1% for all months over the entire period (Fig. 3). On the downside, October hasn’t been down as often as September (36 times so far out of 88 years), but the average of the down years was -4.7%, the worst of any month. However, October’s net change was +0.5%.
October isn’t over, and there are lots of clowns scaring people around the country as Halloween approaches. However, odds are that the stock market will remain listless until we see which of the two clowns running for president wins. Both HRC and DJT have the highest unpopularity ratings of any candidates for the White House before. So the winner will be the one who scares the fewest voters.
Investors seem to prefer HRC. But her economic program includes higher taxes and more regulations. DJT’s program includes significant tax cuts and fewer regulations, but his anti-trade measures could be troublesome.
Both are extremely flawed characters, to say the least. So maybe neither one of them would be good for the economy and stocks.
Nevertheless, despite the fact that economic growth has been weak during the current expansion under the Obama administration — with more regulations and executive orders, higher taxes, and Obamacare weighing on the economy — the S&P 500 is up 214.3% since its March 9, 2009 low, and only 2.9% below its high on August 15 (Fig. 4). The ultra-easy monetary policies of the Fed and the other major central bankers clearly account for the great bull market in stocks.
Joe and I are seeing more articles in the financial press speculating about either a meltdown or a melt-up in the stock market after the November 8 elections. We are more inclined toward the latter scenario, though a continuation of listlessness makes more sense.
We are still aiming for 2300-2400 for the S&P 500 next year, but there could be a prolonged period of wait-and-see after the elections.
Let’s make a list explaining the market’s listlessness:
(1) The Fed. The stock market was listless during the spring and early summer. Then there was a big two-day plunge during June 26 and 27 after the Brexit vote. It was followed by a big rebound. The S&P 500 broke out to a new record high on July 11 and peaked at an all-time new high of 2190.15 on August 15. Apparently, investors correctly anticipated that the FOMC might pass on a rate hike at the September 20-21 meeting of the committee. Now the widespread view is that the FOMC will pass again at the November 1-2 meeting, but finally pull the trigger at the December 13-14 meeting. The spread between the 12-month and nearby federal funds rate futures prices is 27.5bps currently (Fig. 5).
Increasingly weighing on the stock market has been the backup in the 10-year Treasury bond yield from the year’s low of 1.37% on July 8 to 1.75% now (Fig. 6). As a result, the S&P 500 Utilities stock price index is down 9.4% since July 6. On the other hand, the S&P 500 Energy stock price index is up 0.8% over the same period. The market might remain listless until the Fed hikes at the end of the year. That might be followed by a Santa Claus rally celebrating the Fed’s one-and-done-per-year approach to normalizing monetary policy.
(2) Economic fundamentals. The US economy is likely to continue muddling along between a boom and a bust for the foreseeable future. The overseas economy is likely to do the same, though at a slower pace that may be better described as “secular stagnation.” The YRI Weekly Leading Index has been highly correlated with the S&P 500 since 2000 (Fig. 7). The index rose to a record high during the first week of October, led by its Boom-Bust component, which is the ratio of the CRB raw industrials spot price index to initial unemployment claims (Fig. 8). So our index supports a melt-up rather than a meltdown scenario.
(3) Earnings. Joe and I believe that the earnings recession is over. S&P 500 operating earnings per share have declined on a y/y basis for the past four quarters through Q2-2016. Industry analysts are currently estimating that it fell 0.9% during Q3 (Fig. 9). However, Joe and I expect the typical earnings season’s upside “hook” as companies report actual results. So a positive earnings comparison is likely for the latest quarter. S&P 500 forward revenues and earnings are both in record territory.
(4) Valuation. As we discussed last week, there are no bargains in the stock market. Valuations are high. By definition, in a melt-up they certainly would go higher, but that would make the market vulnerable to a meltdown. Our bullish outlook for the market is based on our view that single-digit earnings growth will do most of the heavy lifting.
(5) Sentiment. The Bull/Bear Ratio, compiled by Investors Intelligence, tends to be a good bullish contrarian indicator when it is at 1.00 or lower and bearish when it is 3.00 or higher. Its latest reading, as of October 11, was 2.00, indicating that sentiment is neither bullish nor bearish from a contrarian perspective. The ratio had jumped from this year’s low of 0.63 during the week of February 9 to the year’s high of 2.81 during the weeks of August 16 and 23 (Fig. 10).
(6) Breadth. At the end of last year, the stock market’s breadth, on the basis of the ratio of the equal-weighted to market-cap-weighted S&P 500 indexes, narrowed considerably (Fig. 11). But just as this relative weakness was becoming a concern among technicians, the ratio rebounded 4.4% from 1.505 on January 19 to 1.571 through April 27. Since then, as the election approaches and the prospect of a Fed rate hike is nearing, the ratio has fallen 1.1% through October 17. Nevertheless, the ratio remains near its record-high of 1.597 during April 2015. Further, while only 28% of S&P 500 companies remain above their 50-day moving average (dma) as of October 14, nearly 60% remain above their 200-dma. (See our Breadth.)
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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