“I’ve found you’ve got to look back at the old things and see them in a new light.” ~ John Coltrane

Good evening,

October 2023 was painful, but it ended with markets swinging upwards. We began the week down around 5%, but by October 31, equities investors had received a much-needed Halloween “treat,” as stocks erased more than half of those losses. Still, October ended on Tuesday with the S&P 500 down 2.2%. 

Wednesday was a busy day for macroeconomic data, featuring the FOMC meeting as well as the release of the Treasury’s quarterly refunding plan. The central bank kept the Fed funds rate unchanged, as most predicted, so the post-FOMC market reaction was driven by Fed Chair Jerome Powell’s press conference after the decision was announced. Fundstrat Head of Research Tom Lee felt that Powell “was a lot more dovish than he was in September,” and investors apparently agreed.

To us, much of the November FOMC meeting was a confirmation of our research since the beginning of the year: Powell acknowledged that “inflation has moderated since the middle of last year, and readings over the summer were quite favorable”. He also described the labor market as “continuing to broadly cool off”. At the same time, the FOMC admitted to the possibility of achieving the Fed’s inflation target without also causing a recession.

As implied by Fed funds futures trading, the odds of a December hike plummeted 800 bp in response the day after, and equities surged on Thursday as well. In fact, Thursday was the best day for the S&P 500 since April. 

Lee referred to the week’s action as a “baby rally” on Thursday evening and suggested that we had achieved a “durable bottom” in October. 

Head of Technical Strategy Mark Newton wasn’t quite as certain. Speaking in our weekly research huddle, Newton said that, given the damage that had been done since August, “we need a lot of repair before we can say, ‘Okay, the bull market is back on track’”.

“My S&P cycle work shows that we bottom at the end of November or early December,” he said, “and I think that's going to be the low. I think we've made a low now, but I don't think it's possible to say it's the low, and a lot of work needs to be done”.

That’s not to say Newton was unhappy with the week’s developments. “We had some good news this week, though I’m actually referring more to the trifecta of ADP, manufacturing PMI and [the Treasury Department’s quarterly refunding announcement] all serving as sort of a 1-2-3 punch that caused a big pullback in Treasury yields. Yields pulled back from 5% to under 4.6% on the 10-year, and that’s very significant. And we also saw unit labor costs plunge this week, I think that's important as well”.

Equity markets responded accordingly, but Newton warned that although “this was a welcome sign for the equity market, [...] I do not think this pullback in yields is going to be something that lasts. It's going to be choppy for the next couple of months; rates are likely to hug between 4.50% and 5% during that time. My overall call is that we're going to rally into next week. It might not be a straight shot, but my sense is that we're going to rally into late next week”.

In the meantime, Newton said that sentiment trends favor buying dips. The AAII Investor Sentiment Survey shows bears at 50% and bulls at 24%. That is the biggest bearish percentage of the year, a huge change in the spread between bulls and bears in cent weeks. Clearly, from a contrarian perspective, that favors buying dips. Other sentiment gauges such as the Daily Sentiment Index are also down to levels that historically have coincided with a very meaningful bottom”.

Looking further out

Lee sees potential for this week’s “baby rally” to continue to strengthen over the coming weeks. This is partly due to positive November seasonality and the end of October’s tax-loss harvesting, but, as he put it, “There are also structural reasons to expect stocks to have some positive traction in coming weeks”.

One of the most important is this: the percentage of stocks above their 200-day moving average fell to 23% on October 30 and to 25% on October 31. Looking at data dating back to 1994, these readings fall into the bottom decile. And when looking at bottom-decile readings, the median 6M gain is 9.7%, with an 80% win ratio. This is shown in our Chart of the Week.

Elsewhere 

Global leaders continued to address AI-related risks, with President Biden issuing an executive order requiring major AI developers to develop standards, tools, and tests to help ensure AI systems are safe, secure, and trustworthy; share safety-test results with the government; and work to prevent their systems from being used to perpetrate fraud or create dangerous biological materials. Meanwhile, UK Prime Minister Rishi Sunak hosted a G-7 AI summit after which member states agreed to jointly test major AI models before they can be released to the public. 

President Biden and China’s Xi Jinping have agreed to a face-to-face meeting in San Francisco, sometime during the Asia-Pacific Economic Cooperation (APEC) summit, which runs November 12-18. 

The Panama Canal Authority again reduced the number of ships allowed to pass through the key shipping lane each day, citing the worst drought since 1950. As a result of the drought, the levels in the reservoir that provides the water used in the canal’s lock system have declined to “unprecedented” lows. Under normal circumstances, 35 or more ships can pass through the canal each day. This number was cut to 25 per day beginning Friday, and will be further reduced to 18 per day in February 2024.

A Hong Kong judge warned Evergrande that it would be wound up if the Chinese real-estate giant does not reach a deal to restructure its obligations to creditors by December 4. Evergrande, with $325B in reported liabilities, defaulted on its debts in 2021 and has yet to reach a repayment plan. The company’s founder is under de-facto house detention in China and suspected of criminal misconduct. 

The Bank of England once again left rates unchanged at 5.25%, following the Federal Reserve’s lead from a day earlier. BoE Governor Andrew Bailey said that, although he expects inflation to fall sharply in the coming months, it was “much too early” to consider cutting rates. Bailey also warned that the UK economic growth rate was likely to hover around zero until 2025.

Germany reported its economy slipped 0.1% in the third quarter, following an expansion of 0.1% in Q2. The decline was largely attributed to a slump in consumer spending.

China’s manufacturing PMI contracted in October to 49.5, missing expectations that the number would remain flat at the same 50.2 reading from September.