Wed, October 2, 2024 | 7:45AM ET

October off to "iffy" start and headwinds emerge, but structural tailwinds stronger. We ultimately expect investors to "buy the dip" but watch the VIX term structure.

Name: FS Insight
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Tom Lee, CFA ^AC

Head of Research

October off to iffy start and headwinds emerge, but structural tailwinds stronger. We ultimately expect investors to buy the dip but watch the VIX term structure.

VIDEO: Already headwinds are emerging for October, but we believe the existing tailwinds are stronger and ultimately investors will buy this dip.

Please click below to view our Macro Minute (duration: 4:15).

Equities sold off sharply on the first day of October with S&P 500 down -1% and Nasdaq 100 and Russell 2000 down ~1.5%. For 2024, this seems to be a pattern as 6 of the 10 months so far started with a decline in the first day. We are still in the midst of the “challenging 8 weeks into election day” with 34 days left and we ultimately expect this “dip” to be bought.

To us, there are 3 “headwinds” to emerge at the start of this month but we expect investors to ultimately “buy this dip”:
– the East and Gulf Coast strike by ILA longshoremen.
– Iran launches a ballistic missile strike against Israel, a potential escalation
– Oct has “iffy” seasonality
Regarding the East and Gulf coast strike. While this has potential to be disruptive and extended, we don’t think this is fundamentally changing the outlook for the US economy nor stocks. Of course, in the near-term, the supply chain is disrupted. But we think too many “inflation-istas” will view this as triggering a renewed inflation wave. We view this as an over-reaction.
In fact, US 10-year yields barely reacted, meaning bonds don’t see deep damage yet. Yields have been falling for 3 days now, so instead of being inflationary, this risk is seen as potentially slowing the economy. This would make the Fed even more dovish so it is not necessarily negative for stocks.
Iran used ballistic missiles against Israel, which is an escalation in the Middle East conflict. The path of this conflict is unpredictable, but Iran has a history of taking measured steps in retaliation and this could be one of those instances.
Israel has stated they view the Iran attack as a declaration of war. So, we should be watching for the next steps that Israel would take. This could include economic targets (oil infrastructure), nuclear facilities or even the leadership. We have no insights.
If markets saw the chance for a major escalation, oil prices should be making sizable moves. Oil prices , of course, investors are nervous. WTI crude rose ~3% to $71. To me, this is a very modest move. And potentially signaling markets do not see much escalation.
As for “iffy” October seasonality, here is the historical precedents:
– YTD S&P 500 up 21%, the 9th best start since 1950
– looking at the 10 best starts thru Sept 30
– 7 of 9 saw declines in October with overall median -2%
– so the base case is stocks tread water in October
That being said, 2024 is a strong year. In fact, it is a year where stocks seem to fall on the first day. This has been the case 6 of the 10 months so far. And as we know, investors bought the dip
One thing to watch for a possible “bottom tactically” is the VIX and VIX term structure (4m less 1m futures). The VIX spiked today to 19, and the VIX term structure inverted. That means the 4 month VIX (Jan) has a lower level than 1 month (Oct). So markets see near-term spike in risk.
When this sees peak inversion and starts to “uninvert” is when bad news is likely priced in. This happened in late July. And we watch for this to happen again.
And more importantly, the 3 tailwinds into year-end are even bigger and more durable than the headwinds. And that is why we think investors will buy this dip, like they did in all of 2024.
– Fed launches easing cycle + “no landing”
– China PBOC “bazooka” = positive inflection
– Post-election and cash on sidelines dynamics
The main thing to remember is when the Fed cut and the US economy is not in recession (like today):
– S&P 500 up 3M later 7 of 7 times
– S&P 500 up 6M later 7 of 7 times
– this is bullish
Regarding China, our take is to “respect the breakout” as Mark Newton, Head of Technical Strategy, flagged early last week that FXI has broken a multi-year downtrend. Given the “bazooka” level policy measures taken by the China central bank, we believe the risk/reward has now shifted favorably for investors.
As we highlight below, China has massively underperformed the US on a 3-yr and 10-yr basis. Thus, there is a lot of room for upside if these new measures gain traction:
– 3-yr underperformance -34% (was worse)
– 10-yr underperformance -77%
The cash on the sidelines continues to grow. Total money market balances surged to $6.4T last week, up a near record $130 billion. This balance was $4.2T when the Fed began its “war on inflation” and we continue to see this as a source of firepower. Hence, constructive.
And to repeat, margin debt has not even risen in the last 4 months and basically flat at $797 billion. Keep in mind this figure was $936 billion in Oct 2021. So there is a lot of room for investors to employ margin debt.
Finally, this all favors small-caps versus large into year-end. We have written about it exhaustively, so please review our past notes. But the China rally similarly benefits small-caps mainly as this is evidence of risk on. And our data shows the Russell 2000 IWM correlation to FXI is second only to Consumer Discretionary.

BOTTOM LINE: Expect investors to buy this dip

We ultimately expect investors to buy this dip. Keep in mind, the positive tailwinds for stocks (above) are very strong:

since 1950, when S&P 500 is up >10% in the first half
The second half average gain is 9.8%
The win ratio is 83% and the only down years were during the years when Paul Volcker was Fed chair
This implies S&P 500 reaching 6,000 by the end of 2024

We highlight 19 SMID Granny Shots and 9 Large-cap stocks positively leveraged to an upside move in FXI. The following methodology is used:

Stock is a SMID Granny Shot and/or Top 40 largest stock held
Operates within the top 20 GICS most positively correlated to China

The following are the stocks:

SMID Grannies – Leveraged to China

Semiconductor Materials & Equipment: ACLS, VECO, AMKR, FORM, UCTT
Electronic Equipment & Instruments: NSSC, DAKT
Semiconductors: PI, CRUS
Application Software: PLTR, APP, AGYS, SPNS, MSTR, AVPT
Interactive Media & Services: CARG
Movies & Entertainment: SPOT
Industrial Machinery & Supplies & Components: MLI, FLS

Top Stocks – Leveraged to China

Semiconductors: NVDA, TSM, AVGO, AMD, INTC
Footwear: NKE
Interactive Media & Services: META, GOOGL
Movies & Entertainment: DIS

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42 SMID Granny Shot Ideas: We performed our quarterly rebalance on 7/16. Full stock list here -> Click here

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Key incoming data October:

~~10/1 9:45 AM ET: Sep F S&P Global Manufacturing PMI~~ Tame
~~10/1 10:00 AM ET: Sep ISM Manufacturing PMI~~ Tame
~~10/1 10:00 AM ET: Aug JOLTS Job Openings~~ Tame
10/3 9:45 AM ET: Sep F S&P Global Services PMI
10/3 10:00 AM ET: Sep ISM Services PMI
10/3 10:00 AM ET: Aug F Durable Goods Orders
10/4 8:30 AM ET: Sep Non-Farm Payrolls
10/7 9:00 AM ET: Aug F Manheim Used Vehicle Index
10/8 6:00 AM ET: Sep Small Business Optimism Survey
10/8 8:30 AM ET: Aug Trade Balance
10/9 2:00 PM ET: Sep 18 FOMC Meeting Minutes
10/10 8:30 AM ET: Sep CPI
10/11 8:30 AM ET: Sep PPI
10/11 10:00 AM ET: Oct P U. Mich. Sentiment and Inflation Expectation
10/14 11:00 AM ET: Sep NY Fed 1yr Inf Exp
10/15 8:30 AM ET: Oct Empire Manufacturing Survey
10/17 8:30 AM ET: Sep Retail Sales Data
10/17 8:30 AM ET: Oct Philly Fed Business Outlook
10/17 9:00 AM ET: Sep M Manheim Used Vehicle Index
10/17 10:00 AM ET: Oct NAHB Housing Market Index
10/17 4:00 PM ET: Aug Net TIC Flows
10/23 10:00 AM ET: Sep Existing Home Sales
10/23 2:00 PM ET: Oct Fed Releases Beige Book
10/24 8:30 AM ET: Sep Chicago Fed Nat Activity Index
10/24 9:45 AM ET: Oct P S&P Global Manufacturing PMI
10/24 9:45 AM ET: Oct P S&P Global Services PMI
10/24 10:00 AM ET: Sep New Home Sales
10/25 10:00 AM ET: Oct F U. Mich. Sentiment and Inflation Expectation
10/25 10:00 AM ET: Aug F Durable Goods Orders
10/28 10:30 AM ET: Oct Dallas Fed Manuf. Activity Survey
10/29 9:00 AM ET: Aug S&P CoreLogic CS home price
10/29 10:00 AM ET: Oct Conference Board Consumer Confidence
10/29 10:00 AM ET: Sep JOLTS Job Openings
10/30 8:30 AM ET: 3Q A 2024 GDP
10/30 10:00 AM ET: 3Q24 Treasury Quarterly Refunding Press Conference
10/31 8:30 AM ET: Sep PCE Deflator
10/31 8:30 AM ET: 3Q Employment Cost Index

Key incoming data September:

~~9/3 9:45 AM ET: Aug F S&P Global Manufacturing PMI~~ Tame
~~9/3 10:00 AM ET: Aug ISM Manufacturing PMI~~ Tame
~~9/4 8:30 AM ET: Jul Trade Balance~~ Tame
~~9/4 10:00 AM ET: Jul JOLTS Job Openings~~ Tame
~~9/4 10:00 AM ET: Jul F Durable Goods Orders~~ Tame
~~9/4 2:00 PM ET: Fed Releases Beige Book~~ Tame
~~9/5 8:30 AM ET: 2Q F Non-Farm Productivity~~ Tame
~~9/5 8:30 AM ET: 2Q F Unit Labor Costs~~ Tame
~~9/5 9:45 AM ET: Aug F S&P Global Services PMI~~ Tame
~~9/5 10:00 AM ET: Aug ISM Services PMI~~ Tame
~~9/6 8:30 AM ET: Aug Non-Farm Payrolls~~ Tame
~~9/9 9:00 AM ET: Aug F Manheim Used vehicle index~~ Mixed
~~9/9 11:00 AM ET: Aug NY Fed 1yr Inf Exp~~ Tame
~~9/10 6:00 AM ET: Aug Small Business Optimism Survey~~ Tame
~~9/11 8:30 AM ET: Aug CPI~~ Tame
~~9/12 8:30 AM ET: Aug PPI~~ Tame
~~9/13 10:00 AM ET: Sep P U. Mich. Sentiment and Inflation Expectation~~ Tame
~~9/16 8:30 AM ET: Sep Empire Manufacturing Survey~~ Tame
~~9/17 8:30 AM ET: Aug Retail Sales Data~~ Tame
~~9/17 9:00 AM ET: Sep M Manheim Used vehicle index~~ Tame
~~9/17 10:00 AM ET: Sep NAHB Housing Market Index~~ Tame
~~9/18 2:00 PM ET: Sep FOMC Decision~~ Dovish
~~9/18 4:00 PM ET: Jul Net TIC Flows~~ Tame
~~9/19 8:30 AM ET: Sep Philly Fed Business Outlook~~ Tame
~~9/19 10:00 AM ET: Aug Existing Home Sales~~ Tame
~~9/23 8:30 AM ET: Aug Chicago Fed Nat Activity Index~~ Tame
~~9/23 9:45 AM ET: Sep P S&P Global Manufacturing PMI~~ Tame
~~9/23 9:45 AM ET: Sep P S&P Global Services PMI~~ Tame
~~9/24 9:00 AM ET: Jul S&P CoreLogic CS home price~~ Tame
~~9/24 10:00 AM ET: Sep Conference Board Consumer Confidence~~ Tame
~~9/25 10:00 AM ET: Aug New Home Sales~~ Tame
~~9/26 8:30 AM ET: 2Q T 2024 GDP~~ Tame
~~9/26 10:00 AM ET: Aug P Durable Goods Orders~~ Tame
~~9/27 8:30 AM ET: Aug PCE Deflator~~ Tame
~~9/27 10:00 AM ET: Sep F U. Mich. Sentiment and Inflation Expectation~~ Tame
~~9/30 10:30 AM ET: Sep Dallas Fed Manuf. Activity Survey~~ Tame

Economic Data Performance Tracker 2024:

Economic Data Performance Tracker 2023:

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