Painful Week for Stock Investors as Sentiment Slides

Our Views

Tom Lee, CFA
Tom Lee, CFA
AC
Head of Research

The S&P 500 is down 2% this week. Besides a few high-profile negative reactions to earnings (GOOG -0.57% , META -0.48% ), to me, few macro events can explain the acute weakness – in fact, US 10-yr yields have been relatively more tame than could explain the week’s decline.

Thus, it is possible that mutual fund tax-loss selling is playing a bigger role in 2023 than we appreciate.

The majority of mutual funds have an October year-end, and this means we tend to see tax-loss harvesting as we move into the end of the month. 2022 saw this on display as selling of stocks with negative YTD returns were further under pressure towards the end of October 2022.

This year, not only are there equity tax losses to “harvest” but also bond fund losses. Thirteen of the 15 largest bond mutual funds and 13 of the 15 the largest bond ETFs are down YTD. Within the last 30 years, this is one of the worst years ever for bond funds. This selling of corporate and government bonds probably added to some pressure on yields (pushing prices down, yields up).

Tax-loss harvesting is taking place for those equities down YTD. And roughly 50% of the S&P 500 is down YTD. The good news is this selling pressure should abate in coming weeks, as we move into November.

Despite what many see as a “bad earnings” season, those companies “beating” on EPS are actually doing better than in 1Q23 or 2Q23.

  • 1Q23 beating >2%: +0.2% next 3D
  • 2Q23 beating >2%: +0.3% next 3D
  • 3Q23 beating >2%: +0.5% next 3D

So, earnings reactions are better, but there have been some high profile negative reactions. Overall, with 47% of S&P 500 reported, 79% are beating.

Despite the elevated VIX (>20), the spread between high-yield and speculative grade bonds, or BB vs CCC, has narrowed. The narrowing of the quality spread is actually a positive sign incrementally and generally takes place when economic momentum is improving.

BOTTOM LINE: While equities are down sharply YTD, some divergences bear watching

I wish I could say that the selling is coming to an end for equities. There has been a lot of technical damage and this along with few signs of capitulation (per Mark Newton, see his report from Wed evening) tell me that investors need to be patient. But the window for tax-loss selling closes at the end of October, next week.

Read the Latest First Word
Mark L. Newton, CMT
Mark L. Newton, CMT
AC
Head of Technical Strategy
  • SPX likely to find support as October comes to a close ahead of Nov. FOMC.
  • Gold Miners should be favored as Gold pushes higher towards all-time highs.
  • Small-caps look interesting as a risk/reward relative to Mid-caps and Large-Caps.
Read the Latest Daily Technical Strategy
Sean Farrell
Sean Farrell
AC
Head of Crypto Strategy
  • Bitcoin reached the lower bound of our annual forecast range, exhibiting a distinct divergence from traditional markets and suggesting renewed institutional interest, as evidenced by elevated open interest on the CME.
  • Recent data points to a positive shift in the capital flows, highlighted by a reversal in the declining stablecoin market cap, sustained inflows into Exchange-Traded Products (ETPs), and a surge in Bitcoin’s Realized Cap, all of which suggest renewed investor confidence and potential for a more sustainable rally.
  • We think that China’s recent monetary stimulus and softening stance on crypto, coupled with a lack of attractive domestic investment options and increased crypto activity in Hong Kong, are converging to act as a positive catalyst for crypto prices, as evidenced by Bitcoin’s performance during Asia market hours.
  • Solana reached a new YTD high this past week. While tactically focused investors might contemplate de-risking ahead of the Solana Breakpoint conference, we believe it’s an opportune time for medium-to-long-term investors to consider adding on dips.
  • Core Strategy – Based on robust capital inflows, heightened spot market volumes, significant institutional participation, renewed enthusiasm for an upcoming ETF, and an emerging Flight to Safety narrative, we believe it’s an opportune time to deploy the remaining stablecoins in our core strategy. While we expect Ethereum (ETH) to gain some tactical ground on Bitcoin (BTC) in the next month, BTC’s dominance is likely to persist, interspersed with occasional outperformance from select altcoins.

 

Read the Latest Crypto Strategy
L . Thomas Block
L . Thomas Block
Washington Policy Strategist
  • Louisiana’s Mike Johnson (R) is the new Speaker of the House, winning the vote of every House Republican – including moderates and Biden-district Republicans.
  • After his ascension, Speaker Johnson met with President Biden and Senator Mitch McConnell (R-Kentucky). It was the first time Johnson had met either leader.
  • Johnson is reportedly willing to consider supporting an extension of the current Continuing Resolution to avoid a government shutdown on November 17, as a full federal budget is unlikely to pass by then.
Read the Latest US Policy

Wall Street Debrief — Weekly Roundup

Key Takeaways

  • This week, the S&P 500 fell 2.53% to 4,117.37. The Nasdaq also retreated, closing at 12,643.01 down 2.62%. Bitcoin gained 12.36% to end at around 33,713.10.
  • Tax-loss harvesting pressured both bond and equity markets as the end of the mutual-fund tax year approaches.
  • Rates remain high, but correlation with equities appears to be weakening.

“Read all the time. Don’t just do it because you’re curious about something, read actively.” ~ Byron Wien (1933-2023)

Good evening,

Fundstrat’s Head of Research Tom Lee opened this week’s internal research huddle with a blunt assessment. “The markets were just bleeding every day,” he acknowledged. In his view, some of this had to do with tax-loss harvesting on the part of mutual funds, which mostly end their tax years on October 31. 

“There are all these funds that have incurred huge losses,” he observed, and they’re selling now for tax purposes – to use those losses to offset gains. “This includes bond funds – and this might be the first time they’ve had to do this, because you almost never have losses on bonds,” Lee noted. In his view, “this selling is bleeding into stocks getting pressured, too.” Yet he sees signs that exhaustion is beginning to set in. 

“I'm hopeful of that,” responded Mark Newton, Head of Technical Strategy. “I think that probably is going to be necessary before we can call a true low.” However, Newton doesn’t believe such a low is imminent. “When I look at things like the put-call ratio or traditional sentiment gauges like Investors Intelligence or AAII, most of those have been starting to get more negative in the last couple of days. With the put-call, we're getting close – but we’re still not at bearish levels that we hit back in May or last October,” when the market hit previous lows. 

He continued, “We're likely close. We've now had a negative August and a negative September, and October has gone counter to expectations. And a lot of that's based on interest rates.

Lee suggested that the tax-loss harvesting by bond funds might be helping to push rates higher. And while Newton didn’t disagree, he also proposed that “deficit spending is causing a great amount of supply to be dumped on the market, and that’s likely going to continue over the next year. I think that's a problem for Treasuries.”

Yet both agree that the inverse correlation between rates and equities appears to be weakening. Both of them have previously made this observation, and this week, Newton said he continues to see this happening. “We've seen some divergence in the correlation between Treasuries and equities,” he said, “so if rates continue to go up, especially at a slower rate, then I don't think equities need to go down or be spooked as much; rates are not as much of a factor now as they were a month ago.”

This could be good for equity investors, because, in Newton’s view, “rates are a work in progress. They have been actually sort of sputtering along the top, but they haven’t hit a strict new high. I think we're going to seek out between [5.10% and 5.25%] between now and next month. I don't think it happens right away.”

On the macroeconomic front this week, we saw PMI readings that, in Lee’s view, suggest that “underlying economic momentum is recovering towards expansion.” As he has observed in the past, “the group that is the most positively levered to rising PMIs remain US Industrials (XLI -0.04% ), so this week’s PMI release supports an overweight stance.”

He further notes that Industrials CDS (credit default swaps) are outperforming the broader market, suggesting that on a relative basis, credit investors see risks decreasing for Industrials. As Lee points out, and as our Chart of the Week shows, “Industrials CDS moves tend to lead Industrial equities by 90 days. Thus, this suggests that we should see relatively improving performance soon.”

Source: Fundstrat

For those more technically inclined, it is worth noting that Newton also views Industrials favorably. “I expect to see rates roll over next month, and that should fuel Industrials, and it should fuel Tech,” he said.


Elsewhere 

The European Central Bank paused its rate hikes for the first time in 15 months. By unanimous vote, all the ECB Governing Council members voted to keep the benchmark interest rate at its record-high 4%.

The United Autoworkers (UAW) and Ford reached a tentative agreement on Wednesday, per which workers over the next 4 1/2 years would receive a 25% raise over and above any cost-of-living increases. Meanwhile, this week, the UAW expanded its strike against Stellantis, ordering 6,800 employees at the company’s Dodge Ram plant north of Detroit to walk off the job. It also ordered 5,000 members at GM’s SUV plant in Texas to do the same. 

General Motors withdrew its 2023 earnings guidance due to uncertainty surrounding the UAW strike, company executives said during its 3Q earnings call. GM had raised its full-year profit guidance in July, but estimates that the strike has already cost the company $800 million. As publication time approached, news outlets were reporting rumors that the UAW was close to reaching a tentative agreement with GM and Stellantis.

The UK’s Home Office is putting together a special police force to combat the increasingly prevalent problem of organized-crime groups running shoplifting rings. Major US retail chains have fallen victim to the same phenomenon, which has become serious enough to show up in quarterly earnings reports.

The women of Iceland went on a one-day strike on Tuesday, suspending work in a protest targeting gender pay inequality and violence against women. Among the women participating was Prime Minister Katrin Jakobsdóttir. The World Economic Forum has rated Iceland as the most gender-equal country in the world for 14 consecutive years. 

Chinese authorities have begun multiple investigations into Foxconn, best known as the manufacturer of iPhones. Government-linked news outlets report that the company is suspected of unspecified tax and land-use violations, while others suspect the regulatory action has more to do with remarks about China that the company’s founder, Terry Gou, has made as he runs for Taiwan’s presidency. 

And finally: Former Chinese Premier Li Keqiang died this week at age 68. A trained economist, Li was a strong advocate for free-market reforms and debt reduction. His resignation in March 2023 was widely seen as the result of President Xi Jinping’s pursuit of ever-greater political power.

Important Events

S&P CoreLogic CS home price MoM August
Tue, Oct 31 9:00 AM ET

Est.: 0.70% Prev.: 0.87%

A measure of the change in home prices in 20 major metropolitan regions in the U.S.

JOLTS Job Openings
Wed, Nov 1 10:00 AM ET

Est.: 9215K Prev.: 9610K

The Job Openings and Labor Turnover Survey – monthly data on job openings and turnover from the Bureau of Labor Statistics

FOMC Rate Decision
Wed, Nov 1 2:00 PM ET

Est.: 5.25% – 5.50% Prev.: 5.25% – 5.50%

The Federal Open Markets Committee’s decision on the Fed funds target rate.

Stock List Performance

Strategy YTD YTD vs S&P 500 Inception vs S&P 500
Granny Shots
+10.96%
+3.72%
+80.67%
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