The US stock market just had its best week of 2023 as Treasury yields tumbled, fuelling hopes of an early ‘Santa rally’ to end the year. Scrooge says there’s still plenty in the way.
“I don’t believe in this rebound and I don’t think we’re going to get a year-end rally,” Jason Hsu, chief investment officer at Rayliant, said in a phone interview.
Skeptics contend that early signs of a cooling labour market, which are currently reinforcing market expectations that the Federal Reserve is done raising interest rates, are likely to turn into a full-blown slowdown that will crimp consumer spending and hurt corporate earnings in coming quarters.
Bulls counter that the consumer is holding up well, coming off the back of remarkably strong third-quarter gross domestic product growth that defied economists’ predictions that the US would be in recession by now. Consumer spending has remained robust, rising 4% from July to September.
Consumer credit is where bearish investors see trouble brewing. “The data suggests that the consumer is tapped out in terms of credit,” says Hsu.
Consumers, previously flush with pandemic stimulus payments, have increasingly relied on credit cards to fuel spending. Revolving credit as a share of personal spending is below pre-crisis levels, but the trend is “concerning,” said Michael Reid, US economist at RBC Capital Markets, in a note.
Personal interest payments as a percentage of disposable income reached 2.7% in September and will continue to rise as federal student loan payments resume, Reid said. As monthly interest payments rise, consumers will have to dip further into savings to maintain current spending levels (see charts below).
“With little room for savings to fall further, the current path is unsustainable,” Reid said.
Economists will be watching the Fed’s September consumer credit report on 7 November.
The bulk of the third-quarter earnings reporting season is now in the rear-view mirror. Pessimistic investors focused on weak guidance around the potential for a slower economy.
And in October, analysts cut fourth-quarter earnings per share estimates by a larger-than-average margin, according to John Butters, senior earnings analyst at FactSet.
Bottom-up estimates for fourth-quarter earnings per share fell 3.9% between 30 September and 31 October, he said. Analysts typically lower estimates in the first month of a quarter, but not as aggressively. Butters noted that the average drop in earnings estimates in the first month of a quarter has averaged 1.9% over the past five years and 1.8% over the past 10 years.
A hurting consumer likely means disappointment is in store on the earnings front in coming quarters, Hsu said, even as executives try to prepare investors for a “hard landing”.
So what led to a stellar week for equities? Just as a rapid rise in long-term Treasury yields was the main culprit behind the stock market’s slide from the 2023 high set in late July, a sharp retreat in yields last week gave equities room to bounce back.
After briefly trading above 5% for the first time since 2007 last week, the 10-year Treasury yield BX:TMUBMUSD10Y fell 28.9 basis points this week, its biggest weekly decline since the period ending 17 March.
It was one positive catalyst after another for bond bulls last week. On Tuesday, the US Treasury set plans for less debt issuance at the long end of the yield curve than expected, and employment data, particularly Friday’s payrolls report, showed some signs that a robust labour market may be showing early signs of cooling.
The big event came on Wednesday when the Fed left rates unchanged as expected and Chairman Jerome Powell was seen to leave the door open to another rate hike, but not commit to one. This led investors to largely declare that the Fed is done raising rates, a belief that some investors believe has a good chance of proving premature.
It was a backdrop that allowed stocks to rally sharply a week after the S&P 500 SPX and Nasdaq Composite COMP suffered corrections – a 10% drop from their 2023 highs. The Dow Jones Industrial Average DJIA rose 5.1% last week, its biggest gain since the week ended 28 October 2022. The S&P 500 SPX rose 5.5% and the Nasdaq 6.6% – their biggest weekly gains since last November.
Previously nervous bulls now see a clear path for a year-end rally.
November and December have historically been the best two-month period on the calendar, with an average gain of 3% and positive performance 75% of the time, said Mark Hackett, head of investment research at Nationwide, in a note.
The market’s “relief rally” also had “some notable echoes of the market bottom a year ago, with extreme weakness in momentum and sentiment indicators,” Hackett wrote. “The resilient macro backdrop, strong seasonality and improved valuations should provide a tailwind into year-end.”
Technical analysts said the market’s bounce, particularly Thursday’s 1.9% rise in the S&P 500, had helped to brighten the charts. The bounce also came as markets had become significantly oversold and bearish sentiment was extreme, which can be contrarian catalysts for a rebound.
However, there’s still more work to be done to shake off the gloom, said Adam Turnquist, chief technical analyst at LPL Financial, in a note on Friday.
Thursday’s rally pushed the S&P 500 back above its closely watched 200-day moving average at 4,248. That’s a “step in the right direction,” but a close above 4,400 is needed for the index to reverse the emerging downtrend, Turnquist said, noting that market breadth remains underwhelming, with less than half of the S&P 500 stocks trading above their 200-day moving average.
