Stocks Commentary

Stocks: Seasonal Backdrop, Falling Treasury Yields Cause For Optimism

November 2023

  • The November through January time frame has historically been the best three-month stretch for the S&P 500, and the stars appear to be aligning for gains this time around as well.
  • Investor sentiment has been decidedly bearish since August, but interest rates stabilizing, and a more positive seasonal backdrop could boost sentiment and risk appetite into year-end.
  • The decline in Treasury yields so far in November will likely draw buyers back into mega-cap growth leaders as portfolio managers chase performance into year-end, but some year-to-date laggards could participate as tax loss harvesting ends.
  • We expect market leadership to remain narrow or concentrated into year-end, with growth outpacing value, the U.S. faring better than the rest of the world, and large-caps (S&P 500) performing better than small-caps (Russell 2000).

Entering A Historically Strong Seasonal Stretch For Stocks. Over the prior 30 years, the November through January time frame has historically been a profitable stretch in the calendar for investors in the S&P 500. The stars appear to be aligning again for a positive finish to 2023 as the sharp drop in Treasury yields at the start of November could provide a boost for investor sentiment after a challenging August through October period which saw the S&P 500 lose 8.3% and the small-cap Russell 2000 decline by 16.8%. Stocks, broadly speaking, entered November in oversold territory and bearish sentiment, evidenced by the latest American Association of Individual Investors (AAII) survey, was at a level of pessimism not seen since last December, a dynamic that has fueled a rebound as yields fell sharply to start November. Interest rates stabilizing would be a tailwind for stocks and riskier bonds, broadly speaking, but mega-cap growth, specifically the ‘Magnificent 7,’ would likely benefit the most as portfolio managers will be quick to add to positions in this year’s winners. Falling Treasury yields would also benefit consumer-oriented stocks in the discretionary and staples sectors, along with bond proxies such as real estate and utilities, but mega-cap information technology and communication services stocks that have led year-to-date will likely remain at the top of ‘buy lists’ into year-end.

Small-Caps Aren’t Out Of The Woods Yet, But Could Fare Better In ‘24. Small-cap stocks have borne the brunt of the rise in Treasury yields, as the Russell 2000 index fell 8.1% from September 20 through the end of October. So, if rising Treasury yields/interest rates are a headwind for small caps then falling yields/rates should be a tailwind, right? The short answer is yes, but it’s not so clear cut. If yields are falling due to economic growth expectations moving lower, then that headwind would offset some of the benefit received by smaller companies from lower rates/funding costs. The fall in Treasury yields so far in November has been due, at least in part, to weaker manufacturing data and a cooler nonfarm payrolls report from October, with both pointing toward slowing economic growth into year-end.

This is a headwind for the Russell 2000 which skews toward economically sensitive sectors. It’s also notable that while Treasury yields have moved sharply lower to start of the month, the 10-year yield, specifically, is now back to where it was in late-September and yields across the curve remain elevated relative to recent history. With many companies expected to tap the capital markets in 2024 or 2025 as existing debt matures, borrowing costs and interest expense will rise, but to what degree remains to be seen. Small cap valuations are cheap but justifiably so as headwinds from higher rates have yet to be realized, but we can’t ignore the forecasted increase in net income for the Russell 2000 over coming quarters, which could make small-caps worthy of consideration for more capital at some point in 2024.

A Mixed Outlook For Foreign Markets Into Year-End. Japan’s economic momentum remains impressive and leaves us relatively constructive on Japanese stocks into year-end. However, should the Japanese yen strengthen materially as the Bank of Japan (BoJ) alters yield curve control and yields on Japanese Government Bonds (JGBs) rise, economic growth projections for next year may need to be ratcheted lower. The Eurozone and U.K. are likely to remain challenged from an economic perspective for quarters to come, but over the near-term much may hinge on the weather. A colder winter could lead to a spike in energy/electricity prices which would put significant upward pressure on inflation and may force the European Central Bank (ECB) to further tighten monetary policy, tamping down economic growth. Valuations and dividend yields are appealing, but we don’t expect euro area or U.K. equities to outperform into year-end. China is well worth watching into year-end as one of year’s lagging areas could benefit as tax loss selling abates and portfolio managers look to load up on higher beta exposures to participate in a Santa Claus rally. As China goes, likely so go emerging markets, but the U.S. dollar weakening to start November is a most welcome tailwind for developing economies and, with South Korea banning the short selling of stocks until June of 2024, a bounce into year-end may be in the cards.

As of November 8, 2023


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