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#56 - November's Financial Alchemy: Navigating the Market's Trick or Treat

This November carries a magical aura, reminiscent of 'trick or treat,' enveloping us in its unique sentiment. The question remains: will this month's post-Halloween announcements and speeches bring significant treats, or will we be left with mere trickery?


Market participants were surprised by Powell's speech, although he basically said the same things he has been saying for the last 6 to 8 months. In his words, "the Fed will proceed 'carefully' from here as officials ' address both the risk of being misled by a few good months of data, and the risk of overtightening. We are making decisions meeting by meeting."


Traders now see about a one-in-four chance of a further Fed rate hike by January, up from about one-in-six earlier, and expect Fed rate cuts to wait until June. Longer-term bond yields also rose, helped by a weaker-than-expected 30-year bond auction.


The 'magic' seemed to have worked for equities, with the recovery that started last week of October pushing its way through the first week of November, seemingly reinvigorated by Powell's speech."

Markets love magic as much as the rest of us mortals. One of its representations on Earth seems to be the Halloween Effect—an indicator that equity markets deliver higher returns between November and April than they do between May and October. And the signals point to a relatively good start.

The usual research package created by MACROMETR points to a relatively strong reversal over the last 20 days for equity indices performance, at the detriment of the US$.

In addition to the 'magical' November and the dissipating effect of a 'Halloweenish' October, the most recent CPI numbers have contributed significantly to the equity market's impetus. As illustrated by the following chart, the last 5 days' performance of the equity markets contributed significantly to the 20 days' performance, largely attributed to the CPI announcement day.

If seasonality is any indicator, the real estate sector may be a winner in November, along with Financials (Banks) and Communications (Media), while on the other side of the spectrum, Pharma and Energy have been laggers 7 out of the last 10 years over the same period.

Corporate earnings are also supportive, aligning with the performance of heavyweights such as BPCL, HDFC Bank, JSW Steel, Reliance Industries, and ICICI Bank, while the tech names have not delivered (Palo Alto, Cisco, Applied Materials).


Otherwise, big tech has made the index overvalued, and therefore future returns are likely to be sub-par. Based on Forward P/E forecasts and models, 1-year and 5-years expected returns for the S&P500 TR Index at a 20x ratio will be close to 5%. The long-term view on equities (probably US first) seems to be quite bleak, but the year-end warrants attention and an opposite view due to the recent macro-economic reports.


The lingering negative sentiment is growing in significance together with the weakening consumer sentiment, saving rates at levels below average, credit card balances on the rise, and increasing car and credit card delinquencies.

 

Bottom Line:

Skepticism is the best characterization that comes to my mind when thinking of equity markets, especially the leading US indices. Sentiment has improved, aided by seasonal tailwinds along the way to the end of the year. The market consensus seems to be for a year-end rally in the S&P500 and, subsequently, other major equity indices.

Despite that, the 'magical' November may fade once the 'black magic' of a recession starts crawling into the spotlight, and in addition to rate cuts, it may lead to a significant downside in equity markets. This results in a very bad tradeoff versus the potential return of 5% next year and should raise serious concerns.

High dividend sectors such as Real Estate and Utilities should continue their recent upside. From an analytical perspective, we see the High Yield sector as very stable and outperforming once rates decline. The Tech sector started to show some weakness, and in the short term, the consensus is on taking profits.

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