Trotting into the Holidays

Nov 20, 2023

By Jack Kraft, CFA, Investment Strategist
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U.S. equities trotted higher last week while investors feasted on positive economic data that showed slowing inflation. The S&P 500 and Nasdaq Composite both gained more than 2%, with both indexes posting a third straight week of positive performance. The Dow underperformed its peers, finishing 1.9% higher as last week’s rally favored more cyclical-oriented stocks. Elsewhere, small-cap stocks caught a bid, with the Russell 2000 jumping 5.4% and posting its second-best weekly advance of the year.

At the sector level, all 11 S&P 500 sectors road the gravy train higher, with Real Estate, Materials, Consumer Discretionary and Financials advancing more than 3%. A decline in Treasury yields provided a tailwind to some industries, with banks, homebuilders and retailers outperforming at the industry level last week. This was amid the wrapping up of third-quarter earnings season, which has been better than expected by analysts. According to FactSet, 82% of S&P 500 companies have issued profit results, with the blended earnings growth rate for third-quarter S&P 500 earnings per share currently around 4.3%, well above the (0.3%) expected at the end of the quarter.

The main story last week was the disinflationary data that gave equities a nice push higher. The Consumer Price Index (CPI) indicated that inflation went cold turkey in October, with no change in month-to-month data and increasing on an annualized basis 3.2%. Meanwhile, core CPI, which excludes volatile gas and food prices, showed its lowest increase on an annualized basis since September 2021. Taking a deeper look into the inflation numbers, it is notable that the majority of the 3.2% annualized increase in inflation came from housing-related costs. This is important to note because housing inflation tends to lag real time prices due to the slow rate at which rental leases turn over. Many analysts are now forecasting inflation to decelerate faster than previously anticipated. Further adding to the disinflation theme was wholesale prices falling 0.5% in October, posting its largest monthly decline since April 2020. Wholesale prices measured by the Producer Price Index (PPI) are a proxy for “pipeline inflation,” or inflation that manufacturers are seeing before goods hit the shelves.

The cooler inflation prints that showed up in the PPI and CPI numbers also led to the market repricing expectations for additional rate hikes and future rate cuts in 2024. According to CME Group’s FedWatch tool, futures markets are pricing in a 99.8% probability of the U.S. Federal Reserve (Fed) leaving its benchmark rate unchanged at 5.25%–5.50%. Furthermore, markets are now pricing in 100 basis points of total rate cuts next year. Treasuries rallied last week across the curve, with the two-year dropping to its lowest level since September and the 10-year ending the week around the 4.45% level.

Like clockwork, as the holiday season approaches, investment strategists sit down, talk turkey, and issue next year’s outlooks and forecasts. Goldman Sachs recently released its 2024 US Equity Outlook, which makes some compelling arguments worth noting. Its strategists expect 2024 to be a year of less multiple expansion, with the price to earnings of the S&P 500 remaining around the current level of 18x. The year-end target for the S&P 500 is listed on the outlook at 4700, slightly below the 2022 highs of 4797. This growth is expected to come from positive U.S. GDP growth of 2% and earnings growth of 5%. Strategists at Goldman continue to expect outperformance from mega-cap stocks, given their above average sales growth, margins and stronger balance sheets. However, outperformance is not expected to be anything like 2023, where the “Magnificent Seven” have returned more than 70% year to date. (The Magnificent Seven are AAPL, MSFT,  GOOG, AMZN, META, NVDA and TSLA.)

To every good forecast there is also an upside and a downside associated with it. Goldman lays out an upside scenario where growth is faster than expected as bond yields decline more anticipated. This would allow additional upside for the S&P 500 and put the 5000 level on the table, or roughly 11% higher from today’s level. Conversely, the downside would be a recession scenario where growth contracts on an earnings and GDP basis. Typically, during a recession the S&P 500 falls by more than 20%.

Given the range of outcomes, we recommend holding a diversified portfolio of stocks and bonds, especially in a market where bonds yield a similar amount to some strategists’ 2024 equity returns. As inflation continues to come down, fixed-income correlation with equity should become less positive and act as a hedge against poor equity returns. In stocks, Goldman points out that as the market approaches the end of the Fed hiking cycle, it is beneficial to own equities with quality attributes such as high profitability, strong balance sheets and sustainable earnings.

The shortened trading week ahead will be relatively quiet, as earnings season continues to wind down. Headlining the week will be third-quarter results from Nvidia as investors will see if the chipmaker can continue to provide buzz around artificial intelligence. In central bank news, November Federal Open Market Committee (FOMC) meeting minutes will be released on Wednesday. On the economic data front, market participants will get an update from the University of Michigan on consumer sentiment. Other notable economic reports include jobless claims on Wednesday, durable goods and November flash purchasing managers index updates.

Economic Calendar 11/20 – 11/24
10:00 AM U.S. leading economic indicators Oct. -0.70% -0.70%
12:00 PM Richmond Fed President Tom Barkin TV appearance
10:00 AM Existing home sales Oct. -1.50% -2.00%
2:00 PM Minutes of Fed’s Oct. 31-Nov. 1 FOMC meeting
8:30 AM Initial jobless claims Nov. 18 229,000 231,000
8:30 AM Durable-goods orders Oct. -3.50% 4.60%
8:30 AM Durable goods minus transportation Oct. 0.50%
10:00 AM Consumer sentiment (final) Nov. 60.8 60.4
Thanksgiving holiday, none scheduled
9:45 AM S&P flash U.S. services PMI Nov. 50.2 50.6
9:45 AM S&P flash U.S. manufacturing PMI Nov. 49.8 50


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