THE HOME STRETCH
The bull market rolls on as November was the strongest month of the year so far with the S&P 500 advancing 5.7%, NASDAQ up 6.2%, the Dow Jones +7.5%, and the Russell 2000 (small caps) up 10.8%. This year is on track to be the best year for stocks since 2013. It seems that in the past three months everything that could go wrong went right including:
– Economic soft landing. The Fed got it right. Although there were concerns over the economy late in summer and early fall, data has stabilized and even started to improve so much that the Fed may dial back the pace of rate cuts.
– The election. Much of November’s gains for stocks came after the election as many investors are comfortable with Trump’s 2.0 economic policies – except maybe for tariffs. We will get a better idea of which policies he campaigned on will become priorities. What we do know is that taxes and regulations are likely to be lower and interest rates and tariffs have the potential to be higher. We must remember, however, while the person in office can have some impact on financial markets, it is only one piece of a very big puzzle.
– Earnings season. Results were good for earnings and revenue beats. Guidance was mixed. The average stock rallied in reaction to its results. Another strong showing.
– The Fed. Will the Fed keep cutting rates, including in December? And what is the new neutral rate? (The neutral fed funds rate is a way to quantify the rate at which policy is neither supporting nor suppressing economic growth.) A higher neutral rate means fed funds need to be higher and vice versa. A growing number of FOMC members think the current fed funds rate isn’t that far above the neutral rate. While that doesn’t mean we won’t get a December rate cut, each successive indication of a higher neutral rate makes it less likely.
With these factors behind us for now, where are the market weaknesses? Here are three:
– Technology, for years the most reliable sector of the market, has been on a roller coaster ride since summer, especially semiconductors. Outside of Nvidia and a few others, semis have performed poorly. When the S&P 500 is at a 52 week high and the relative strength of semiconductor stocks is at a six-month low (like now), forward returns have been weak.
– Another potential warning for the market is breadth. More specifically, the S&P 500’s cumulative advance/decline line hasn’t made a new high in over a month. So how did the market do so well in November with weak breadth? Good question. This is reason for caution in the short-term, a yellow light.
– Two heads of the three headed monster are rising; the dollar and interest rates. The third head, crude oil prices, remains under control. When all three factors are declining it can be very good for stocks and risk assets in general. Alternatively, rising levels can stifle economic growth. These trends aren’t bearish yet, but they are no longer bullish.
These concerns aren’t enough to shake us off our bullishness, but they should be monitored. It always makes sense to have a balanced analysis, especially when everything in the market seems to be in alignment. The stock market’s home stretch in December should be interesting.