/ October 06 / Weekly Preview
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Monday:
N/A
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Tuesday:
N/A
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Wednesday:
FOMC Minutes
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Thursday:
Initial Jobless Claims (200K exp.)
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Friday:
Michigan Consumer Sentiment Prel
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Monday:
N/A
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Tuesday:
Constellation Brands Inc
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Wednesday:
N/A
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Thursday:
Pepsico, Inc.
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Friday:
Delta Air Lines, Inc.
Q4 Outlook Seems Strong
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As we wrap up Q3, the main driver of all price moves in financial markets is the treasury yield, specifically the US 10-Year Treasury. This touched 5.34% last Thursday and settled the week at roughly 5.28%. The 30-Year meanwhile pushed to 5.67%. And stocks absorbed the shock much better than one would expect.
SPY is up +1.21% on the week, while the Nasdaq (QQQ) is higher by +2.67%. Nvidia set a record, topping $5.7 trillion in market value. The Dow (DIA) lagged, as financials and other rate sensitive names were hit hardest.
So far, the 3-Month percentage rise in the 10-Year did not hit the 1-STD threshold associated with stock market declines, so this partly explains the calm that is being witnessed (historically, the market cares more about the rate of change of interest rates, not the absolute yield).
The ISM manufacturing index remained at 54.5, while its prices component surged 6.8 points to 77.9, the highest level since the start of the Iran war. Every reported commodity increased in price. Oil retreated from the mid-September highs, and oil volatility sits at the lower end of the recent range, as 80% of prewar Gulf supply was restored during the month;
Friday’s jobs report flipped the script on inflation. September payrolls increased by only 29,000, well below the roughly 85,000 expected. Revisions subtracted about 60,000 jobs from July and August combined. The unemployment rate climbed to 4.2% (as the participation rate also increased from 61.6% to 61.8%), and wage growth decelerated to 3.0%.
Markets read the bad news as a positive development, at least from the perspective of a Central Bank that’s less inclined to hike rates. The odds of an October rate hike tumbled to roughly 18%. Yields backed off their highs temporarily, as traders bet that a cooling labor market will force the Fed to stop tightening, even as pipeline inflation keeps climbing.
This setup has a name — “Stagflation”. Hotter input prices combined with weak hiring are two of the ingredients. The missing ingredient is weak economic growth, which is not happening at the moment, as Q3 estimates run just under 4% (according to the Atlanta Fed GDPNow forecast).
The absolute level of yields matters in a single context, and that’s asset allocations. At more than 5%, the 10-year Treasury offers investors a risk-free return that equities haven’t offered since 2002. The TINA trade (“there is no alternative, equities are a must-buy”) has been completely reversed. As such, bonds may earn a larger piece of the pie, when it comes to macro decision making at the asset allocation level of portfolio construction, to the detriment of equities.
Leadership remained relatively narrow. Tech (XLK) led with +3.3% returns, with Energy (XLE, +2.16%) along for the ride as well. Healthcare (XLV), Real Estate (XLRE), Staples (XLP) and Financials (XLF) all underperformed.
The story is familiar: AI infrastructure investment remains robust, while commodity price pressures and energy demand are high. With yields in the 5.24% - 5.34% range, many dividend paying bond proxy stocks from the rate sensitive sectors fell along with the price of treasuries. If yields continue to stay above 5% after Wednesday’s auction and minutes, rate sensitive stocks will remain under pressure. A drop back below 5% would give the broader market some relief.
From a technical perspective, SPY has bounced off key support at $765 (M-Trend & 50-DMA) and is just now hitting upside resistance at the August 13 ATH ($775). The bounce is very relevant in this scenario, as the 50-DMA has acted as support since the post-April recovery.
Most primary trends are bullish: SPY is trading above rising 20, 50 and 200 DMAs, the 2Y regression slopes positive, same with the short term MACD. Only the weekly MACD is showing a negative trend, but that could reverse if stocks can break out of the recent range. Since sellers repeatedly stepped in near all time highs on August 13, September 3, and September 21, a breakout would also be technically significant.
For now, that upper end zone would in theory be a place to trim rather than chase, at least until a credible rally can sustain closes above $775 on a weekly basis.
Our core asset allocation strategy (Enterprise) is in agreement with this technical interpretation since today’s rebalancing event does not change the overall allocation for equity risk. The model is keeping stocks at 35% weight, while preferring commodities as the main asset class to run (45% weight).
As such, the Enterprise Regime study still indicates a "yellow regime," favoring a long but hedged exposure profile. We’re not out of the woods just yet, despite the rally on Monday.
The issue of Market Breadth remains. The tape is narrow to the point of breadth suggesting we are in the midst of a market correction. 445 stocks trade in “topping patterns” a metric that is associated with deeper drawdowns when above 400.
Yet SPY is in striking distance of records, being almost solely dragged upward by 3 sectors: Healthcare (XLV), Energy (XLE) and Tech (XLK). The rest of the market is underperforming in both the relative as well as an absolute sense.
The 2Y ratio of equal-weight to cap-weight (RSP / SPY) has dropped from +2.5 STD in late July to -0.87 STD today. That is a steep drop that signals a narrow tape and sits closer to correction lows than bull market highs.
The skeptics will tell you a market this narrow has to break, and eventually they may be right. However, if this ratio drops to the -1.5 STD limit, it would trigger a fantastic buy signal making this a study to watch. Deeply oversold sectors are exactly where a “broadening” rally would come from. Real estate, utilities, and financials are the groups most hurt by rising yields. They also have the most room to snap back if a pullback in rates takes shape. Lower yields will do more for the broad market than any earnings report.
Ryan Detrick of Carson Investment Research examined every year since 1950 in which the S&P 500 was up between 10% and 20% at the start of Q4. 21 such years qualified. In those cases, the fourth quarter finished higher 18 times, an 85.7% win rate, with an average gain of +5.3% and a median gain of +5.5%. By comparison, across all years since 1950 Q4 has averaged a +4.2% gain and risen 80.3% of the time.
SPY was up +13% at the start of Q4, so the performance is squarely in this group.
The losing years deserve attention because losses were modest. Over the full 21 observations, the largest fourth-quarter drop was only -1.3% in 1979, while the top gain was +11.6% in 2003, and eight of the 21 years produced gains of +7.5% or more. The key takeaway is the asymmetry: the downsides were small while the upside results were substantial.
The other seasonal tailwind is the political layer. October is the best month of midterm years since 1950. It averages a +3.0% gain and finishes higher 73.7% of the time. November isn’t far behind at +2.7%, and it’s the most consistent month on the midterm calendar, closing higher 78.9% of the time. Add the three fourth-quarter averages together, and you get roughly +6.5%.
Our Trading Strategy (Sigma Portfolio)
Corporate buybacks are the largest single buyers of U.S. stocks. So far, these have been notably absent over the past month. The blackout period reduces corporate purchases by about 35%. Those windows begin to reopen company by company as earnings get reported, starting with banks in mid-October and Delta Airlines on Friday.
The dry powder to accumulate remains substantial: Citadel Securities reports U.S. companies had authorized $1.3 trillion in buybacks through September 29, a record amount for this point in the year. Buyback activity typically resumes around October 15 and historically accelerates into November.
Coupled with still depressed investor sentiment, and various measures suggesting plenty of cash on the sidelines, it looks like most market participants are not well positioned for any upside move.
Timing will be as important as direction. Citadel noted that in 14 of 24 midterm-election years since 1930, the fourth-quarter low occurred in October, with a median rally of +10% from that low to year-end. Historically, October weakness has benefited investors who planned for such weakness.
The weight of evidence seems to suggest that yields will soon hit a temporary top (which also coincides with the US Dollar topping out), with a reversal being the path of least resistance. This should help market breadth rebound and power our portfolio and models to all-time highs through the start of 2027.
Disclosures / Disclaimers: This is not a solicitation to buy, sell, or otherwise transact any stock or its derivatives. Nor should it be construed as an endorsement of any particular investment or opinion of the stock’s current or future price. To be clear, I do not encourage or recommend for anyone to follow my lead on this or any other stocks, since I may enter, exit, or reverse a position at any time without notice, regardless of the facts or perceived implications of this blog post. I currently do not own or plan to own any position, long or short, in the securities mentioned.
I am not a financial advisor licensed in the United States. Nor am I providing any recommendations, price targets, or opinions about valuation regarding the companies discussed herein. Any disclosures regarding my holdings are true as of the time this article is written, but subject to change without notice. I frequently trade my positions, often on an intraday basis. Thus, it is possible that I might be buying and/or selling the securities mentioned herein and/or its derivative at any time, regardless of (and possibly contrary to) the content of this blog post.
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