As drill sergeants like to say, “Pain is weakness leaving the body” — leaving unspoken the fact that it can also be a sign of something more serious. A fair amount of hurt has been inflicted on markets in recent months, even if it should be well within the tolerance band of a seasoned investor. The S & P 500 shed almost 5% in September, sustaining a maximum pullback from the late-July cycle peak of more than 7%, settling its second straight losing month up almost 12% for the year so far. .SPX YTD mountain S & P 500 in 2023 The median stock in the index, though, is nearly 16% off its 52-week high and is flat year to date. The S & P also went nine straight sessions through Wednesday recording a lower low than the day before, something that had only happened a dozen times over the prior century, says SentimenTrader.com. Bonds fell in lockstep with stocks in the third quarter – or rather, led stocks slower. The rush higher in bond yields to 16-year highs confounding investors not only for its speed (the 10-year from 3.75% to 4.5% in a bit over two months) but because it seemed not a function of repricing the Federal Reserve policy path or rising inflation expectations or a pickup in economic momentum. US10Y YTD mountain 10-year yield this year Heavy Treasury supply, a psychological shift toward rates staying elevated for longer and the momentum born of mispositioned traders forced to scramble were more at work. Not to mention oil prices galloping from $74 to above $90 over the same period the 10-year ramped from 3.75% — also largely on supply concerns. Treasuries and oil did pause late last week, allowing an oversold and antsy stock market modest relief. “Oversold” is an overused and under-understood term, in this case simply describing relative extremes in the number of stocks under short-term trend lines, a spike in new-52-week lows to 10% of all stocks in the S & P 500 last Wednesday, and other gauges of one-sided action. Typical of markets in the midst of some type of a correction, the past couple of days saw low-conviction bounce attempts, headline-sensitivity and outsized focus on trading levels and a fixation on handicapping systematic-fund flows. Enough pain yet? So, has there been enough pain yet to give way to a period of gain? Has two months of downside chop done enough to pull the market more in line with the probable economic and corporate-earnings path, while resetting investor expectations toward realism? Positioning has undergone a purge, helpfully, with rapid retrenchment by the big money. Deutsche Bank strategists after Friday’s close noted: “Our measure of aggregate equity positioning tumbled to slightly below neutral this week, clocking one of the biggest weekly declines since early 2022, comparable to drops seen in March this year around the SVB collapse and in June last year when recession fears were rampant.” It’s perhaps notable not only how far down the S & P has dropped to the recent low beneath 4300 but to what point in time this takes the market back to. Specifically, last week’s low goes back to a level first reached on June 2 — the day of a much stronger than expected monthly jobs report that sparked a peppy rally and began the process of investor consensus embracing the soft-economic-landing scenario. In a sense, the market is reaching back to test investor conviction about the resilience of the economy, which is now facing a much higher long-term bond yield as psychological and financial hurdle rate. Has enough work been done to alleviate valuation risk, with stock prices falling at the same time forward consensus profit forecasts have held up? Depends what eye is beholding the available facts and frameworks. But the raw numbers say the S & P 500 has dropped from 19.7-times the next 12 months’ projection to 17.9-times in two months. Not cheap through most any lens. And we can debate what sort of haircut should be needed given higher rates. (The risk-free rate is a relevant input but the gap between earnings yield and Treasury yield was routinely near current levels in the ’80s and ’90s, even if the spread was far wider in the 2010s with rates extremely low.) But as noted frequently, excessive valuation is also top-heavy, with the biggest stocks nearly all at big premium multiples. The equal-weight S & P 500 is at 14.3-times forward earnings; it bottomed last October just under 13. Long-tenured stocks such as Johnson & Johnson, Target and American Express now trade right in line with their 20-year averages. One metric that has consistently shown the market to be less overvalued is free-cash-flow yield, whether because of higher-quality businesses among the secular-growth market caps, or lower taxes and interest costs (until now). This gauge popped back to its 10-year average near 5% (which is also around its multi-decade average). Whatever the technical and valuation setup, it’s not as if the market owes investors much of anything right here. The S & P 500’s annualized total returns for the last three, five and ten years are all between 10-12%, slightly above the long-term average. What do the charts say? And yet the market continues to track a path that places it almost exactly flat over the past two years. I noted this odd echo effect in the market here three weeks ago , showing the S & P’s trajectory this year closely following the one from 2021. The chart has been updated telestrator-style to show the movement since Sept. 8 – still in tight formation. Bespoke Investment Group also calculates that the ten calendar years since World War II whose price action most closely correlates statistically with this year (including 2021), the S & P 500 was up from Sept. 28 through year end each time, by a median gain near 6%. It’s hard not to feel as if the standard seasonal market patterns have been overplayed this year, as noted here last week . The fact that stocks started falling on cue on Aug. 1, bottomed in the middle of the month, then sank again through the “worst month of all,” September, has encouraged investors to defer more than usual to these sub-rational and perhaps superficial rhythms. The way the market acted last week once everyone’s gauges started flashing “oversold” also invites a bit of skepticism for the perfectly pat adherence to – or anticipation of – widely observed triggers. With many observers handicapping a test of the S & P 500’s upwardly sloping 200-day moving average near 4200 — just about the same level as the market’s former longstanding ceiling – the index bottomed for the week less than 1% above it. As traders noted a collective desire to see the CBOE Volatility Index surpass 20 to set up a relief bounce, the VIX stopped at an intraday high of 19.7. The CNN Fear & Greed Index, a composite of market-based conditions rather than subjective surveys, fell into the Extreme Fear zone – for exactly one day, before climbing out. So, sure, perhaps tactical investors maneuvered in a way that seems a bit too neat and tidy as the culmination of a market setback. Certainly, no “all clear” can be sounded with confidence based on this behavior, if one ever can. Then again, maybe that’s the way seasonal effects work: Some self-fulfilling caution descends in late summer that then feeds off readily available negative news and nagging concerns – a breakneck bond selloff, government shutdowns and strikes and student-loan repayment and a higher-for-longer Fed breaking something. With any luck, people start doubting the seasonal relief will arrive until – most years, but surely not all – it does.
