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Going looking for ghosts in October isn’t a great way to see one, as it turns out. At least so far. The prevailing sense among investors and market handicappers entering the month was to expect choppy, irresolute action full of potential scares. As with most consensus beliefs, this one was plausible. This time of year typically tests nerves, more so when — as now — an election is onrushing and the S & P 500 was already up 20% for the year. Instead, the index has continued its dogged grind to new record highs, 45 of them for 2024, even after investors last week walked the dark hallways and opened closet doors labeled ” Warmer CPI, ” “Higher jobless claims,” “Rising Bond Yields” and “Fewer Fed rate cuts.” All without frightening results. The big-picture, keep-it-simple characteristics of this market moment are easy enough to recite like self-help maxims: Inflation continues to retreat more quickly than the economy has slowed. The Federal Reserve has begun cutting short-term rates into an impending upswing in earnings for most companies, a rare pairing. The way markets perform following an initial rate cut is entirely dependent on whether a recession ensues within a few months, and GDP continues to track above expectations. Credit markets could scarcely be any stronger. These are, of course, the same struts that support the majority of investors’ bullish longer-term view: The collective expectation of a post-election year-end rally is at least as strong as the notion of a choppy October. 21-21-21 market For sure, there is plenty of month left for some payback. But for the moment, those reassuring fundamentals, along with a widespread belief that a soft economic landing is underway and a nagging notion about seasonal hazards, have produced a rare 21-21-21 market: S & P 500 up 21% for the year, its price/earnings ratio above 21 and a Cboe Volatility Index hovering right near 21. The 21.9% gain makes this the best performance to this point in the calendar since 1997, and the best presidential-election year ever. The five straight months of gains (and five straight weeks at this point, too) reflect the kind of upside persistence that essentially never precedes a buckling of the real economy. In the first half of the year, all know it was the super-cap glamor tech leaders that dominated the index appreciation. Since June 30, the equal-weighted S & P 500 has gained 9.5%, more than triple the Nasdaq 100’s rise. And among the so-called Magnificent 7, the stocks have diverged dramatically over the past three months, a sign of a less-monolithic, more discerning investor approach. The result is a more-balanced market that has undone the skyward overshoot of the mega-cap tech cohort without the Nasdaq 100’s longer-term relative uptrend having broken down decisively. While the broad market has racked up the superlatives, there has been a pronounced flattening of the rally over the past three months, with more downside tests and a less-generous risk-reward bargain. A buyer at the mid-July S & P 500 peak of 5667 sustained a quick 8% tumble in three weeks. Aggregate upside since July 16 has been just 2.6%. The forward P/E of 21.8 on the index is undeniably elevated. Higher readings haven’t been sustained over the past half-century except in the 1999-2000 Internet craze climax and during the furious pandemic bull run. It’s tough to sidestep the math that says multi-year returns will be restrained for investors paying today’s price, though beyond that valuation has little to say about returns from here to the visible horizon. Since 1990 or so, valuation has shifted higher as the index itself became less cyclical and higher quality, investment flows turn the public less valuation-sensitive and the Fed has grown more transparent. More immediately, it suggests equities are pretty priced for that soft landing, a scenario that will be alternately believed and doubted as it’s constantly tested against incoming evidence. Still, when earnings are on the rise and the Fed is in easing mode, as now, severe pressure on the market multiple isn’t typically applied. FactSet projects third-quarter earnings will easily surpass recently reduced forecasts to settle around a 7% annual growth. After reporting season, inevitably, the forward estimate will stretch another three months into the hope-infused future, which is how the market can move the chains even from a pricey starting point. Unheard-of combination The near-21 VIX is the most glaring anomaly given the rest of the setup. Goldman Sachs calculated VIX being this elevated with the S & P 500 calmly clicking to record highs is essentially unheard-of. As a reminder, all it says is there is heavy demand for hedges against severe index moves over the next 30 days, after which VIX futures imply an instant evaporation in volatility. This reflects anticipation of a close election that could take time to sort out and will leave half the adult population disappointed, possible escalation of Middle East conflict – we all know the source of the VIX bid through October. .VIX YTD mountain Cboe Volatility Index, YTD This should not be mistaken for broadly fearful sentiment. This is not a hated, ignored or under-owned equity market. It’s well-owned though perhaps not fully trusted, with room for tactical players to chase it higher for a bit if they feel forced. True, the American Association of Individual Investors survey last week showed the fewest bears since December, while Deutsche Bank’s aggregate investor positioning gauge finished Friday with equity exposure at the 60 th percentile, just above neutral. It’s a standard, if lazy, talking point of the bulls that the towering balances in money-market funds “on the sidelines” are somehow poised to tip into stocks. It almost never works that way except at the end of punishing bear markets when cash holdings are bloated relative to equity market value. Not to mention that less than half of the $6.5 trillion in money market assets is directly held by retail investors – and those retail investors have fairly modest cash allocations strictly because their equity holdings have appreciated so much. Bank of America’s wealth-management clients’ cash is below average as a proportion of total portfolios. But this is fine, the bull market doesn’t need some torrent of cash to enter stock funds to carry on. Cash that’s still yielding well more than inflation and bonds holding their value allow investors to shoulder higher equity exposures rather than rotating out. More immediately, by Friday’s close the S & P 500 was growing a bit stretched relative to its own trend (more than 4% above its 50-day moving average), though not quite as dramatically as it was at the July market peak. There were signs of headlong buying in some of the biggest laggard and most-shorted stocks at the end of last week, often a sign that a rally is reaching down in quality as it matures. These observations shouldn’t prompt any real fright, but it’s best not to shut one’s eyes to them either.
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