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Dec 06, 2023
November Update
November represented one of the largest rallies across stocks and bonds in recent memory. After 3 consecutive negative months posted by stocks, the S&P 500 Index rose 9.13% in November representing the 7th highest monthly return in over 30 years. Meanwhile, the bond market, after posting 6 consecutive negative months (a feat never before achieved in the history of the Aggregate Bond Index), produced its largest single month gain in 30 years, returning 4.53%. The “all asset” rally was fueled predominately by expectations that the Fed and other major central banks are poised to pause their multi-year rate hiking cycle with a view that a pivot to lower rates may come sooner in 2024 than previously expected. An upwards GDP growth revision (from 4.9% to +5.2% YoY) combined with slowing inflation and a softer job market gave investors confidence in declaring an end to the Fed’s tightening cycle (even though the Fed is not communicating a definitive end quite yet).
The Fed, Inflation & Jobs
The Fed started its most recent tightening cycle in March of 2022 with the mandate of stamping out the spike in inflation stemming from the pandemic. Over the course of the last 22 months, the Fed has increased rates 11 times taking the Fed funds rate from 0.25% to 5.5%. Recent economic data now indicates that further hikes may not be necessary. Most notably, the Fed’s preferred inflation measurement, the Personal Consumption Expenditures Index (PCE) continues to fall with the Core PCE falling to 3.5%, its lowest reading since May of 2021.
The labor market is also contributing to the view that the Fed is poised to pause. Jobless claims rose to 218,000, an increase of 7,000 from the previous period, although still below consensus estimates. However, continuing claims swelled to 1.93 million, an increase of 86,000 and the largest level since November of 2021. The indications of a softer job market are key to slowing the economy and stemming inflation, leading investors to gain confidence in predicting the end of the Fed’s tightening cycle.
So, what, or more importantly, when is the next move for the Fed? Many are looking for the Fed to pivot to begin lowering interest rates as early as March of 2024, with the consensus that the Fed funds rate drops by 1.3% over the next year. An aggressive decline in rates would be indicative that, either rates at this level are artificially inflated, or there is a future catalyst that warrants the Fed to take defensive measures. Historically speaking, the Fed Funds Rate has averaged 4.9% with periods of artificially high rates such as the late 70’s-early 80’s to combat rampant inflation or artificially low rates such as in the wake of the financial crisis.
At its current level, roughly in-line with the historic average, we do not believe the Fed Funds rate to be artificially too high or too low. Therefore, in order for there to be a pivot to a rate reduction cycle, we believe the Fed will need to see a compelling catalyst. Unfortunately, that catalyst would likely take the form of a deeper than currently expected economic downturn. With inflation creeping closer to the Fed’s long-term target, the labor market softening, yet the economy remaining resilient, we do not see an imminent catalyst that would warrant the Fed to take any action (up or down).
Diverging Manufacturing & Services Sentiment
The November reading for the ISM Manufacturing Purchasing Managers Index (PMI) was below 50 for the 15th consecutive month, tied for the longest streak in history. This index measures the expansion (above 50) or contraction (below 50) within the manufacturing segment of the economy (supply and demand of goods). While the downturn is not the deepest in history, it is the most prolonged. Declining new orders indicate that this weakness is likely to persist into the early months of 2024, at least until inventories are drawn down and demand stabilizes. Conversely, the ISM Services PMI (a measurement of service industry sentiment) reading ticked up in November and has remained in expansionary territory for nearly all of the past several years. While the non-manufacturing industries have been more resilient of late, there are indications of weakness surfacing with fewer global economies reporting an expanding service economy.
Looking ahead, we can see a scenario where a modest recovery in manufacturing is offset by a softening of the service economy, creating conflicting narratives for markets and investors. We believe this could add volatility to broad markets as it tries to discern what it means for economic growth in 2024.
Market Breadth Expansion
Earlier this year, we highlighted the distorted impact that a handful of the largest stocks in the S&P 500 Index, the “magnificent 7” (Nvidia, Meta, Apple, Microsoft, Tesla, Google, Amazon), had on results. As of the end of May, those 7 stocks accounted for 96% of the total return of the S&P 500. Since then, market performance has broadened out to where other companies are now meaningful contributors to results. According to a Blackrock publication, currently only 69% of S&P 500 returns are attributable to the “magnificent 7”, with the contribution from the rest of the index rising from just 4% in May to 31% at the end of November.
Market breadth has also expanded beyond the US borders. On the surface, the traditional indices would indicate that once again, the US is significantly outperforming other developed markets. However, when you even the playing field by equally weighting the security indices (i.e. removing the distorted impact of the “magnificent 7” in the US), the numbers reverse with international stocks outperforming the US on a year-to-date basis.
Despite expected sluggishness in global economic and earnings growth, international valuations already appear to have braced for a challenging 2024 with the price-to-earnings ratio of the MSCI EAFE Index trading at 15% below its 10 year average. This offers a compelling opportunity for international stocks to continue to outpace US stocks in the coming months, and potentially years.
The Big Picture
For the last two years, both equity and bond markets have relied on the actions of central banks to be the arbiter of returns. With all assets reacting to this single input, correlations between asset classes have naturally spiked.
As the Fed appears likely to pause its tightening cycle, and without a clear catalyst that requires a pivot, we could be entering a period where the market reverts to focusing on traditional corporate earnings and economic data to drive returns. We anticipate short-term bouts of volatility in both rates and equity markets as investors navigate this transition.
Speaking of volatility, the November rally has driven the Chicago Board of Exchange Volatility Index (VIX) – otherwise known as the “fear index” – to some of its lowest readings since pre-pandemic times. This could mark a shift back down in the volatility regime, a change that occurs every 3-5 years on average. While there will certainly be short-term spikes in volatility, as always, a lower volatility regime would be a positive signal for risk assets.
Happy Holidays
As we head into the holiday season, the Bison team would like to take the opportunity to thank you all for the wonderful friendships, partnerships, and support over the past year. We appreciate each of you and wish you all a happy holiday season.
Disclosures
Important Information
Investment Advisory services are provided through Bison Wealth, LLC located at 3550 Lenox Rd NE, Ste 2550 Atlanta, GA 30326 or Bison Advisors, LLC located at 140 Cateechee Trail, Hartwell, GA 30643. Securities offered through Metric Financial, LLC. located at 725 Ponce de Leon Ave. NE Atlanta, GA 30306, member FINRA/SIPC. Bison Wealth, LLC and Metric Financial, LLC are not affiliate entities. More information about Bison Wealth or Bison Advisors and its fees can be found in their respective Form ADV Part 2, which is available upon request by calling 404-841-2224. Bison Wealth and Bison Advisors are independent investment advisers registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training.
The statements contained herein are based upon the opinions of Bison Wealth, LLC (“Bison”) and the data available at the time of publication and are subject to change at any time without notice. This communication does not constitute investment advice and is for informational purposes only, is not intended to meet the objectives or suitability requirements of any specific individual or account, and does not provide a guarantee that the investment objective of any model will be met. An investor should assess his/her own investment needs based on his/her own financial circumstances and investment objectives. Neither the information nor any opinions expressed herein should be construed as a solicitation or a recommendation by Bison or its affiliates to buy or sell any securities or investments or hire any specific manager. Bison prepared this Update utilizing information from a variety of sources that it believes to be reliable. It is important to remember that there are risks inherent in any investment and that there is no assurance that any investment, asset class, style or index will provide positive performance over time. Diversification and strategic asset allocation do not guarantee a profit or protect against a loss in a declining markets. Past performance is not a guarantee of future results. All investments are subject to risk, including the loss of principal.
Index definitions: “U.S. Large Cap” represented by the S&P 500 Index. “U.S. Small Cap” represented by the S&P 600 Index. “International” represented by the MSCI Europe, Australasia, Far East (EAFE) Net Return Index. “Emerging” represented by the MSCI Emerging Markets Net Return Index. “U.S. Aggregate” represented by the Bloomberg U.S. Aggregate Bond Index. “Treasuries” represented by the Bloomberg U.S. Treasury Bond Index. “Short Term Bond” represented by the Bloomberg 1-5 year gov/credit Index. “U.S. High Yield” represented by the Bloomberg U.S. Corporate High Yield Index. “Real Estate” represented by the Dow Jones REIT Index. “Gold” represented by the LBMA Gold Price Index. “Bitcoin” represented by the Bitcoin Galaxy Index