Three In a Row

Photo by Charlotte on Unsplash

Figure 1: Stock Market Movement Scale Oct23

October brought the third down month in a row for the ASX, a total loss of -7.35% on the S&P/ASX 200 Accumulation Index.

Three In a Row

The mood was certainly mirrored in US individual (AAII survey) investors’ sentiment registering 50% bearishness (see “Last Week” with the elongated red bar in Chart 1) which is only 2% shy of the worst bearish sentiment in the last 12 months (Chart 2 right red bar). Geopolitical uncertainty during October played a part in that sentiment.

Chart 1: AAII survey; Source: AAII

Chart 2: AAII survey history; Source: AAII

Rolling on to November, the leftmost "Latest" bar on Chart 1, is showing a change in sentiment with a much higher green bar.

This improved sentiment is partially aided by the pausing of rate hike in the US where we saw the US 10 year yield coming off the high of 5% (Chart 3). Though we were not as lucky in Australia, copping another 25bp rate hike. 

Chart 3: Source; Acumen Investors, IRESS

Interest rate sensitive sectors enjoyed some reversal of fortunes.

Chart 4: S&P 500 sector performance for the week; Source: S&P Dow Jones Indices Data as of 8 Nov 2023

Are we out of the woods (of the bear)?

Many of the issues markets were contending with are still being played out. Investors continue to have the need of balancing the scale of a soft landing on one side and recession on the other.

Some of the indicators shaping investors' thinking include:

Health of US GDP Growth

It was encouraging to see US third quarter growth coming in at a healthy 4.9% (Chart 5), contributed by inventory rebuilding, resilient consumers and business investments. However, this reading is not expected to be repeated.

Chart 5: US GDP Growth Rate; Source: Trading Economics

The OECD tracker is forecasting the next quarter growth in the US to be 1.8% (Chart 6). The possibility of this below-trend growth dragging the US economy into a recession still lingers. This consideration has certainly contributed to the Fed's wait-and-see stance before hiking more. 

GDP expectation in Australia is quite similar.

Chart 6: OECD Weekly Tracker of US Growth; Source: OECD

US Third Quarter Corporate Earnings

On a more encouraging note, is the US third quarter corporate earnings which is above expectation in the recent reporting season (Chart 7).

Chart 7. S&P 500 Q3 2023 share=weighted Earnings ($B); Source: LSEG I/B/E/S

As of last week, 91% of the 500 companies in the S&P 500 Index have reported earnings for Q3 2023. Of these companies, 81.3% reported earnings above analyst expectations (a typical quarter [since 1994] is 66%) and 14.5% reported earnings below analyst expectations (with 20% typical miss estimates).

This improved picture is reflected in the forward quarter S&P 500 PE ratio for the week of 18.2 (Chart 8), which is above the median of 16.5 with small caps still below the average at 12.1 times.

Chart 8. Forward PE ratio for S&P Indexes; Source: I/B/E/S data by Refinitiv

Whilst in Australia, the forward PE ratio is sitting at just under 15x, at its long term average, but earnings growth are expected to fall moving into 2024 (Chart 9).

Chart 9. Australia’s Earnings growth forecast; Source: I/B/E/S data by Refinitiv

US New Home Sales

US new home sales have risen despite rate hikes (Chart 10).

Chart 10: US new home sales; Source: Trading Economics

In Australia, property prices remain resilient, supported by immigration growth.

Inflation

US Inflation is forecast to be heading in the right direction (downward), which is a positive vote towards the Fed staying put, or more optimistically, starting to cut.

Chart 11: Inflation Trend; Source: JP Morgan Economic Research

Wage Growth

Chart 12: US Salaries and Wages Growth; Source: Trading Economics

What investors would like to see is the continued weakening of wages growth (Chart 12) to avoid an economic hard landing. The expectation for Oct'23 is a 4.4% print after the 5.31% read in September.

Australia is equally challenged by services inflation (wages) in the midst of low productivity growth, made worse by persistently high rental expense (with strong population growth) propping up inflation. This is unfortunately keeping Bullock's finger on the hike button.

As we move towards 2024, bites from cost pressures in corporate margins and consumer spending (which makes up about 55% of Australian GDP) are likely to sink deeper into the economy, translating to anaemic growth. If inflation does not get too out of hand and start trending down, then we might see peak cash rate. This might then cause investors who are too heavily in cash to scramble for other solutions for yield and growth. It's always best to plan ahead and start re-positioning and diversifying portfolio strategies for the change underway - low growth, high corporate debt and potential high default risk (of low investment grade debts) to after-tax yield solutions (like franking credits) and extra income generating strategies (like one suggested below) to help buffer portfolios.

What's In Store Short Term?

As Christmas draws near and as trading tradition will have it, a top of mind question may be, "Will there be a Christmas rally?"

From what we can observe from Chart 13, ranges are still in place on the S&P/ASX200 index. Unless we see the index breaking above around the 7100, prudence remains.

Chart 13: S&P/ASX 200; Source: IRESS

Options Corner

(For wholesale investors. Note TMD in disclaimer)

Investors who use options as part of their portfolio construction, can do more with just buying stocks with no protection. A Buy-Write strategy (Buy stock and Write/Sell Call options) could provide a more balanced risk/reward outcome. This strategy works well over side ranging stocks, especially those with good yield (and franking credits). The option premium provides some extra income which works as a downside buffer whilst stock ownership allows for entitlement to upcoming franked dividend. Good candidates are those sold down in the current environment like energy stocks where the recent “conflict premium” are traded out with upcoming dividends in the February reporting season in Australia.

Chart 14: Buying Shares and Writing Call Options; Source: OptionsWise, page 98