SPY: Is a Correction on the Horizon?

Throughout 2023, the U.S. stock market experienced several micro-cycles. From January to July, the SPDR S&P 500 ETF Trust (SPY), which tracks the performance of the S&P 500 index, advanced over 19% on a total return basis. However, in late October, nearly half that momentum had withered, with the Index briefly plunging into correction territory, indicating a 10% decline from July's peaks.

The rising bond rate between late July and October contributed to the recent correction. The three-month period provided an adequate opportunity for investors to pivot away from stocks. Adding to the investors’ worries was Chair Jerome Powell’s comment: “The question of rate cuts just doesn’t come up.”

October witnessed the weakest performance in the S&P 500 since 2018 – its third successive month of contractions. This decline was perhaps predictable, considering the economic forecast concerns, stubborn inflation rate, prolonged apprehension over Federal Reserve policy rates, and geopolitical turmoil.

The financial picture brightened in November when stocks rallied robustly, nearly restoring the S&P 500 to its July peak. Making an impressive rebound in just 16 sessions, the S&P 500 effectively exited its correction phase, marking the swiftest turnaround since the 1970s.

As evidence of an overheated economy finally began to cool, investor tension eased, and the S&P 500 got a significant boost, surging by 8.5%. This surge brought its progress close to a 20% year-to-date increase, coinciding with the 10-year Treasury rates plunging below 4.5%.

Furthermore, another lower-than-expected inflation reading offers a flicker of hope that the contentious battle against inflation might soon abate.

As the Thanksgiving holiday curtails November's U.S. trading week, investors are waiting to see if this resurgence in the stock market will endure until year’s end.

So, is the pathway clear?

While drawing definite conclusions could be too soon, let’s look at some promising indications suggesting the rally could persist until the close of the year…

After the Fed’s 20 months of stringent monetary policy tightening, it remains unclear to officials if the financial conditions are sufficiently restrictive to control inflation – a rate seen as surpassing the central bank's 2% target.

Despite this uncertainty, the Fed maintains interest rates within the expected range of 5.25%-5.50%. Chairman Jerome Powell has not dismissed the possibility of further monetary tightening, leaving markets to ponder possible future actions of the Fed.

Forthcoming economic indicators will primarily guide decisions regarding future rate hikes. Depending upon inflation trends, there is potential for introducing interest rate cuts during the second quarter of 2024 or the following months.

If the Fed successfully facilitates a "soft landing" for the economy, implementing rate cuts while avoiding a recession, this could potentially set off a stock market rally. Conversely, investors might encounter unexpected skepticism if economic growth continues at its current pace and inflation returns in the following months.

Consumer spending is paid attention to, which, till now, has been crucial for sustaining economic growth amid climbing interest rates that often lead to economic slowdown. Historically, November has proven to be a strong month for the S&P 500, with an average yield of 0.88%, making it the third most lucrative month.

Historically, the S&P 500 recorded positive returns 68% of the time during Thanksgiving week, an achievement exceeding the average week. The sales recorded during Thanksgiving and Black Friday act as a barometer of market sentiment. Strong retail figures may herald the beginning of a robust shopping season, potentially boosting stock prices.

U.S. consumer spending accounts for about 70% of the economy. However, core U.S. retail sales registered a marginal increase of just 0.2% in October as higher borrowing costs and persistent effects of inflation curbed spending, leading to struggles for retail stocks. An uptick in sales could lay the groundwork for a December rally.

Displaying a notable robustness, the U.S. economy has continued to grow at over 2% annualized pace in the first and second quarters of 2023, surging to a 4.9% annualized growth rate in the third quarter. There is additional optimism as the GDPNow forecast for the fourth-quarter GDP has been revised upward to 2.1%.

Favorable economic circumstances like a robust employment market coupled with a resolute trend in consumer spending have contributed significantly to the sustainability of this positive economic momentum. Corporate earnings, too, reflected optimistic trends in the third quarter, a sign that economists regard as propitious.

Analysts are hopeful for a mildly favorable turn in earnings moving forward. While current economic metrics remain somewhat subdued, they do not signal an impending recession. Consequently, the equity market remains a scene of active engagement.

However, should investors be more cautious? Quite likely. Let’s understand why…

This year's most optimistic occurrence was when the small-cap stocks in the Russell 2000 significantly eclipsed the returns of the SPY. Especially notable is the seemingly undervalued status of the small-cap index, which further intensifies with prospective Fed’s interest rate cuts scheduled for the first half of 2024. Historically,  debt-heavy small-caps perform well during Fed-induced rate reductions. Consequently, small-caps could potentially witness a significant boost as investors begin to speculate on the completion of the Fed's interest rate hike cycle.

The sign of an assuredly bullish market is the heightened risk appetite, funneling investors toward smaller, growth-oriented companies. This pattern aligns with the traditional long-term advantage of small caps over large caps, an edge not witnessed in recent years.

However, certain risks continue to loom. Most significantly, small-caps' vulnerability to recessions.

Despite Russel 2000’s attractive valuation, large-cap stocks have carried on their ascent while small caps are again underperforming, sparking questions regarding the genuine bullish nature of this market.

SPY’s promising gain offers encouragement. This arises from the fact that it's challenging to maintain a confident bullish stance when all the gains are primarily accruing to the so-called ‘Magnificent 7’, previously known as FAANG. These stocks have mainly driven the market-cap-weight gain in the S&P 500 in recent years, leaving the rest of the stock and bond market on the sidelines.

Over the past year, one prevalent error among investors was underestimating the potential rise in price-to-earnings multiples, particularly for large-cap and mega-cap stocks like those comprising the ‘Magnificent 7.’

Furthermore, the era of viewing stocks as the sole viable investment option has waned. For the past two years, investors have experienced attractive returns through bonds or even by allocating a portion of their portfolio to a money-market fund, with several offering yields exceeding 5%.

Bottom Line

Within just three weeks of November, a significant shift occurred — from initial skepticism about the bull market's validity to witnessing its first correction and ultimately seeing the S&P 500 Index rise to a new historical peak. A swift recovery saw stocks rise again, erasing the memory of the recent correction.

Every sector within the S&P 500 Index closed in positive territory, with more cyclical and economically sensitive industries leading the charges. This demonstrates the enduring expansion and robustness of the bull market, which, up until recently, has primarily been propelled by the strong performances of ‘Magnificent 7.’

With the current bullish trend and the anticipated positive impact of the holiday season, stocks could maintain their rally, even reaching previous high levels.

Bank of America Corporation's strategists suggest that due to U.S. companies' resilience in dealing with higher rates and macroeconomic disturbances, the S&P 500 is on track to reach a fresh peak in 2024. Meanwhile, RBC's projection for the SPY's EPS in 2024 stands at $232, indicating a promising trajectory for additional gains in the coming year.

However, the existing price of the index appears to already factor in the expected recovery in the SPY's forecasted EPS for 2024. Therefore, it may not be sufficient to drive the index's growth at this year's remarkable pace. It should also be noted that potential factors like a recession or emergent political or geopolitical unrest could pose further complications. Therefore, investors should tread with caution.

SPY: Mapping the Road to Recovery - Strategies for Cautious Investors

Paradoxically, the season traditionally associated with the supernatural often aligns with a propitious period for Wall Street. This is due to the 'Halloween Effect,' which generally casts a favorable light on financial markets. However, this was not the case in October, which proved somewhat unsettling for investors.

The SPDR S&P 500 ETF Trust (SPY) witnessed a decline in October, marking its third consecutive loss-registering month and the most prolonged losing streak since the beginning of the pandemic in 2020. Given the global upheavals, this decrease was not entirely surprising.
The Russia-Ukraine conflict, geopolitical tension in the Middle East, and rising interest rates have negatively affected financial markets. As October's harsh investment climate subsides, investors should prepare for possible additional volatility in November, known historically as one of the stock market's most fluctuant months.

The U.S. stock market indices rallied nearly 2% intraday amid positive quarterly financial results and expectations that the Federal Reserve has concluded its interest rate hike campaign. The S&P 500 rallied by 79.92 points or 1.89%, reaching 4,317.78.
Let’s look at some key factors that contributed to the recent market downturn and the potential implications they may hold for the near future. These will undoubtedly serve to drive future investment strategies:

Interest Rate Hikes

Nearly 20 months into the Federal Reserve's rigorous monetary policy tightening, it remains ambiguous to officials whether financial conditions are adequately restrictive to control an inflation rate viewed as exceeding the central bank's 2% objective.

The Fed kept the interest rates steady within the 5.25%-5.50% range, as predicted. Chair Jerome Powell has not ruled out further monetary tightening measures. Most investors have interpreted these elevated interest rates as precursors to a significant economic cooldown from a robust rate of 4.9% recorded in the third fiscal quarter of 2023.

Incoming economic indicators will chiefly influence decisions concerning future rate hikes. Depending on inflation trends, there is potential for interest rate cuts to be introduced during the second quarter of 2024 or in subsequent months. If the Fed manages to usher the economy towards a "soft landing," implementing rate cuts while skirting a recession, this could potentially trigger a stock rally. However, should economic growth maintain its current momentum and inflation revive in the ensuing months, investors could face an unforeseen disenchantment.

Bond Rate

The Fed’s interest rate hike measure serves as a tactic to raise borrowing costs, consequently moderating economic activity and curbing inflation. Since inflation remains above its 2% target, it is plausible that interest rates will maintain their elevated status for an extended period.

Growing concerns about the longevity of these heightened interest rates have spurred a persistent rise in the U.S. 10-year yield. Moreover, robust U.S. retail sales, labor market data, and inflation figures exceeding expectations have contributed to this yield surge.

After remaining below 4% for most of the year, 10-year U.S. Treasury note yields crossed 5% – the first in 16 years. The recent escalation in interest rates across multiple bond market segments may be attributed to a combination of factors that have transformed the investment landscape.
As of the beginning of October 2023, yields on short-term debt securities persist at an elevated level, culminating in an unconventional investment climate that prompts investors to consider the optimum positioning of assets within fixed-income portfolios.

Three primary factors underpin the current leap in bond yields — the Fed's assertive approach to quelling inflation, the formidable strength of the U.S. economy so far into 2023, and an increasing supply of U.S. Treasury securities.

However, despite bond rates retreating after breaching the 5% level, the stock market has failed to bounce back as anticipated. There exists a possibility of bond rates recovering once again. Currently, investors are adopting a wait-and-see strategy, interested in discerning what transpires next.

Job Growth

The job market report surfaced amid the pivotal moment in the marketplace following the Fed's recent policy verdict. It exposed a deceleration in job creation across the U.S. economy for October, confirming the prevailing anticipation for a slowdown. This may alleviate pressure on the Fed in their ongoing efforts to combat inflation.

According to the Bureau of Labor Statistics, nonfarm payroll growth totaled 150,000 in October, while the unemployment rate escalated to 3.9%. The unemployment rate has reached its highest since January 2022, as last month's auto strikes negatively impacted the labor market.

Wages, a critical variable for tracking inflation and assessing worker leverage in the labor market, rose at a softer-than-anticipated pace last month. Average hourly earnings increased 0.2%, less than the projected 0.3% increase, whereas the 4.1% year-on-year increment slightly exceeded forecasts. Concurrently, the average working week slightly dipped to 34.3 hours.

ISM Manufacturing

Institute for Supply Management has reported alarming contraction within the manufacturing sector, triggering renewed anxiety about a potential recession. The ISM manufacturing index dropped to 46.7% last month, compared to September's 49% reading. The data was weaker than expected, as economists predicted it to remain stable.

While an index below 50 might be viewed positively by some, indicating a slowing economy that could reduce inflation and potentially hasten Fed rate decreases, others are cultivating fears of an impending recession that could devastate stock value.

ISM Services

Services demand initially surged as American consumers readjusted to pre-COVID-19 life. However, this growth appears to have plateaued, with consumer preference again favoring goods over services. Expenditure on goods drastically exceeded outlays on services in the third quarter.

The services industry, constituting two-thirds of the U.S. economy, experienced its second consecutive month of slowdown in October. However, projections indicate potential momentum recovery in the future attributable to increased growth in new orders.

The ISM non-manufacturing PMI recorded its five-month low, falling to 51.8 from 53.6 in September. The Services PMI has been on a downward trend since experiencing a six-month peak in August.

New orders received by service businesses increased to 55.5 last month, though export orders suffered, reflecting the dollar's increasing potency against the currencies of the U.S.' principal trading partners.

Meanwhile, services inflation persisted, creating challenges for the Fed's efforts to reduce inflation to its 2% target. The prices of services proved less responsive to interest rate increases. The measure of prices paid for services businesses for inputs decreased slightly to 58.6.
Ultimately, the declining services PMI could signal a worrying contraction in the services sector that may deter investors and negatively impact stock prices.

CPI Report

The Consumer Price Index (CPI), a key indicator of economic health, has significantly decreased post its summer 2022 peak, which marked a forty-year record high of 9.1%. The CPI observed a 0.4% month-to-month increase in September and a 3.7% year-over-year increase.

However, the continuous elevation of energy and food commodity prices has triggered concerns regarding potential inflation. A sustained surge in fuel and food costs has the potential to undermine recent advances in mitigating inflation rates. Similarly, the ongoing Israel-Hamas conflict adds another level of uncertainty due to potential disruptions this could cause in the global energy market, particularly if the violence escalates to destabilize the oil-rich Middle East.

Considering these factors, inflation levels may remain elevated over a more extended period than what is currently projected by financial markets. This could necessitate the Fed to increase interest rates and maintain them at these higher levels over an extended duration.

If this circumstance arises, it would indicate that the Fed's battle against inflation is far from over. This could undermine investor confidence in the stability of the financial market.

Q3 Earnings Season

As Wall Street sails into the third quarter's reporting season, investors are keenly anticipating earnings slated for release in November. Analysts' predictions for the quarter have taken a significant upturn, with current projections anticipating a year-over-year earnings growth rate of 2.7% for S&P 500 firms, according to data by FactSet.

Bottom Line

Amid forthcoming U.S. polls, shifting monetary policies, and mounting Middle East tensions, a general air of unease is inescapable in the current climate. Citigroup Inc's Jane Fraser said, “We’re sitting here with a backdrop of the terrorist attack in Israel and the events that have unfolded since, and it’s desperately sad. So, it’s hard not to be a little pessimistic.”

Experts are slowly retreating from their predictions of a soft landing on the economic front, with a growing faction anticipating a significant downturn by 2024. Paul Singer from Elliot Management speculates that such a decline or a noticeable recession might encourage the Fed to reduce interest rates to as low as 1%-3%, a figure considerably lesser than projections for future interest rates. Citing fears of an increasingly volatile global economy, Singer urges investors to tread cautiously.

In addition to deteriorating manufacturing and services PMI, the consumers, accountable for approximately 70% of the economic activity, are under substantial duress. Credit card debt and auto loan balances have reached historical highs while student loan repayments – after more than three years of taxpayer-funded pause – resume for over 40 million Americans. These mounting financial pressures, coupled with high interest rates, are creating formidable economic challenges that could likely impact earnings moving forward.

The rise of U.S. Treasury yields amplifies the allure of bonds over stocks, exacerbating a pre-existing equity sell-off and potentially impacting long-term equity performance. There is very little risk premium in buying the S&P 500 compared to the “risk-free” rate provided by U.S. Treasuries.
Current equity valuation perhaps relies heavily on unrealistically optimistic earnings estimations. If higher interest rates do indeed dampen the economy's pace, as many analysts predict, achieving the desired targets might become an uphill task. The S&P 500 companies, according to LSEG IBES, are projected to escalate their earnings by 12.1% in 2024. Should excessively high interest rates persist, attaining such targets appears challenging.

SPY Set To Lose Its Crown

Since 2017, the King of the Exchange Traded Fund world has slowly been losing ground to its closest competitors.

The SPDR S&P 500 ETF Trust (SPY), the undisputed ETF King since ETFs became popular, is set to lose its crown within the next few years. Well, perhaps it would be better to say that it will lose one of its crowns or maybe one of its world titles while still holding a few others. Let me explain...

The SPY ETF is and has been, with the exception of just a handful of months over the last 20-plus years, the largest Exchange Traded Fund in terms of assets under management. Currently, SPY has $365 billion under management.

In contrast, the next closest competitor, iShares Core S&P 500 ETF (IVV), has $298 billion, and then there is the Vanguard S&P 500 ETF (VOO) at $264 billion in assets.

The SPDR ETF has more than $65 billion in assets compared to the second largest ETF and more than $100 billion compared to the third largest ETF. So why are there predictions that its competitors will overtake it in the coming years?

First and foremost, since 2017, it has been losing ground to IVV and VOO, and based on results from the first half of 2022, the trend doesn't appear to be changing. VOO has added $29.2 billion in assets year-to-date, while IVV has added $15.7 billion. On the other hand, SPY has lost $22.7 billion. Continue reading "SPY Set To Lose Its Crown"

How Well Has Your Portfolio Done Year-to-Date

The first six months of 2019 have been odd, but there is never a better time than now to look at where your money is and how it has performed as we pass over the half-way point of the year.

The year started with the markets rallying back after a disastrous end of 2018, then the trade wars heated up, the economy has begun showing signs of weakness, the Federal Reserve is holding off on interest rate increases and even considering rate cuts, but the markets continue to set new record highs.

If you have been heavily invested in certain sectors you have had a losing 2019, maybe a mediocre year or a great year. On July 1st, the SPDR S&P 500 ETF Trust (SPY) was up 17.42% year-to-date. All of the major indexes and their corresponding Exchange Traded Funds have performed well during the first half of the year. The SPDR Dow Jones Industrial Average ETF Trust (DIA) is up 15% year-to-date, while the Fidelity NASDAQ Composite Tracking Stock (ONEQ) is up 19.92% year-to-date. Even the broader indexes and their ETF’s such as the iShares Russell 1000 ETF (IWB) or the Vanguard Russell 3000 ETF (VTHR) are up 17.53% and 17.47% as of the morning of July 1st.

While the indexes all performed better than average years, if you were more industry-focused then as I said before, it depended on what industry you wherein during the first half of the year on whether or not you kept up with the market. The worst performing ETF during the first half of the year, outside of leveraged or any specialty products focusing on futures, was the Breakwave Dry Bulk Shipping ETF (BDRY) which has lost 29.22% since the start of 2019. The best performing ETF following the same guidelines was the Invesco Solar ETF (TAN), which is up 47.22% in 2019. Continue reading "How Well Has Your Portfolio Done Year-to-Date"

Should You Own ETFs In A "Stock Pickers Market"

Most Wall Street participants believe 2019 will be a “stock pickers” year; So how will that affect Exchange Traded Fund investors?

Well first off, what is a “Stock Pickers” market or year? That is a market in which to make a decent return; investors will need to pick individual stocks, not just buy the market as a whole or an index such as the S&P 500 or Dow Jones. At this point, most Wall Street analysts believe the major market indexes will end the higher just slightly higher. In mid-February, Goldman Sachs analyst posted a note indicating they think the S&P 500 will only climb to 3,000 by the end of the year, but the next few months could be flat.

Vanguard went a little further and said it believes the market will only return roughly 5% median annualized return over the next 10 years. Vanguard’s opinion paints an even worse picture than Goldman’s and hints at the idea that investors will need to be “stock pickers” for the next decade if they want to see returns greater than 5% annualized.

So, the experts are telling us that investors need to cherry pick individual stocks if they want to make a real-return greater than a few percent over the next year or maybe more. But what if they don’t know how to find and pick market-beating stocks, they need not worry because that is why actively managed ETFs where created. Continue reading "Should You Own ETFs In A "Stock Pickers Market""