Seasonality Says You Should Be Bullish

You’ve probably heard the saying “Sell in May and Go Away” as stocks historically on average underperform over the 6-month period from May to October. Now that October is finally closed (good riddance), seasonality has become a bullish talking point for investors. In fact, going back to 1945, November and December combined have historically represented the best two-month period of performance for the S&P 500 with an average gain of 3.0% and positive performance 75% of the time. Bear in mind, past performance does not guarantee future performance. Thus, seasonality is just a tool and should only be used as an adjunct when assessing market conditions. Given three consecutive months of losses in the S&P 500 and a volatile October, we find it especially prudent to give you a high-level overview of key themes weighing on the market to determine whether conditions are consistent with a bullish or bearish outlook for the remainder of the year.

For starters, the sharp rise in 10-year treasury yields has been a key contributor to the recent weakness across equities. This makes it difficult to be bullish without seeing a pullback in yields. Underneath the hood, there are many fundamental reasons baked into the term premium that continue to push yields higher – we’ve written about them most recently in Tom Martin’s Spotlight “Who are the Bond Vigilantes, anyway.” Structurally, higher yields are troublesome for financial stability as it becomes more costly to borrow money and service debt. This has become even more worrisome as fiscal spending climbs and the trade deficit grows. As a country, we’re borrowing more at a higher cost, while generating less revenue. This seems unsustainable. At this point, it is difficult to determine where yields will ultimately settle out, but it is our belief that in the near-term, yields have risen too far too fast and are due for some consolidation.

We saw some reprieve in yields and a rally in equity markets after the November Fed meeting where the committee decided to hold the Fed Funds rate at 5.25-5.50. With one more meeting left in the year, fed futures reflect the notion that the Fed is done with hikes for 2023. Additionally, cuts are being priced in for the first half of 2023. Peak Fed Funds rate historically has had a positive effect on stocks, though this likely depends on the US economy avoiding a recession.

In terms of earnings, we’ve seen strong Q3 beats, however the percentage of companies issuing negative guidance is higher than the 5-year average. Coming into Q3, it was widely expected that Q4 would be the rebound quarter. Now companies are citing macro uncertainty and softening demand suggesting conditions are still tepid. Consequently, analysts are now forecasting earnings growth of 5.3% for Q4 2023 down from the 8.1% we saw on September 30. However, the historical path of estimates is to begin high and trim as the date approaches.

Year to date, growth stocks have outperformed value stocks across all market caps, as measured by the Russell indices. Additionally, we’ve seen cyclicals outperform defensives over the year. However, during the most recent pullback we’ve seen more strength out of cyclical areas, namely Staples and Utilities, after having been weak for much of the year. In fact, some oversold areas of the market are picking up positive momentum. Simultaneously, many overbought areas of the market have pulled back to more attractive levels. This coincides with seasonality acting as a tailwind. In short, the “set up” could be viewed as attractive especially when combined with sentiment, which has become quite negative. As always, we remain on high alert and nimble as we await confirmation on key indicators.

Sources: CME Group, Factset, Morningstar, Piper Sandler, Reuters, Strategas

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