The U.S. stock market just had its best week of 2023 as Treasury yields slumped, raising hopes of an imminent year-end “Christmas rally.” Scrooge says there is still a lot in the way.
“I don’t believe in this recovery and I don’t think we’ll see a year-end rally,” Jason Hsu, chief investment officer at Rayliant, said in a telephone interview.
See: Dow posts best week since October 2022 as stocks rise following soft jobs report
Doubters contend that early signs of a slowdown in the labor market, which is currently bolstering market expectations that the Federal Reserve is done raising interest rates, will likely lead to an outright slowdown in the coming quarters, curbing consumer spending and hurting corporate profits.
Bulls counter that consumers are doing well after posting remarkably strong gross domestic product growth in the third quarter that contradicted economists’ forecasts that the U.S. was now in recession. Consumer spending remained robust, rising 4% from July to September.
Pessimistic investors see difficulties in consumer loans. “The data suggests that the consumer is maxed out when it comes to creditworthiness,” Hsu said.
Consumers previously hit by pandemic stimulus payments are increasingly relying on credit cards to fuel their spending. Revolving credit’s share of personal spending is below pre-COVID-19 levels, but the trend is “concerning,” Michael Reid, U.S. economist at RBC Capital Markets, said in a note.
Keywords: Target’s CEO says consumers are cutting back — even on grocery spending
Personal interest payments as a share of disposable income reached 2.7% in September and will continue to rise as federal student loan payments resume, Reid said. As monthly interest payments rise, consumers will need to continue investing in savings to maintain current spending levels (see charts below).
“With little scope for savings to fall further, the current path is unsustainable,” Reid said.
Economists will be keeping an eye on the Fed’s November 7 consumer credit report for September.
See: Spending like crazy? Struggling between paydays? Consumers are sending mixed signals ahead of the holidays
Most of the third-quarter earnings reporting season is now in the rearview mirror. Bearish investors focused on weak forecasts about the potential for a weaker economy.
Analysts in October cut fourth-quarter earnings per share estimates more than average, according to John Butters, senior earnings analyst at FactSet.
Bottom-up fourth-quarter earnings per share estimates fell 3.9% between Sept. 30 and Oct. 31, he said. Typically, analysts lower the bar in the first month of a quarter, but not by this much. Butters noted that the average decline in earnings estimates in the first month of a quarter has averaged 1.9% over the past five years and 1.8% over the past decade.
A weakening consumer likely means there will be disappointment on the earnings front in the coming quarters, Hsu said, even as executives try to steer investors toward a “hard landing.”
So what helped stocks have a standout week? Just as a rapid rise in long-term Treasury yields was the main reason the stock market slipped from its 2023 peak in late July, a sharp decline in yields last week gave stocks room to recover.
After briefly exceeding 5% last week for the first time since 2007, the 10-year Treasury yield BX:TMUBMUSD10Y fell 28.9 basis points this week, marking its biggest weekly decline since the period ended March 17.
This has been one positive catalyst after another for bond bulls over the past week. The U.S. Treasury on Tuesday laid out plans for fewer bond issuances at the long end of the yield curve than expected, and labor market data, particularly Friday’s jobs report, showed some signs that a robust labor market may be starting to show signs of slowing.
The big event came on Wednesday when the Fed left interest rates unchanged as expected and Chairman Jerome Powell left the door open for another rate hike but did not commit to one. That led to investors widely declaring that the Fed was done raising interest rates – an assumption that some investors say will almost certainly prove premature.
It was a backdrop that allowed stocks to post a big bounce a week after corrections in the S&P 500 SPX and the Nasdaq Composite COMP – a 10% decline from their 2023 highs. The Dow Jones Industrial Average DJIA rose last week, up 5.1%, the largest such increase since the week ending October 28, 2022. The S&P 500 SPX rose 5.5% and the Nasdaq rose 6.6% – their biggest weekly gains since last November.
Previously nervous bulls now see a clear path to a year-end rally.
November and December were historically the best two months on the calendar, with an average increase of 3% and positive performance 75% of the time, Mark Hackett, head of investment research at Nationwide, noted in a note.
Additionally, the market’s “relief rally” had “some notable echoes of the market bottom a year ago, with extreme weakness in momentum and sentiment indicators,” Hackett wrote. “The robust macroeconomic backdrop, strong seasonality and improving valuations should provide tailwinds through year-end.”
Technical analysts said the market’s recovery, particularly the S&P 500’s 1.9% rise on Thursday, helped lift the charts. The rally also came when markets were significantly oversold and bearish sentiment was extreme, which can be contrarian catalysts for a rally.
However, there is more work to be done to overcome the gloom, Adam Turnquist, chief technical analyst at LPL Financial, said in a note Friday.
Thursday’s rally pushed the S&P 500 back above its closely watched 200-day moving average of 4,248. That’s a “step in the right direction,” but a close above 4,400 will be needed for the index to reverse the emerging downward trend, Turnquist said, noting that market breadth remains disappointing and less than half of stocks are the S&P 500 is trading above the 200-day moving average.