Investing Environment Review and Outlook – Volume 76
- U.S. Equities Shift to Bullish 5 Rating
- U.S. Treasury Bonds oversold extreme: Bullish
- Gold Futures Traders Short: Bullish
- Weak European Investor Confidence: Bullish
The human tragedy of war is a constant over time. However, market impacts can be vastly different. The October 1973 Yom Kippur War, when Israel was invaded by Egypt and Syria, was followed by a quick 10% S&P 500 decline. The 1990 Iraqi invasion of Kuwait was followed by a U.S. bear market and recession. In both cases the price of oil spiked (up 4x in 1973 due to an Arab Oil Embargo and doubled in 1990 from $20 to $40 a barrel). In January 1991, the U.S. responded with an invasion of Kuwait. In that case equity markets rallied sharply and began a new bull market. While the escalation and wider involvement of the war is unknowable, transmission mechanisms like commodity prices, interest rates, and international equity indices are predictive signposts.
In this case, despite intense world interest in the Israel Hamas war, new signals have been muted. For instance, since the war started, crude oil rallied just $6, not even breaking the $92 September peak. Rising Treasury bond yields are more of a concern, but that upward trend was in place before the war started.
Last month, we discussed the investment implications of recent moves higher in the dollar, crude oil and inflation. This month, we discuss the positive conditions for equities despite the extreme move in bond yields, the negative positioning in gold, and the counter intuitive bullish conditions for European equities. We raised U.S. equities to a bullish 5 rating. Foreign-developed and emerging markets equities remain bullish 5 ratings. Long-term bonds remain a neutral 3 rating. Gold remains a bullish 5 rating. Lastly, we cut industrial commodities to a bullish 4 rating.
Raising S&P 500 Rating to a Bullish 5: Goldilocks in Q4
In July with the S&P 500 up 19% YTD, investment conditions were neutral. Since then, there was a typical 3-month consolidation period when the S&P 500 declined 6.7% and the Russell 2000 declined 14.3%. Despite the daily headlines of war, recession and inflation, equity market conditions have shifted bullish once again. The historical combination of slow growth and neutral inflation outlook indicators resulted in an S&P 500 return of 16.6% vs. the norm of 10.5% since 1973. It is counter intuitive for most investors to view slower growth as a positive. In fact, it is the STRONG growth periods, historically, when equity returns turn negative, particularly if accompanied by rising inflation. Today is the opposite. Combine these bullish economic conditions with low investor positioning in the fourth quarter and you have strong historical odds of equity upside through year end. The spike in the 10-year yield is certainly an offset for now, holding equities back, but any reversal will act like a spring for equities to the upside.
Bonds Oversold Extreme: Bullish
U.S. Treasury yields are up a full 1% from 3.8% to 4.8% just since July. Bond futures have only been this weak less than 1% of the time back to 1980. When this type of weakness occurred in the fourth quarter, typically yields were close to a reversal. In this case more fundamental bond indicators like weak industrial metals and weak equity markets are pointing to lower yields, making a reversal in yields and rise in bond prices more likely.
Treasury Bond Supply: Not the Bearish Impact Assumed
One of the media stories explaining the move is Treasury issuance of bonds overwhelming demand. It sounds logical that an increase in supply of bonds will cause a lower price (and consequent higher yield). However, a look at history shows many cases of the opposite, when a large supply of government bonds like we saw during the 1980’s deficits is often accompanied by falling interest rates. Higher bond supply during deficits in 2008-2010 was also accompanied by falling interest rates, so history does not support the case.
S&P 500 up 10% in First Half: Bullish for Q4
It is no secret that stocks tend to rise in the fourth quarter (up 79% of the time since 1950). However, conditions are even better this year. In the 22 prior years since 1950 when the S&P 500 rallied over 10% in the first half (up 15.9% this year), Q3 often consolidated (as it did this year falling 3.7%) with an average return of just 1.5%. Q4 was even stronger than the norm, with an average return of 6.1%. 86% of cases were higher. The outlier was 1987 when the market crashed and finished the quarter off 23.2%. Conditions were different that year, including a 10-year yield reaching 10%, double this year.
Gold Futures Traders Positioning: Bullish
The recent 13% decline in gold from May to October was followed by traders cutting positions. In the last 10 years positioning this low was followed by higher gold prices.
Treasury Yield Inversely Correlated to Gold Price
The 13% decline in gold from May to early October was accompanied by the large rise in the 10-Year Treasury Yield (inverted on this chart). A further rise in the 10-year yield would be negative for gold, but an oversold reversal in bonds, as we discussed, would be a big positive for gold prices.
Weak European Economy and Investor Confidence: Bullish for Equities
By almost any measure, the European economy is weak. For instance, Germany’s GDP was negative in 3 of the last 5 quarters since Russia invaded Ukraine. The September German manufacturing purchasing managers index was 39.6, weaker only during recessions in 2020 and 2008. The September Sentix European Investor Confidence Index was -21.5, in the bottom 20% of readings since inception. Following the weak economy and underperformance to the U.S., many investors have reduced their exposure to European equities. While logical, historical observations show that a weak economy and even low investor confidence was bullish for German equities like the DAX Index. For instance, when the German Purchasing Managers Index was below 47, the DAX returned 11.8%, over 2x the norm since 1998. Likewise, the DAX returned 24.9% since 2002 when the Sentix was below -15, over 3x the norm of 7.0% over that period. In other words, despite the pervasive investor gloom, equities rallied when faced with these economic conditions historically.
This month we discussed the renewed bullish conditions for U.S. equities after a 3 month consolidation period, despite the heightened geopolitical risk from the Israel Hamas war. In addition to the economic conditions, low investor positioning in the fourth quarter further increase the odds of upside through year end. Similar conditions exist in Europe, with low investor confidence and a weak German PMI testing well for the DAX Index of German stocks. Gold remains a bullish 5 rating partly due to the low investor positioning there, as well, following the 13% decline from May to October. We will continue to watch our indicators on a daily basis and shift exposures as needed. Thank you for your support and please contact us with any questions.
This review and outlook report (this “Report”) is for informational, illustration and discussion purposes only and is not intended to be, nor should it be construed as, financial, legal, tax or investment advice, of Brenton Point Wealth Advisors LLC or any of its affiliates (“Brenton Point”). This Report does not take into account the investment objectives, financial situation, restrictions, particular needs or financial, legal or tax situation of any particular person and should not be viewed as addressing any recipient’s particular investment needs. Recipients should consider the information contained in this Report as only a single factor in making an investment decision and should not rely solely on investment recommendations contained herein, if any, as a substitution for the exercise of independent judgment of the merits and risks of investments.
This material is based upon information obtained from various sources that Brenton Point believes to be reliable, but Brenton Point makes no representation or warranty with respect to the accuracy or completeness of such information. Views expressed herein are current only as of the date indicated and are subject to change without notice.
This Report contains certain forward looking statements opinions, estimates, projections, assessments and other views (collectively “Statements”). These Statements are subject to a number of assumptions, risks and uncertainties which may cause actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by these forward looking statements and projections. Brenton Point makes no representations as to the reasonableness of such assumptions or the likelihood that such assumptions will coincide with actual events and this information should not be relied upon for that purpose. Changes in such assumptions could produce materially different results. Past performance is not a guarantee or indication of future results, and no representation or warranty, express or implied, is made regarding future performance of any financial instrument mentioned in this Report.
Any benchmark shown herein is shown for illustrative purposes only. No index benchmark is available for direct investment. It may not be possible to replicate the returns of any index, as the index may not include any trading commissions and costs or fees, may assume the reinvestment of income, and may have investment objectives, use trading strategies, or have other materials characteristics, such as credit exposure or volatility, that do not make it suitable for a particular person. This is not an offer or solicitation for the purchase or sale of any security, investment, or other product and should not be construed as such. References to specific financial instruments and to certain indices are for illustrative purposes only and provided for the purpose of making general market data available as a point of reference only; they are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities. Investing in securities and other financial products entails certain risks, including the possible loss of the entire principal amount invested, as the value of investment can go down as well as up. You should obtain advice from your tax, financial, legal, and other advisors and only make investment decisions on the basis of your own objectives, experience, and resources.
Brenton Point accepts no liability for any loss (whether direct, indirect or consequential) occasioned to any person acting or refraining from action as a result of any material contained in or derived from this Report, except to the extent (but only to the extent) that such liability may not be waived, modified or limited under applicable law.
This Report may provide addresses of, or contain hyperlinks to, Internet websites. Brenton Point has not reviewed the linked Internet website of any third party and takes no responsibility for the contents thereof. Each such address or hyperlink is provided solely for your convenience and information, and the content of linked third party websites is not in any way incorporated herein. Recipients who choose to access such third-party websites or follow such hyperlinks do so at their own risk.
All marks referenced herein are the property of their respective owners. This Report is licensed for non-commercial use only, and may not be reproduced, distributed, forwarded, posted, published, transmitted, uploaded or otherwise made available to others for commercial purposes, including to individuals within an institution, without written authorization from Brenton Point.
Source of data and performance statistics: Bloomberg L.P. and Factset Research Systems Inc.
©Brenton Point Wealth Advisors LLC 2023
Director of Market Research
Michael Schaus is the Director of Market Research for Brenton Point Wealth Advisors and Zweig-DiMenna. Since joining Zweig-DiMenna in 1992, his focus has been on macroeconomic research, the analysis of…READ MORE