Stocks: Staying Positive Into Year-End
November 2024
U.S. large cap stocks generated a negative return in October, with the S&P 500 dropping 1% to post the first losing calendar month for the Index since April. Still, October’s drop provided little for us to fret over, and as we continue to see enough encouraging signs under the surface that leave us constructive on U.S. large caps into 2025. Some measures of market breadth or participation were deteriorating as November began, but 50% of S&P 500 constituents were trading above their 50-day moving average and 70% of the index still traded above their 200-day moving average at the time of this writing. It’s the latter of these two measures that we are paying the most attention to, as pullbacks in early-August and again in early-September were not accompanied by meaningful deterioration in the percentage of S&P 500 companies trading below their 200-day moving average. In hindsight, this was technically reason enough for investors to remain invested and in position to take advantage of subsequent sharp rebounds for stocks. So long as we continue to see 60% or more of the S&P 500 trading above their 200-day moving average, a more defensive or bearish stance on U.S. large cap stocks likely won’t be justified or rewarded.
Solid, measures of participation within the S&P 500, albeit modestly deteriorating, still provide firm footing for large-cap stocks, while a continuation of the post-election relief rally should lead to improved breadth metrics this month. The November through January time frame has historically been the strongest consecutive three-month stretch for the S&P 500, and investors will likely be well-served by positioning portfolios to take advantage of a more positive seasonal environment. The liquidity backdrop should also remain supportive of risk taking as central banks across the globe ease monetary policy to varying degrees in the coming quarters, which should keep a bid under investment-grade and high-yield corporate bonds, along with stocks. Lastly, credit spreads on lower quality corporate bonds remained tight as Treasury yields rose sharply throughout October, evidence that market participants appear to see few signs of economic turbulence on the horizon and remain willing, and able, to seek out higher expected returns in riskier asset classes as a result. Market breadth will likely be the variable most worth watching into year-end for signs that a more significant pullback or correction could be afoot.
Potential M&A Uptick In ’25 Reason Enough To Stay The Course With SMid. Small and mid-cap (SMid) U.S. stocks have produced positive returns year-to-date, with the S&P Midcap 400 higher by 12.7% and the S&P Small Cap 600 turning out a less impressive 6.4% gain through October, each trailing the S&P 500’s 21% gain by a wide margin. Entering 2024, we were more constructive on SMid due to our belief that the FOMC would be easing monetary policy early in the year and that the U.S. economy could potentially reaccelerate as a result. But that’s not how the year initially played out as inflationary pressures remained ‘sticky,’ preventing monetary policy authorities from easing sooner. Small-caps finally caught a bid after the FOMC cut the Fed funds rate by 50-basis points in September as investors expected a more aggressive pace of monetary policy easing to lower borrowing costs for smaller companies which rely on shorter-term and/or floating rate debt. However, smaller companies have, so far, failed to see much benefit from rate cuts as bank lending standards have not yet begun to ease.
Small-cap stocks are often viewed as a higher beta way to play a reaccelerating U.S. economy due to larger exposures to economically sensitive sectors than the S&P 500. Given our view that the U.S. economy is settling back into a 2% GDP growth environment and is not on the cusp of reaccelerating, the economic backdrop isn’t likely to be supportive of small-cap outperformance in the near-term. However, a underweight position in small caps isn’t warranted as we expect a more relaxed regulatory regime with potential leadership changes at the Department of Justice and Federal Trade Commission to boost merger and acquisition (M&A) activity in the coming year(s), which should provide a floor of support for sectors such as financial services, health care, and industrials, among others, that are rife for consolidation and have been under a merger moratorium of sorts over the past four years.
Like the S&P Small Cap 600, the S&P Midcap 400 has substantial exposure to cyclical sectors such consumer discretionary, financial services, and industrials but is made up of generally more established and higher quality companies with greater earnings visibility. Compared to the S&P 500, the 400 can provide portfolio diversification due to greater exposure to economically sensitive sectors and far less exposure to communication services and information technology, which have powered the S&P 500 higher in recent years. While we see SMid as a mixed bag over the near-term, we maintain exposure to both small and mid-cap stocks in-line with our strategic target allocation. Investors that have been rewarded for carrying higher weights in U.S. large cap stocks in recent years may want to consider reallocating or rebalancing after another year of outsized S&P 500 performance in advance of what could be an active environment for M&A activity in the coming year.
U.S. Election Outcome Clouds The Near-Term Outlook For Markets Abroad. Foreign stock markets don’t usually perform well on a relative basis when the U.S. dollar (USD) is strengthening, which generally signals that either U.S. economic growth is expected to outpace growth abroad to the point that foreign investors are increasing exposure to dollar-denominated assets to take advantage of stronger U.S. growth, or that capital is flowing into the U.S. from abroad as a defensive or de-risking move. In October, the U.S. Dollar Index, or DXY, posted its largest monthly gain in over a year, rising from $100.78 to $103.98 due in part to markets pricing in some combination of faster U.S. growth and higher inflation as polling data pointed toward a higher probability of a ‘Red Sweep’ which is what materialized. Political uncertainty may have lessened stateside, but the impact of policy uncertainty stemming from the election on our trading partners can’t yet be fully understood and priced in. Investors may believe they are best served to maintain a sizable U.S.-bias in their equity portfolios as they await clarity on the policy front before allocating additional capital abroad.
The election outcome is likely to weigh on investor sentiment surrounding both developed and developing markets abroad over the near-term as uncertainty lingers well into 2025.With global liquidity likely to rise into year-end as central banks ease monetary policy, capital is more likely to make its way into the U.S., buoying U.S. large-caps first and foremost, followed by U.S. Smid, as a play on an improved U.S. economic outlook. The potential for more protectionist U.S. trade policies, including expanding tariffs on a broader swath of imports from China, the Eurozone, and Mexico, could pose a headwind for foreign stocks well into 2025 and could buoy the U.S. dollar until some degree of comfort surrounding the path forward on the trade front can be achieved.
