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December 2023
Current Equity Exposure
Stocks rallied in November on slower-than-expected inflation data, falling Treasury yields, and speculation that the Fed will be able to pull off a soft landing. The S&P 500 and the Dow advanced 9.1% and 9.2%, respectively, while the technology-heavy Nasdaq rallied 10.8% for the month. Markets seemed to take the month’s data as an indication that the Fed will likely cut rates aggressively soon (a full percentage point cut by the end of next year is currently forecasted by the futures market). However, we do not expect rate cuts until the second half of 2024. We also believe the U.S. economy is on a weak growth trajectory with interest rates remaining high. Our market outlook remains cautious with restrictive monetary policy staying in place, expensive equity valuations, fewer tailwinds from consumer spending and tightening credit standards. Also, in our view, the market’s expectations for corporate earnings are too optimistic, with consensus implying a 10% EPS growth globally. We believe high interest rates will eat into corporate margins, and softening corporate pricing power will likely lead to margin pressures. With this backdrop, we maintain a cautious allocation to equities and keep our U.S. equity exposure at 43%. Given the relatively cheap valuations and stronger consumer and business sentiment signals in our international market timing model, our international equity exposure was higher (around 75%) during the month.
The Factors
Valuation
Valuation metrics for equity remained negative. P/E increased from 20.6 at the end of October to 21.8 at the end of November.
Forward P/E increased to 21.0 at the end of November from 19.3 at the end of October.
Inflation-adjusted valuation metrics continued to be negative.
Equity valuation metrics relative to bonds remained negative with high bond yields.
Sentiment
U.S. manufacturing activity contracted for the 12th consecutive month, with the ISM manufacturing index falling to 47.6 in October from 49 in September.
The University of Michigan Consumer Confidence Index fell again in November to 61.3 from 63.8 in October, with fear of higher inflation and elevated interest rates.
The NAHB index fell 6 points to 34 in November with high mortgage rates and poor affordability.
Technical
Technical indicators were positive overall, with positive momentum and fear signals outweighing negative reversal signals.
The S&P 500 was 7% above its 200-day moving average, 3% above the 100-day average, and 5% above the 50-day average.
The VIX index declined significantly and settled at 12.9 at the end of this month, with improved risk sentiment and low levels of realized equity volatility.
Macroeconomic
Nonfarm payrolls rose by 150,000 in October, showing signs of a cooling labor market. The four-week moving average of initial jobless claims edged higher to 220,000 as of November 25.
Retail sales weakened and fell 0.1% in October with high overall inflation and interest rates weighing on sales.
U.S. industrial production fell 0.6% in October, weaker than anticipated.
What's Driving the Markets?
Inflation surprised on the downside:The closely watched Consumer Price Index report surprised on the downside: the headline CPI was unchanged in October with a significant decrease in energy prices, resulting in year-over-year inflation down to 3.2%. Core inflation was 0.2% in October, bringing annual core CPI to 4.0%, the slowest pace since summer 2021. We expect inflation to continue to fall for the following reasons: 1) Although the CPI for shelter (about 40% of core CPI) remains a significant contributor to inflation in October, we believe that the current inflation data has not fully reflected the slowdown in rents due to a lagging effect. 2) We expect the CPI for core services excluding shelter - a key metric referred by the Fed as “supercore” to continue its downward trend. This inflation component is most sensitive to the labor market, with wage inflation playing a key role. Our wage index has declined to 4.0% YOY this month, down from its 6.0% peak in July 2022. Recent labor market data has shown signs of decelerating job growth and quit rates have fallen back to their pre-Covid level.
Fed Policy:During its November meeting, the Federal Open Market Committee (FOMC) again chose to maintain its policy rate at a range of 5.25% to 5.5%. It is increasingly likely that the current tightening cycle is done. The surging longer-term yields in October have made it easier for the Fed to keep its wait-and-see mode. The FOMC's statement and Chair Powell's press conference were viewed by the market as slightly dovish, as the FOMC acknowledged that the recent tightening in financial conditions could potentially play a similar role as further rate hikes. Fed Chairman Powell also emphasized that solid economic growth alone would not necessarily lead to additional rate hikes, highlighting the importance of various economic factors and their impacts on the labor market and inflation. Our current baseline is that the rate hike is likely done, and we predict the first rate cut to occur around mid-2024. However, we still expect a restrictive monetary policy in the year 2024.
Labor market rebalancing:The labor market has finally shown signs of cooling after the very tight market that originated from the significant mismatch between labor supply and demand during the pandemic. The October employment report from the Bureau of Labor Statistics (BLS) demonstrated that job growth has slowed meaningfully by adding 150,000 jobs in October, down from the revised 297,000 net payrolls in September. Labor demand, as measured by the Job Openings and Labor Turnover Survey, has also come down significantly from its peak (9.5 million open jobs in October compared with 12 million in early 2022). At the same time, the quits rate was back to its pandemic level and has been steady at 2.3% for three consecutive months. Another important indication of a cooler job market is the wage growth. Various measures of wages, including the employment cost index, BLS’s private sector average hourly earnings and the Atalanta Fed Wage Growth Track, all indicated that wage growth has moderated recently. We expect the job market to continue to cool down in the fourth quarter of 2023 and through 2024, which would be the most sustainable support for lower inflation.
As of 11/30/23. Data provided by Bloomberg, NorthCoast Asset Management, Federal Reserve History.
1 The NorthCoast Navigator is a market barometer displaying NorthCoast's current U.S. and international equity exposure and outlook. This aggregate metric is determined by multiple data points across four broad market-moving dimensions: Technical, Sentiment, Macroeconomic, and Valuation. The daily result determines equity exposure in our tactical strategies.
NorthCoast Asset Management is a d/b/a of, and investment advisory services are offered through, Connectus Wealth, LLC, an investment adviser registered with the United States Securities and Exchange Commission (SEC). Registration with the SEC or any state securities authority does not imply a certain level of skill or training. More information about Connectus can be found at www.connectuswealth.com.
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