Slip-Sliding Through Sector Rotation

Key Concepts

• Market Volatility: Fluctuations in market prices, currently characterized by "cold winds of volatility" and a "chill" in the markets.
• Correction: A decline of 10% or more from a recent peak.
• Inflection: A point where a trend changes direction.
• Sector Rotation: The movement of investment capital from one industry sector to another.
• Bonds: Fixed-income securities, specifically government and corporate bonds, which have been in a bear market for five years but are now rallying.
• Bloomberg US Aggregate Bond Index (Agg): A broad measure of the U.S. investment-grade bond market, up 6.7% year-to-date.
• Federal Reserve (Fed): The central bank of the United States, whose anticipated rate cuts are influencing bond markets.
• Inflation: A general increase in prices and decrease in the purchasing value of money.
• Two-Speed Economy: An economy characterized by differing performance between high-income and low-income segments.
• Equity ETFs: Exchange-Traded Funds that track equity indexes, experiencing record inflows.
• AI Bubble: Concerns about overvaluation in artificial intelligence-related stocks.
• Price-to-Sales (P/S) Ratio: A valuation metric that compares a company's stock price to its revenue per share.
• Price-to-Earnings (P/E) Ratio: A valuation metric that compares a company's stock price to its earnings per share.
• Weight of the Evidence Approach: A methodology that combines historical data, economic cycles, fundamentals, and technicals to inform investment decisions.
• Diversification: Spreading investments across different asset classes, sectors, and geographies to reduce risk.
• Nvidia: A prominent technology company whose earnings report is a key focus for the week.
• Case Freight Index: An indicator of shipment volumes, currently showing a decline.
• People Magazine's Sexiest Man Alive: Used as a non-scientific recession indicator.

Market Volatility and Potential Causes

The current market environment is characterized by significant volatility, described as "cold winds" and a "chill." This has led to a shaky market over the past couple of weeks, with some ground recovered after a recent sell-off. The transcript explores whether this volatility is normal, a correction, an inflection point, or simply sector rotation.

• S&P 500, NASDAQ, and Dow Industrials: All have experienced slight declines over the past five days.
• October 29th Volatility Onset: Since this date, the S&P 500 is down 2.3%.
• Normal Volatility: Volatility is considered normal, especially as the current bull market is entering its fourth year.
• Historical Perspective on Corrections: Sam Stovall of CFRA notes that since World War II, average declines following post-recession recoveries have been less than 10%. A 10% reversal or correction is considered normal.
• Infrequent Corrections: The market has only experienced two corrections since the 2022 bear market, which is considered unusual. Historically, bull markets typically see three to five corrections.

Investor Behavior and Asset Flows

Investors have shown a strong inclination towards risk-on assets, particularly equities and technology.

• Record Inflows: There have been record inflows into equity ETFs and the technology sector.
• Outflows: Money has been flowing out of real estate and small caps.
• Bond Rally: Despite the strong equity performance, bonds have also rallied, which is unusual. The Bloomberg US Aggregate Bond Index (Agg) is up 6.7%.
• Agg Index Composition: The Agg includes U.S. government securities, government-related debt, corporate bonds, and securitized debt.
• Reason for Bond Rally: The anticipated Federal Reserve (Fed) rate cuts are driving the bond rally. Lowering interest rates typically increases bond prices.

Expert Insights: Keith Lerner of Truist Wealth

Keith Lerner, Chief Investment Officer and Chief Market Strategist at Truist Wealth, provides a detailed perspective on the current market conditions.

• Bull Market Bias: Lerner maintains a bull market bias, viewing the current pullback as a "reset of prices that got stretched a little bit and sentiment that became a little bit one-sided."
• Two Steps Forward, One Step Back: He emphasizes that market movements often involve setbacks, and the lack of a significant pullback since April is more unusual than the current volatility.
• Fundamental and Technical Analysis: Lerner advocates for a combined approach, integrating fundamental analysis (company profits) with technical analysis (price trends).
• "Admission Price" for Returns: Pullbacks are seen as the "admission price" for potential higher long-term equity returns.
• Weight of the Evidence Approach: Truist Wealth uses this framework, combining history, economic cycles, fundamentals, and technicals to make higher-probability decisions.
• Two-Speed Economy: Lerner describes a two-speed economy where the high end (stock market wealth, housing wealth, stable jobs) is doing well, while the low end is feeling squeezed due to slower wage growth and persistent inflation. He expects this to continue into next year.
• Focus on Profits: Despite economic uncertainties, Lerner emphasizes focusing on corporate profits as the "north star" of the bull market.
• Historical Bull Market Performance: Since 1950, bull markets that have reached three years old have historically seen positive returns in the following year.
• Modest Equity Bias and Team USA: Truist Wealth leans towards a modest equity bias, favoring U.S. equities despite international outperformance.
• International Exposure: They have increased international exposure, noting that over 90% of tracked countries are in uptrends.
• Diversification: Diversification is seen as working this year and expected to continue working next year.
• Globally Diversified Portfolio: For investors, diversification starts with understanding personal goals, time horizon, and risk tolerance. Truist Wealth uses benchmark allocations and adjusts based on whether they are on offense or defense.
• Fixed Income and Gold: High-quality fixed income has performed well. Gold is also viewed positively for its diversification benefit, especially on days when stocks and bonds are both down.
• AI and Tech Bubble Concerns: Lerner does not see a bubble in the technology sector, though he acknowledges richness and frothiness. He compares current valuations and year-over-year gains to the late 1990s bubble, finding them significantly less extreme.
• Earnings Momentum: A key indicator for negative sentiment would be a decline in earnings momentum for the technology sector relative to the overall market.
• Retail Investor Concentration: Lerner acknowledges that many individual investors are heavily concentrated in tech and growth stocks, making them vulnerable to pullbacks. He suggests using current volatility as a "gut check" for portfolio allocation.
• Tax Considerations: While acknowledging tax implications, Lerner suggests that market performance can sometimes mitigate the need to sell due to taxes.
• Unknowable Future: The future is unknowable, and diversification and probabilities are key.
• Focus on Tech Leadership: The leadership of tech is crucial for the market to re-engage.
• Fed Obsession Overstated: Lerner believes the fixation on the Fed's rate cut timing is overstated, suggesting the economy may be less interest-rate sensitive on the way down. He prioritizes corporate profits and economic/labor market data over Fed pronouncements.

Money in Motion and Retail Investor Activity

Recent data highlights significant retail investor activity.

• Top Stocks Bought by Retail Investors (October): Nvidia, Meta, Microsoft, Amazon, and Palantir.
• Top Stocks Sold by Retail Investors (October): AMD, Intel, Tesla, and Eli Lilly.
• Long-Term Holding Strategy: Many retail investors express intentions to buy and hold these stocks for the next 10 years.

Key Economic Data and Earnings to Watch This Week

The end of the government shutdown means a return of crucial economic data and a busy earnings week.

• Monday: Empire State Manufacturing Survey, earnings from Aramark.
• Tuesday: Homebuilder Confidence Index, Industrial Production and Capacity Utilization (October), earnings from Medtronic, BU, and CLA.
• Wednesday: Nvidia earnings report (key focus), Existing Home Sales, FOMC Minutes, earnings from Home Depot, Lowe's, and Target.
• Thursday: Jobs Report (September), Initial Weekly Jobless Claims, earnings from Walmart, Intuit, and Gap.
• Friday: Consumer Sentiment (final reading for November), earnings from BJ's Wholesale Club.
• S&P 500 Earnings Growth: The latest quarter showed 13.5% S&P 500 earnings growth, with companies under $50 million in revenue showing almost 13% growth. This strong profit growth is what investors are paying for.

Indicator of the Week

• Case Freight Index: This indicator of shipments (transatlantic cargo, rail, truck) has been declining, suggesting potential weakness in orders or tariffs. A continued decline could signal a less robust holiday shopping season.
• People Magazine's Sexiest Man Alive (Non-Scientific Recession Indicator): A TikTok user highlighted a correlation between People magazine editors getting their "Sexiest Man Alive" pick "right" and subsequent recessions (e.g., 1991, 2000, 2001, 2009). The current pick is Jonathan Bailey. While not a trading strategy, it's presented as an interesting talking point.

Conclusion and Takeaways

The market is experiencing volatility, but experts like Keith Lerner suggest it's a normal part of a mature bull market, with potential for further pullbacks. Investors are heavily concentrated in tech and growth stocks, making them susceptible to these movements. The focus remains on corporate profits, with upcoming earnings reports, particularly from Nvidia, being critical. While economic data is returning, the underlying strength of earnings and the potential for continued Fed rate cuts are key drivers. Diversification remains important, and investors should use current market conditions as a gauge of their risk tolerance and portfolio allocation. The "Sexiest Man Alive" indicator, while not scientific, adds a touch of levity to the market discussion.