What the Markets Are Really Saying as Year-End Nears

Key Concepts

• S&P 500 Performance: The S&P 500 experienced three consecutive years of double-digit gains, a surprising outcome given initial expectations.
• Economic Data Interpretation: A cautious approach to interpreting recent economic data is advocated, highlighting potential discrepancies between headline numbers and underlying components.
• AI & Capex Spending: Artificial Intelligence and capital expenditure are identified as key drivers of recent GDP growth, but their sustainability is questioned.
• Value vs. Growth Investing: A potential rotation from crowded mega-cap growth stocks towards undervalued cyclical and value names is suggested.
• Consumer Spending & Inflation: The American consumer is becoming more thriftier, and inflation is impacting spending through rising costs in areas like healthcare.
• Volatility & Risk: Low volatility is seen as a potential warning sign, suggesting a higher risk of a market correction.
• K-Shaped/Tree-Shaped Economy: Discussion of the uneven economic recovery, moving from a K-shaped (distinct haves and have-nots) to a more nuanced tree-shaped distribution.

Market Performance & Economic Outlook

Tony Zaparo, CEO of Equity Set, expressed surprise at the S&P 500’s three consecutive years of double-digit gains. He admitted to initially anticipating a flat or even 5-10% decline, aiming for a target around 5500 or lower by the end of 2023. He attributes this miscalculation to the unexpected strength of the market, particularly in mega-cap stocks. He stated, “I’ve been humbled… I wasn’t expecting double digit gains.”

Analysis of Economic Data

Zaparo advocates for a skeptical yet data-driven approach to assessing the current economic landscape. While acknowledging positive headline numbers like GDP growth and CPI, he cautions against uncritical acceptance. He points out that the strong GDP figure was heavily influenced by AI and capital expenditure (capex) spending, stating that without these factors, GDP would have been flat or slightly negative.

Regarding inflation, he notes discrepancies between headline CPI figures and the components used to calculate them, citing instances where data collection was limited, resulting in calculations based on fewer data points than usual. He also highlights a slight uptick in unemployment and the fact that consumer spending is being driven by rising healthcare costs, not necessarily discretionary income. He summarized this perspective by saying, “I don’t believe the headline numbers, but investors have seemingly believed them to date.” He acknowledges revisions to economic data are common, and their impact on investor sentiment remains to be seen.

Market Rotation & Investment Strategy

Zaparo suggests a potential shift in investment strategy for 2024, advocating for a rotation into undervalued “beaten-up” value and cyclical names. He believes the mega-cap growth trade has become crowded and overvalued, despite strong earnings potential. He anticipates a potential correction and suggests investors consider sectors that have underperformed, such as logistics and cyclical industries. He believes these sectors, down 60-80% in some cases, offer potential for recovery.

Specific Investment Ideas

He identifies specific companies and sectors for potential investment:

• Cyclical Value: UPS, FedEx, Old Dominion (anticipating a rebound in freight if economic theory holds true).
• Healthcare: Biogen, UnitedHealth (seeking companies trading at low price-to-earnings ratios).
• Consumer Discretionary: Lululemon (recognizing recent negative sentiment but identifying potential for a turnaround).
• Technology (Beyond AI): Adobe, Avery Dennison (highlighting strong earnings and fundamental strength despite less media attention).
• Defensive Plays: Clorox, General Mills, Campbell Soup (for potential downside protection).

Consumer Spending & Economic Trends

Zaparo observes a shift in consumer behavior, with Americans becoming more thriftier and cutting back on discretionary spending. He notes that while some continue to spend on experiences like travel, others are facing increasing financial pressures from rising costs, particularly in healthcare and insurance. He believes this trend will lead to a moderation in economic growth as consumers prioritize saving. He stated, “I think the American spender is being thriftier than you know the last couple years.” He describes the economy as moving from a K-shaped recovery (where the wealthy benefited disproportionately) to a more nuanced “tree-shaped” recovery, but still acknowledges significant disparities.

Risks & Catalysts

Zaparo emphasizes the importance of monitoring volatility, noting that the VIX (Volatility Index) recently reached a one-year low of 13. He views this low volatility as a potential warning sign, suggesting a higher risk of a market correction. He also points to the potential impact of factors like rising metal prices and debt levels as potential catalysts for a market downturn. He warned, “when things are quiet and and there seems to be no negative headlines… those are when the catalyst hits.” He also highlighted the risk associated with the dollar.

Conclusion

Zaparo’s analysis presents a cautiously optimistic outlook, tempered by concerns about economic data interpretation, market valuations, and potential risks. He advocates for a proactive investment strategy that prioritizes value, diversification, and risk management, anticipating a potential rotation from growth stocks to undervalued cyclical names. He stresses the importance of remaining vigilant and prepared for potential market corrections, particularly in an environment of low volatility and rising debt. His core message is to be prepared for a potential shift in market dynamics and to prioritize a balanced, risk-aware approach to investing.