Fed Funds 5.25% - 5.5%, US Ten Year 4.62%, Oil $77.26
Stocks continued their welcome reversal from August through October’s softness, higher again for the second week in November. A belief that the Federal Reserve may pause interest rates hikes into next year has been the catalyst for the market. Lower rates help high growth, high P/E stocks more than more value-oriented, higher-yielding stocks. Note below how in November the Nasdaq composite index has climbed more than the “blue chip” stocks in the Dow Jones Industrial (blue) and S&P 500 (green) indices. And quality still matters, with the small cap stocks as represented by the Russell 2000 (violet) lagging their larger peers.
That the smaller capitalization stocks have not participated to the extent as the bigger companies is another indicator that market breadth may be low, with much of the rise in the indices being fueled by a few very large cap tech stocks, as has been the case since the rally began. But that may be a temporary condition. Below we see that the S&P has been in a downward channel since it peaked on July 31. It looks to pierce through the top line of the channel, and as I write this on Friday it is doing just that. Closing above 4,400 would be a bullish sign. Another bullish signal would be if the index filled the September gap marked in yellow.
Considering fundamentals, the equity risk premium, or extra return one should expect stocks to return over the risk-free rate, is just one percentage point above the 4.5% of the ten-year treasury security. At a forward price earnings ratio of 18, the earnings per share is 100/18, or $5.5 (5.5%) for every $100 invested. Historically the equity risk premium has been 3%. In that scenario the expected return would be 7.5% and the P/E would be 13.3.
So, are stocks wildly expensive? Not necessarily. Barron’s reports that whenever the equity risk premium is between zero and one, the S&P advances by 12% in the following year. Moreover, as I reported last week, there has never been a down year in the stock market from October 31 of the year before the election to October 31 of the election year. It comes down to expectations on interest rates and earnings estimates, which look good for 2024.
As we enter the Veterans Day weekend, we ask our readers to keep in their thoughts the thousands of US military members stationed far from home in harm’s way in many areas of armed conflict across the globe.