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The move higher in the unemployment rate is ominous, but in the last couple of quarters there’s been a surprising development that could—if it continues—cushion the blow to profits from a downturn.

At the pre-COVID business-cycle peak of February 2020, the qualifying income for a median-priced home was $47,232. As of September 2023, that level had surged exactly $60,000—to $107,232! How many households have enjoyed a pay boost of even one-third that amount in the last four years? 

We think Small Caps’ severe underperformance is an economic distress signal that’s been amplified throughout 2023 by the action of financial stocks—and banks in particular. On the same day the Russell 2000 violated its 2022 bear market low, the S&P Financials sector came within 4% of doing the same.

We’re surprised the recent surge in bond yields hasn’t produced any high-profile casualties (… well, aside from three of the four-largest U.S. bank failures in history—but that was back in March).

We still believe the U.S. economy will suffer a recession in 2024, and it’s also possible the official business-cycle peak will be identified (long after the fact) as having occurred in one of these final months of 2023.

With Small Caps still down 30% from their cycle peak, and now undervalued on many of our measures, we’d expect them to be more “levered” to a continuing economic expansion than the more diversified and internationally-exposed Large Caps. But no.

Richard Russell, who wrote Dow Theory Letters for 58 years until his death in 2015, would sometimes say, “The stock market always does exactly what it is supposed to do, but never when.”

With the S&P 500 back to near 10% of its January 2022 all-time high as of early November, it might be worth considering the bear market in time since mid-2021.

Read this week's Major Trend.

With October’s 2% loss, the S&P 500 has now experienced three consecutive monthly declines—a streak not achieved since the onset of the pandemic.

One of this year’s most fascinating stories in financial markets evolves around investors’ atypical response to the dreadful returns posted by TLT (iShares 20+ year Treasury bond ETF). Despite its dismal performance, investors have been moving a tremendous amount of money into TLT. 

Our analysis has consistently affirmed that actively managed portfolios do relatively better against their benchmarks during weaker market settings. In terms of active vs. passive, portfolio managers should love bearish environments, and third-quarter returns held true to that notion.

Health Care Equipment and Health Care Supplies were both downgraded to Unattractive this month.  Weight-loss drugs have generated most of the negative headlines in the space, but we’ve also observed slow and steady deterioration in top- and bottom-line growth. 

Another month, another yawning performance gap between the Cap- and Equal-Weighted S&P 500. Since the end of January, the more democratic of the two has underperformed the top-heavy version by nearly 14%. To find a nine-month span with greater relative underperformance for the Equal Weighted Index, you’d have to go all the way back to the very top of the Tech Bubble in March 2000.

Three of our six style boxes are now in negative territory for 2023. The Mega Cap Growth proxy—Royal Blue Growth (+16.4% YTD)—has been the only game in town.

The most appropriate proxies for this comparison, the Equal Weighted S&P 500 and the S&P 600, were down 4.2% and 5.8%, respectively, in October. Hence, the minimal 1% widening for the Small Cap discount makes sense.

The number of firms beating on both the top and bottom lines has been underwhelming thus far. Those that missed EPS estimates have seen their equity drop an average of 4-5% relative to the index. That’s quite a bit higher than the usual 2-3% decline we’d expect given the history of data.

Our Risk Aversion Index moved higher in October and triggered a new “Higher-Risk” signal.

The 10Y-2Y yield curve broke above the key level of -0.4% and that means a double-bottom pattern is in play. While we are confident that a major steepening cycle is here, we have to acknowledge that the nascent move could fail. A steepening move is also the market’s way of signaling easier conditions ahead.

A little over half of the S&P 500 reported earnings for calendar Q3-23 in October. Bottom-up operating EPS estimates for the quarter have remained basically flat since May. This is a positive development given the proclivity of EPS estimates to erode over time. We should note, however, that longer term, the decline in estimates for Q3 has been well above average—diminishing by 14% since April of 2022. If there will be another reporting window pop in EPS estimates for Q3 like we saw for Q1 and Q2, it will have to come in November.