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  • Writer's pictureJade Rossback

Is it Too Late to Catch the Rally in Stocks?



There were two distinct types of investors this year. Those that are ecstatic with returns they didn’t believe would happen this year and those are incredulous, on the sidelines having missed the entire rally. This article serves as a bit of hope and solace for those who have missed the incredible rally. I’m here to answer the question of, is it too late to catch the rally in stocks? The answer is a resounding “No, it’s not too late!”


20/20 Retrospect

The ball has yet to drop on the year but we are close enough to gauge how the market performed overall. It doesn’t matter which major market average you look at, they all performed very well this year. As of December 26th, the Dow Jones Industrial Average is up a little over 13% on the year and is putting up all-time highs nearly every day.


Image Source: Zacks Investment Research


Many investors look to the S&P 500 as the best indicator of the overall performance of the stock market. This broad average is up over 24% YTD. That puts it close to the returns of 2009, where the market famously bottomed after the Great Recession.


Tech stocks have outperformed by a wide margin. This year has turned out to be one of the strongest on record for the NASDAQ Composite and the NASDAQ 100. The Composite index is up nearly 44% while the NASDAQ 100, led by the Magnificent 7, is up over 54%.


Wall of Worry 2.0


With returns like that, you would think that the economic backdrop was very strong all year. To the contrary, there were some troubling datapoints. That’s what made this rally so unloved. Very sharp, intelligent investors found themselves on the sidelines because of worries that economic data gave them.


There have been warning signs of weakening consumer demand. Several earnings reports from large retailers have pointed to concerns about continuing inflationary pressure. Giants like Nike have seen “indications of more cautious consumer behavior globally.”

 

Earnings are moving in the wrong direction. My boss, Director of Research here at Zacks, Sheraz Mian posts his weekly Earnings Trends report. In the December 20th version, he shared the chart above. Q4 earnings in aggregate are moving to the downside. Heading into the middle of October, analysts were looking for 5.5% earnings growth for Q4. That number has slowly been revised to the downside, coming down to a 20-bps contraction forecast.


Earnings estimates are down for 11 of the 16 Zacks sectors. Sheraz points out that this trend is not exclusive to Q4 2023. Full-year estimates for the S&P 500 have come down from $2.123 trillion in mid-October to $2.099 trillion last week.


The market has a tendency to climb this “Wall of Worry.” Eventually, those that have been on the sidelines reach peak FOMO, or fear of missing out, and they pile back in. We haven’t quite hit this FOMO point yet, we are still very much climbing this Wall of Worry.


Don’t Fight the Fed


Hesitant investors naturally point to the economic headwinds during their handwringing. One way to get over that, is buy zooming out to the big picture to understand what’s happening. The economy is cooling off, which is bringing inflation down. In other words, the Fed accomplished its mission. It successfully brought down inflation without forcing the world into a crippling recession. The elusive “soft landing” was achieved.


Image Source: FOMC FedWatch Tool


Expectations for rate hikes have now pivoted with the Fed. Investors are now expecting rate cuts next year. This move from a tightening regime to the re-establishment of a dovish stance is a huge boost for equities. Above is the FedWatch tool from the CME Group. The tool uses Fed Funds futures prices to determine the probabilities of various Fed activities moving forward. It’s a wonderful tool you can use to gauge the market’s expectations in any given month.


Here I have the target rate probabilities for the December 2024 meeting a year from now. The current overnight rate of 5.25% is nowhere on the radar here. There is only a 0.5% chance of 3 rate cuts. That 3 cut mark at 4.50% is the most hawkish of all. The highest probability here is the 3.75% level, which is a full 6 rate cuts below today’s rates.


Interest rates have already come down dramatically on the long end of the curve. The 30-Year Treasury Bond yield peaked in October over 5.1%. Rates are already down to 4% there. Shift on over to the 10-Year Note where rates are off from 5% to under 3.9%. Never mind what the CPI data might be telling you or what the Fed says on any given day. The market is telling you that it is expecting rates to come on crashing down.


Election-Year Hopes


The Presidential election later this year brings with it surprisingly positive returns. Dating back to the 1944 election year, there have only been two years where the S&P 500 total return is negative. This included 2000, when the Dot Com bubble saw some volatility as well as 2008 when the Great Recession had the investing world reeling.


Looking past those two years, there have been some incredible returns. Looking back at the 23 election years since the S&P 500 index began, 19 of the 23 years have provided positive performance. On average, election years provided a return of 11.28%.


The High-Beta Laggard


Looking at the returns on higher beta names can definitely make investors feel like they have missed the boat. However, there is a high-beta index that has lagged well behind both the NASDAQ Composite and the S&P 500. That is the Russell 2000. The 16% move higher for 2023 so far looks great, but not when you set it beside those tech stocks rocketing higher.


Image Source: Zacks Investment Research


The small caps that make up the Russell 2000 are amongst the most volatile in the market. They have struggled to breakout from technical resistance for months. Last week, the index finally broke out from the 2,000 level. This was an area that pounded the Russell 2000 down on no fewer than 3 occasions dating back to the start of 2022. With this area finally conquered, the small caps have their sights set on all-time highs over 2,400.


Bottom Line


I am betting on the breakout continuing and the market climbing this wall of worry in 2024. There are plenty of negative headlines out there and several areas of worry on the broad economic front. Even with a potential earnings recession, the forward-looking nature of the market is likely lead to positive returns again in 2024.


by David Bartosiak, Editor of Zacks Surprise Trader and Zacks Blockchain Innovators

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