/ November 25 / Weekly Preview
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Monday:
N/A
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Tuesday:
CB Consumer Confidence (111.6 exp.)
New Home Sales (0.73M exp.)
S&P/Case-Shiller Home Price YoY (4.9% exp.)
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Wednesday:
Core PCE Price Index MoM (0.3% exp.)
Personal Income MoM (0.3% exp.)
Personal Spending MoM (0.3% exp.)
Initial Jobless Claims (217K exp.)
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Thursday:
Market Closed - Thanksgiving
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Friday:
Market Partially Closed - Thanksgiving
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Monday:
Agilent Technologies A
Zoom Video Communications ZM
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Tuesday:
Abercrombie & Fitch ANF
Best Buy BBY
Dick's Sporting Goods DKS
Kohl's KSS
Dell Technologies DELL
CrowdStrike CRWD
Autodesk ADSK
Nutanix NTNX
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Wednesday:
N/A
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Thursday:
Market Closed - Thanksgiving
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Friday:
Market Partially Closed - Thanksgiving
Strong Margins Drive Hot Valuations
Over the past weeks, we’ve discussed the impact of Trump’s election victory and the resulting effect on financial markets and valuations. The initial reaction was exceedingly positive and risk assets rallied hard on expectations of tax cuts, tariffs, and deregulation. Since then, trading had gotten a bit ahead of itself and we’ve seen some consolidation and profit taking.
Last week market a bounce and come-back from that consolidation period, as NVIDIA’s earnings failed to be a downside catalyst. In fact, there is a conspicuous lack of apparent downside catalysts, as economic projections have turned increasingly optimistic. But more on this later.
Fow now, we are looking at a holiday shortened week, as Thanksgiving is celebrated on Thursday, when markets are closed. Friday will also feature a half-open day, which is traditionally ignored by most traders.
The same holiday spirit is expected to prevail in December as well, since most important catalysts for this year have already been exhausted. From now until the end of the year, the single most important date is 18 December, when the FOMC meets for the last time in order to set benchmark interest rates.
As such, the main drivers of the market become technical rather than fundamental, with share buybacks and portfolio window dressing driving the supply and demand equation from week to week. We expect momentum to become the dominant theme. Outperforming stocks will be bought, as managers look to show they are invested in the hottest stocks, while under-performers will get sold for tax optimisation reasons.
Share buybacks and this bias toward out-performers will certainly put a bid under the market, most likely at around $580, where support lies (50-DMA & M-Trend). Our immediate upside target now stands at $619 (R1). In just two weeks from now, we will update our quarterly bottom-up analysis for the S&P 500 Price Target and EPS Growth rate.
The graph below from Carson Research confirms our belief that seasonality will act to push this market higher into late November and December. There is another patch of weak trading in early December, as mutual funds complete their annual distributions. While there is no reason to be bearish at the moment, we need to be very aware of what exactly markets are pricing in and where the optimism is coming from.
No matter one’s political leanings or bias toward more or less risk, one thing is for certain: the longer term driver of stock price returns is the growth in corporate earnings and earnings per share. At the moment, market forecasts are very bullish, and Wall Street analysts are one-upping each other in their price target forecasts.
As we see it, one of the main catalysts of higher price targets is not only an anticipated acceleration in revenue growth, but the context of near-record margins for S&P 500 companies. If these margins can be maintained (without inflation re-accelerating no less) and revenue grows from current levels, then yes, we agree that the future is bright for the equity market.
During the past week, one of the more interesting market forecasts came from long-time bear Michael Wilson of Morgan Stanley. He matched Goldman’s forecast of 6500 as a base case with a bullish case of 7400 for the S&P 500. That is interesting because Michael Wilson has been a long-time market bear. His basis for making this call is certainly interesting:
“A potential rise in corporate animal spirits post the election (as we saw following the 2016 election) could catalyze a more balanced earnings profile across the market in 2025.”
The concept of animal spirits in financial markets, introduced by John Maynard Keynes, refers to the emotions, instincts, and psychological factors that influence investor behavior and economic decisions, often leading to irrational market movements in both directions. These "spirits" drive confidence, fear, and herd behavior, impacting asset prices, investment, and consumption patterns. This happens beyond purely rational, data-driven decision-making.
Wilson is basically saying that there is an upside risk of corporate managers making irrationally positive bets on the economy.
The counter-point to optimism is of course the only tether to “reality” - valuations. As shown, there are limits to what earnings multiple can be sustainably applied to the stock market without a subsequent major reversal event. Sure, we could see P/E ratios stretch up to 29 (+26% from the present), but what then?
The most likely scenario remains a normalization of valuations to about 21-22 x Earnings, on account of EPS itself rising. While this does NOT mean the market is about to crash, it does suggest that earnings have not kept up with investor’s expectations. Most of the rise in stock prices has been associated with expanding multiples, not higher EPS.
The problem with elevated valuations is the risk an “event” occurs that causes investors to realign expectations with actual reality.
For the moment, EPS growth remains elusive for the average S&P 500 constituent company. The last two years have seen median EPS essentially flat.
When adding a disappearing equity risk premium into the mix, we get an understanding that investors are not being adequately compensated for the potential to lose money on their holdings.
Our Trading Strategy
Our strategy can be summed up as follows: “We need to dance until the music stops.” That’s really all the is to it.
We are aware that there is a major positive bias in analyst expectations and economic projections. We are aware that there are risks to our and our clients’ portfolios. But, as long as prices are rising and the benchmark indexes are performing, we need to make money as well. And the only way to do that is to maintain long positions in place.
In the short term, the same drivers remain as far as supply and demand are concerned:
Corporate share repurchases
Performance Chasing
Momentum
As we enter 2025, the landscape will certainly change, especially as president Trump takes office and starts enacting his policy. On that note, betting website Polymarket is showing a 95% chance of Trump being inaugurated on January 20’th. In other words, bettors are saying that there is a 1 in 20 chance of….. what exactly?
There’s the tail risk in action. This risk also exists in the stock market. Being a much more liquid instrument, this risk becomes “invisible”. But it’s there, we know it, and we are prepared, just in case.
Signal Sigma PRO members will be notified by Trade Alert of any live portfolio changes (if subscribed). If you’re not on this plan yet, you can get a free trial when you join our Society Forum. If you need any help with your trading strategy (or would like to implement one on your account), feel free to reach out!