Seasonal Buy Signal Triggered

Over the past few weeks, we’ve discussed how markets have broken out to new highs in anticipation of a more aggressive rate-cutting cycle from the Fed. Last week’s inflation report has reversed part of that fundamental thesis. CPI rose 0.2% versus a 0.1% expectation, bringing the annual inflation rate to 2.4%, which was also higher than the expectation of 2.3%. Core CPI also rose 0.3% versus a 0.2% expectation.

Housing — (the biggest component of the CPI calculation and also lagging by about 6 months) — continued to reverse its previous gain, but Food and Beverages increased since the latest survey. Transportation declined, as did Energy, on the back of falling oil prices, offsetting the increase in Medical Care.

Overall, inflation pressures are returning to a more normalized trend. The increases seen across certain categories are not enough to deter the Fed’s rate cut path at the moment. After all, the Fed Funds rate currently stands at 5%, and headline inflation at 2.4%. Many economic models would call the Fed’s stance as “restrictive”, and we agree. The Fed still needs to cut rates in the months ahead.

With that understanding, losses in the equity market were limited on Thursday, after the slightly disappointing data was released. On Friday, a cooler than expected PPI report triggered a rally, and with it, the seasonal strong period of the year begins. As shown in the table below, mid-October to late April is when the market usually records its strongest performance.

During the past weeks, we’ve also touched on the market’s indecisiveness when it comes to discounting future earnings growth. In our Q3 Market Outlook, we have defined two probable scenarios for a non-recessionary outcome in 2025:

• Optimistic EPS Growth, where SPY hits $280/share by the end of 2025

• Lower than expected, but still positive EPS growth (around $260/share)

Based on these assumptions, we have projected different technical trading ranges into 2025. What is interesting about the current breakout is that the “Neutral” scenario, implying a $546 median Price Target and 10% CAGR is getting disproven by the price action:

If the “Neutral” scenario is proven to be too conservative, that is very good news for the bulls. Our optimistic scenario, implying a $672 Price Target and a 21% CAGR now truly comes “in play”, and despite the recent breakout, there is still about 15-16% of potential upside left.

The series of high lows, now combined with higher highs, remains a significant bullish backdrop for investors. Support stands at $567, near the lows of the recent month, while upside is at $602, where we expect SPY to finish 2024.

An optimistic take was also recently published by SentimenTrader, echoing our own analysis (and bullish bias) so far:

“When 90% of cyclical sub-industry groups close above their respective 10, 20, 50, 100, and 200-day moving averages for the first time in six months, and the S&P 500 is within 2% of a five-year high, the world’s most benchmarked index displayed solid returns and consistency across all time horizons. Over the following three months, the S&P 500 advanced 81% of the time, achieving 13 consecutive gains since 1992.”

Growth-oriented sectors outperformed the S&P 500 over the subsequent year.

Besides technicals, we’d like to note a couple of bullish and bearish fundamental catalysts which are bound to affect the market going forward. In the bullish camp, we have:

✅ A Resilient Labor Market

Unemployment remains historically low, and job growth, though slowing, continues to be positive.

✅ Lower Inflation and More Rate Cuts

With price pressures easing, the Fed is bound to cut interest rates. All other things being equal, this should support valuations and foster consumption, decreasing the odds of a recession.

✅ Consumer Spending

Consumer spending remains strong, despite persistent inflation and higher interest rates. If the consumer was able to weather 5.5% interest rates, without tipping the services economy in a recession, it’s reasonable to expect this trend to continue in a less restrictive rate environment. Hence, no recession.

❌ Business Expectations for Future Sales

According to the latest NFIB Survey, many small business owners expect sales to decline over the next six months. This pessimism is particularly pronounced in the retail and service sectors, where rising costs and shrinking profit margins force many businesses to scale back their operations.

❌ Hiring Difficulties and Labor Costs

Despite the strong labor market overall, small business owners report that labor shortages are one of their biggest challenges.

❌ The Potential for Rising Inflation

While Wall Street is optimistic that inflation is cooling, the NFIB survey indicates that many small businesses still struggle with rising input costs, which are weighing on profitability. The small business optimism index now stands near a mid-pandemic low, and not too far from the immediate aftermath of the Great Financial Crisis. Strange, for what is supposed to be a “roaring economy and bull market”.

Our Trading Strategy

Both the bulls and the bears have good fundamental arguments on their side, but only the bulls benefit from positive technicals. Also, the bearish takes we’ve seen are mostly focusing on smaller economic actors, not on the mega-cap corporate world. To a certain extent, this looks like a battle between a pessimistic “Main Street” versus a much more optimistic “Wall Street”.

We continue to remain long-biased in our live trading Sigma Portfolio, and we expect the following period to bring strong returns for the companies that we are invested in. The fact that we are not yet seeing “euphoric” levels of participation and excitement tells us that we are still a ways away from a market “top”. Valid bearish concerns give the market space to “climb a wall of worry”.

Increased exposure to bonds is also allowing us to hedge part of the risks associated with equity ownership. There will come a time to take profits more agressivley, but that will most likely coincide with the median stock being overbought. For now, that is not the case, and our long-bias remains valid.

Some volatility and drawdowns are to be expected (as is always the case), so we will be monitoring the risks and perform rebalancings on a weekly basis as needed.

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