The Full Story:
Last week’s rally fizzled into this week as long-term interest rates resumed their ascent. The 10-year Treasury revisited 4.3%, exerting downward pressure on multiples and psychology. As we have noted, this pullback serves a purpose for rally fans as sentiment must reload to load Santa’s pack. This week, let’s dig a little further into the anatomy of this pullback.
Depth and Duration
Markets retrench from high points every year. This chart chronicles the depth of annual pullbacks for the S&P 500 and total returns each year:
Note that the average intra-year retreat is 14%. However, this average gets skewed by some large outliers like 2008. If we take the median rather than the average to reduce the skew, the average intra-year retreat falls to 10%. For 2023, we hit our first intra-year peak on February 2nd at 4179 on the S&P. The index then retreated 8% into the March lows and didn’t recover the February highs until May 18th. In total, that 8% pullback lasted 105 days.
From there, support from economic resilience, earnings surprises, and accelerating disinflation provided the uplift to reach another intra-year high of 4588 on July 31st. Unfortunately, stocks 20% higher mid-year led to investor overconfidence and bullishness reached threatening levels. Stressors emerged to challenge the complacent consensus. Interest rates, the dollar, and oil prices rose. Chinese and European economic momentum fell. Politics became more bellicose, and even our old foe, COVID, reemerged. From the July highs, the S&P fell 5.5%. Currently, we sit 3% below the July peak. We are now 41 days into this pullback period.
Should this pullback achieve average depth and duration, we would bottom out near 4150 (the 200-day moving average) somewhere near mid-October. For reference, we closed the week at 4440. This is not a prediction, but it is well within the range of typical pullback behavior. We do not anticipate an accompanying deterioration in disinflation, economic, or earnings growth, rendering this a psychological retreat rather than a fundamental retreat. Therefore, investors should focus on sentiment levels rather than market levels for orientation. Here are our indicators of the moment and the thresholds we would like to see met:
Investor bullishness falling below 25% and/or negative readings for the Citigroup Economic Surprise index would position reality to begin exceeding expectations once again, a durable precondition for further gains. Earnings tailwinds will then add a fundamental boost as disinflation powers profit margins–making 2024 a much more fundamental and much less sentiment-driven market.
Have a great weekend!
David S. Waddell
CEO, Chief Investment Strategist