It’s a great time to be a stock market bull! A whole year’s worth of returns are being compressed into the month of November. Investors are in a bullish mood, cheering several pieces of news:
- Political stability as President Trump paves the way for the incoming Biden administration
- Biden’s appointees are hewing more to the middle of the political spectrum, including former Fed Chair Janet Yellen as Treasury Secretary
- Vaccine progress continues and rollouts should begin soon
- Fed remains dovish and markets are anticipating a potential change in December to the central bank’s asset purchase plan
- Hope springs eternal for another pandemic support package in Congress
With one trading day left in November, the S&P 500 is up 11.4%. That gain is easily dwarfed by domestic small-caps, with the Russell 2000 index up 20.7%. The Dow Jones Industrial Average broke 30,000 for the first time ever this month. And returns for international markets, on the whole, are even stronger; MSCI’s International Developed Markets index is up 17.0%, with incredible strength in Europe where the Euro Stoxx 50 rose 19%. Emerging market equities are lagging recently, but are still up 11.6% so far this month, benefitting globally-focused portfolios.
These solid returns may be just the beginning of the stock market’s holiday cheer to close out this unusual year. The best three months of the year for the S&P 500, historically, are November, December and January (https://www.yardeni.com/pub/stmktreturns.pdf).
Digging into the drivers of November’s price action tells a different story than the prior 10 months of the year. Small-caps and value are trouncing large-caps and growth. The average stock in the S&P 500 is up 15.6% in November, while the market-cap weighted index is up 11.4%. That speaks to the big rally in the past few weeks for stocks that were labeled Covid-losers as the pandemic spread in the spring.
The market is not ignoring the surge in infections, but rather is looking past it. The expected vaccine rollouts possibly by mid December give investors a timeline for returning to some semblance of normal, and lets them lean on a valuation anchor that they had to abandon when the lockdowns occurred in March.
The political news is reassuring as President-elect Biden fills out his team. The tone of the incoming government is about steading the ship of state and striking traditional themes; only a Senator Elizabeth Warren or Senator Bernie Sanders at the Commerce or Labor Departments can upset that feeling amongst Wall Street. In Congress, negotiations continue on a stimulus package to help those who are out of work and in need, however there’s no assurance a deal will be struck before New Year’s Day.
Mirroring the optimism in stocks, government bond yields are higher in November. But interestingly, real yields – which are often thought of as the market’s proxy for GDP growth – are tumbling. The Federal Reserve’s pledge to stay extremely dovish for many years partially explains the disconnect. It is somewhat concerning that equity and bond investors are not on the same page about what the future holds. Time will tell who is right.
Risks remain, and not just for stocks. Investor positioning is extended, flashing warnings across asset classes and we are paying close attention to it. Positioning typically only matters at extremes, and this has been a year full of them, so we can’t rule out some choppy price action in December. However, the backdrop remains very positive for asset prices, and we believe any dips will be bought aggressively.
Gold is a good example of how extended positioning can drive prices. It was in demand as a haven, given that Treasury bond yields are so low they no longer cushion equity market losses the way they once did. Gold would also typically get a lift from a weaker dollar and falling real yields. But with the outlook for the economy and virus improving, there’s less of a need for a haven and those speculative positions are being unwound.
As real yields fall on government bonds and equities rally, credit markets are enjoying plenty of investor appetite. Spreads continue to grind lower. We believe it may be a good idea to buy weakness.
The minutes from the last Federal Reserve meeting indicated a robust discussion around the future of their asset purchases. Optimism is building in the market that they will increase the maturity of their purchases in their December meeting. Our take is different: they will strengthen the language on forward guidance but not extend the maturity at this time. That may cause a brief back-up in long-term yields that we would view as an opportunity to extend duration in light of the Fed saying it will keep rates low for the foreseeable future.
What to Watch This Week
Covid and vaccines – Post holiday, cases will spike. How much and what measures are taken to slow the spread? When will the first vaccine doses be administered? Europe has shown noticeable progress in suppressing their recent surges – can this continue?
Iran – The killing of their top nuclear scientist Friday demands a response and threatens a reinstatement of the 2015 Joint Comprehensive Plan of Action (JCPOA) under a Biden Administration. This could threaten oil supply just as the global economy is restarting. This is unlikely to weigh heavily on investor sentiment, but it’s what isn’t expected that matters.
Friday’s jobs report – Recent jobs data has weakened. What kind of momentum does the economy have as we enter the difficult winter months?
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