Equities Dip on the Week, but Tailwinds Remain
Equities finished down on the week as the S&P 500 fell 0.8%. Small caps fell 3.2% and continue to be prone to large downside capture. This is a big reason why over longer time frames large cap equities continue to outperform small caps. The Sortino ratio measures excess return per unit of downside volatility. Over the last year, the S&P 500 has had a Sortino ratio of 2.7 versus the Russell 2000 at 1.63.
And, Just How Strong are Equity Markets?
- The S&P 500 is up 22.2% year-to-date.
- This is the fourth best gain through October 23 since 1990.
- The year-end rally is strongly tied to the performance of the market prior to the final two months of the year.
- This is due to leveraged actors that now have a higher asset base that allows more buying to reach the targeted leverage ratio.
- Only six years since 1990 recorded negative returns from October 23 through December 31.
- The six losing periods exhibited weak equity performance into October 23, with three having negative year-to-date returns, two had returns under +2%, and the best was only +7%.
Do Election Risks Matter and Might it Change Things this Time?
Usually, the market is over-hedged for known risk events like elections and Federal Reserve (Fed) meetings. When the event passes, the hedges come off and buying commences. The following S&P 500 returns are from October 23 to the end of the year:
- 2020 = +8.4%
- 2016 = +4.1%
- 2012 = +0.9%
- 2010 = +6.1%
Economic Surprises Continue as Bond Yields Move Higher
The two key indicators that sum up the economic landscape are the Citigroup Economic Surprise Index (CESI), which is now at a six-month high, and jobless claims of 227,000. These do not support a weakening economy. Retail sales were about twice as good as the survey estimate and the big surprise on the week.
Rising Treasury yields are making headlines. The 10-year Treasury is up over 60 basis points since the Fed began their rate hiking cycle. Historically, when the Fed began cutting interest rates, the 10-year Treasury went lower or drifted sideways. This has been the fastest increase in yields once a Fed cutting cycle began.
The bond market continues to price in 7.5 cumulative cuts, but history suggests the Fed only goes about three to four total cuts if the economic data improves and equity prices move higher. The bond market does not appear to reflect the current situation but instead an outlook for a weakening economy.
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Sources: BTC Capital Management, Bloomberg
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