Clockwork seasonality

12-07-2023
Clockwork seasonality

Textbook November market bounceback

 

While not every investment strategy has worked as planned this year, one has done very well of late: seasonality.

Since the summer, equity markets have followed the seasonal pattern to a tee. After a quiet summer, volatility picked up in August, and markets fell under the stress of uncertainty through September and October. But just as market sentiment fell into extreme bearish levels, along came the seasonally strongest month of the year, November, to save the day.

Of course, just flipping the calendar wasn’t enough to change the results for thousands of companies and investors. It took a combination of better economic data and stronger earnings throughout the month, but it helped to support a change in the tone.

As we have learned over the past few years, as much as equity investors like to think they can set the pace, it’s really the bond market that is in charge. Once again, that happened as bond yields fell throughout the month, providing the relief equities needed to bounce. And what a bounce it was. For many markets, it was the best monthly return in years.

Using the U.S. 10-year bond as a guide, yields hit cycle highs of 5% in October on fears the battle with inflation wasn’t done. Markets even began to price in future rate hikes as the the U.S. Federal Reserve’s Federal Open Market Committee would extend its hawkish positioning. However, through November, those expectations were completely reversed. Futures markets are no longer expecting rate hikes and have even begun to price in rate cuts in both Canada and the U.S .by the second quarter of 2024. This expectation shift pushed the U.S. 10-year bond yield down a remarkable 80 basis points (bps) to 4.2% at the end of the month.

The relief of falling bond yields

The drop in yields helped nearly everything. Consumers struggling under the weight of higher housing and food costs may finally be able to get some relief, which contributed to a broadening out of the equity rally. For most of the year, the leadership of the equity market has been led by the mega-cap technology stocks fueled by AI enthusiasm. While those sectors once again had a strong move higher, one of the more positive developments for many investors was that this month’s move included many of the lagging groups, such as REITs, Banks, and Telecom companies.

It also must be stated that with the combined performance of both equity and fixed-income markets, November was the best month ever for the 60/40 balanced portfolio. This comes as a relief for many, as 2022 was the worst year ever for that strategy.

Of course, nothing ever goes in a straight line, and by no means has the “all clear” been signalled, as the economic data for the Canadian economy are now signalling that we are already in or near a recession. Central banks may be done hiking, but we need to make sure the damage from the rate increases isn’t too severe. We now enter the period where “bad news is bad” and “good news is good.”

As we head into year-end and look forward to 2024, after such a strong year built on the optimism of a “soft-landing” for the U.S. economy, we must answer whether equity markets have gotten ahead of themselves. Did the gains observed in November include some pulled forward from next year?

The seasonality for December remains strong, but there can be cases in which markets can stumble. We are starting to see some of the more beaten-up names bounce, as it seems they have run out of sellers. On the contrary, those who have been able to capture the gains for the year in the technology stocks may be hesitant to recognize those profits until the new year. December is shaping up for more muted returns than the last few months, which may be a welcome change for the holidays. But investors need not get too complacent as next year looks like a return to volatility.

Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments Inc.

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