S&P 500 Signals Historic Rally Has Staying Power Despite Eerie Calm

Beneath the excitement generated by November's surge in the stock market lies an unusual tranquility that suggests further gains for equity investors, at least until the year's end.

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Last week, the S&P 500 Index experienced an average daily fluctuation of 0.3% in either direction, marking its most subdued movements in six months. This period of calm followed the market's deceleration towards the end of its second-best November since 1980. The Cboe Volatility Index (VIX), also known as the VIX, declined to its lowest levels of the year on Friday, coinciding with a rise in stocks subsequent to Federal Reserve Chair Jerome Powell's explicit indication that interest rate hikes have concluded.

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According to Frank Cappelleri, founder of CappThesis LLC, the market's ability to work off overbought conditions through a slowdown in price action over time is considered constructive following the robust first half of November. This shift in momentum, rather than a decline, is viewed positively by equity bulls as it indicates that the risk-on sentiment has not led to the kind of euphoria often associated with market downturns.

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The S&P 500 Index recorded a modest 0.8% gain last week, marking the smallest increase in its five-week winning streak. This subdued performance was a result of a relatively quiet period following the initial fervor in the first half of November, with the index going 11 days without a 1% move in either direction, reflecting the calmest end to a month since July.

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Looking ahead to December, historical data suggests it is unlikely to bring significant selling pressure. Since 1950, December has been the third-best month for the S&P 500, with an average gain of 1.4%, as per data from The Stock Trader’s Almanac. Portfolio managers typically enhance their funds' standings by purchasing outperforming stocks towards the year-end, contributing to this seasonality. Additionally, stocks tend to perform well in the period spanning the last five sessions of December and the beginning of the new year.

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Despite the optimistic outlook, there are lingering risks. While markets are positioned for a soft landing in the economy, uncertainties remain about the resilience of growth after the full impact of the Fed's tightening measures. A concerning sign is the continued contraction in US factory activity for the 13th consecutive month in November.

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Another potential risk is that a significant portion of this year's market gains has been driven by a narrow group of stocks, representing the narrowest set of drivers for a rally exceeding 15%, according to data from Societe Generale. Furthermore, a key momentum indicator, the benchmark's 14-day relative strength index, has swiftly shifted from oversold to overbought levels in less than a month.

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Brian Frank, portfolio manager of the Frank Value Fund, expresses caution about the market's rapid advance, suggesting that the strong run in November may impact the historic strength usually observed in December. In response, Frank is focusing on shares of small- and mid-cap staple companies with a reputation for dividends.

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Despite these concerns, corporate executives are providing reassurance to bulls by increasing their purchases of company shares in November. The Washington Service's data indicates that the ratio of buyers to sellers reached its highest level in six months.

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The options market also reflects confidence, with the VIX futures curve indicating a lack of demand for crash protection. It currently sits lower than at the start of November across various maturities.

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While minimal suspense surrounds the Fed's December 13 policy decision, where steady rates are widely expected, potential turbulence may arise from the economic projections released on that day and Powell's subsequent press conference. Powell recently dismissed bets on rate cuts by mid-2024, but bond traders have increased wagers on Fed easing next year.

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In conclusion, the current market environment, characterized by subdued volatility and a steady climb in equities, suggests a positive sentiment among investors, but risks persist. The interplay of economic data, the Fed's decisions, and market dynamics will likely shape the trajectory of equity markets as they navigate the final stretch of 2023.