- Stocks hit new highs during the month with eight of eleven sectors moving higher.
- Significant sector rotation saw Financials and Industrials outperform; Utilities and Treasuries sold; off.
- Small cap stocks outperformed large caps by the widest margin since December 2000.
- There were a number of historic moves across a range of asset classes (see below).
A November to Remember:
- The blue chip Dow Jones Industrial Average (DJIA) crossed 19,000 for the first time.
- The Dow saw its second biggest weekly percentage gain in over five years including one session where the futures moved 1,172 points.
- The Russell 2000 had 15 consecutive days in the green, tying an all-time record, and included a 9.75% low-high range in the futures session following the election. The index saw its second best weekly gain in seven years.
- The KBW Bank Index (BKX) rose more than 17% for its largest monthly gain since March 2000 ending the month at a record high.
- The Nasdaq Biotech Index saw its biggest weekly gain since its inception in 2001.
- The U.S. Dollar gained 9.23% versus the Japanese Yen in November making it the largest gain since August 1995 and third largest since January 1971.
- The long bond ETF (TLT) saw its biggest weekly decline since its inception in 2002.
- Treasuries ended the month with the highest yields since July 2015.
- The implied probability of the Fed raising rates in December now stands at 96%, up from 71% last month.
- Global bonds had their worst monthly declines since the Bloomberg Global Aggregate Index began in 1990.
We concluded the Looking Ahead section of our October report with the following sentence: The Presidential election, the M&A trend, and an expected FOMC increase in interest rates should keep things interesting.” We had no idea how interesting. November has seen investors react to the surprise election results by bidding up stocks to new highs and, perhaps more importantly, significantly reallocating capital to sectors that are perceived to benefit from policy changes, fiscal stimulus, and an almost certain December rate hike.
The Dow Jones Industrials, S&P 500, Nasdaq Composite, and Russell 2000 all hit record highs during November including the DOW’s first move above the 19,000 milestone on 11/22/16. The Russell 2000 was November’s top performer with an 11% gain including a record streak of 15 consecutive days in the green. The Russell 2000 was November’s top performer with an 11% gain – including a record streak of 15 consecutive days in the green – and is now up 16.4% YTD. In November, the DJIA and S&P 500 gained 5.4% (+9.8% YTD) and 3.4% (+7.6% YTD), respectively.
November’s price action saw all the major equity indices reach “overbought” technical levels as investors are pricing in immediate benefits to changes that may occur slowly or not at all. Below we outline some winners and losers given the significant funds flows and sector rotation in November.
Financials – Financial stocks were the strongest performers for the month with the S&P Financials Index up 13.7%. Bloomberg News noted that the sector added over $300 billion in market cap through the 25th, the largest ever increase in such a short time. The group benefited from an expected increase in interest rates and steepening of the yield curve, both of which help bank profitability. Some of the policies discussed by the incoming Trump administration are seen as stimulative and a cause for higher inflation expectations. The potential loosening of regulations on banks was also cited as a positive. Regional Banks were the strongest amongst small cap names, as the KBW Regional Bank Index (KRX) climbed almost 20% in November, the steepest advance since October 2011. Pricing in higher fiscal spending, fewer regulations and the increased likelihood of a Fed rate hike next month has helped the group break out from its 2016 underperformance.
Small caps – Small cap stocks are seen as benefiting from fiscal stimulus while at the same time being more insulated from a stronger dollar and retaliatory protectionism if either should occur. The Russell 2000 rose 11% in November vs. 3.4% for the S&P 500, the greatest outperformance since December 2000. Companies focused on domestic U.S. sales were favored, even amongst larger companies. The WSJ pointed out that from the election through 11/21, S&P 500 companies with 90% of revenues inside the U.S. outperformed companies with a majority of revenues outside the U.S. by 230 basis points. The Russell 2000 finished November on the longest consecutive winning streak since 1996 with 15 straight days of gains.
Industrials and Materials – Both sectors soared post-election on expected infrastructure spending. Industrials gained 8.5% in November, the largest monthly gain in a year and second largest since October 2011, while Materials added 6.6%. Both the S&P Materials Index and the S&P Industrials Index had record closes in November.
Biotech – Within the healthcare sector the biotech industry experienced historic gains. The Nasdaq Biotechnology Index gained 14.4% during the week of the U.S. election – the largest weekly gain since its inception in 2001 – but sold off to end at a 6.8% gain. The incoming Trump administration is expected to remove the negative overhang of drug price controls while providing M&A expectations from hoped-for repatriated cash. The index is still down 19% for the year.
Consumer Discretionary – Consumer Discretionary stocks had a strong month post-election and strong Black Friday and Cyber Monday Results. The group also benefited from higher incomes driven by higher wages, lower unemployment and a boost from lower gas prices. The broad-based S&P Retail Select Industry Index was up 10% for the month while the large cap S&P 500 Consumer Discretionary sub-index rose 5.5%.
Energy – Most of the gains in Energy came on the last day of the month as OPEC members met in Vienna and formally agreed to cut production by 1.2 million barrels per day – about 1% of global output. Crude oil rallied on the news, gaining over 8% on November 30 alone. For the month, WTI and Brent crude both gained 4.5%.
Treasuries – Treasuries saw a record decline with bonds suffering their biggest loss in 26 years at one point in November when the yield on 10-year U.S. Government Debt rose as much as 70 bps off the November lows to 2.42%. Funds flowed out of bonds into stocks with rising inflation expectations as the main culprit. While zero and negative rates in Europe and elsewhere helped drag down U.S. yields only a few months ago, these factors took a backseat to the rush to sell post-election. The two-year yield finished the month at 1.10% vs. 0.84% at the end of October. It was just four months ago that the 10-year Treasury yield hit its all-time low at 1.37% immediately following the Brexit results. The July lows on the two-year were near 0.55%. Whether U.S. rates can continue to rise in the face of slow global growth and low rates elsewhere remains to be seen. Bond bears say that fiscal stimulus in the U.S. will kick start inflation and growth.
Utilities – Along with other bond proxies such as REITs, Utilities sold off sharply in the days following the election as an expected rate hike and pro-growth policies began pricing in. Utilities rose an astounding 21.2% during the first half of the year so were ripe for profit taking. The sector has shed gains since then and is now up only 7.2% YTD. Interestingly post-election some smaller cap utility stocks decoupled from the sector and traded higher along with the Russell 2000.
Tech – Tech stocks fell as any trade sanctions would hurt these stocks disproportionately. Some were already trading at high multiples (FANG stocks) so were sources of funds for the sector rotation we observed. A stronger dollar and FCC concerns for some on net neutrality also played a role. Some Technology stocks were amongst the best performers this past earnings season, but the positive news couldn’t outweigh funds flows into other sectors.
All S&P sectors traded in a tight pattern ahead of the U.S. election, but the sector rotation noted above is apparent on the chart below. Financials (purple) and small caps (green) were clear winners with utilities (red) lagging.
In summary, eight out of eleven S&P sectors closed higher in November. The meaningful outperformance in banks (KBW Bank Index +17%) helped the S&P Financial Index post the best sector performance for the second straight month. Bond proxy sectors like Utilities, REITs and Staples remained under pressure. YTD the top three performing sectors are now energy, industrials, and financials.
According to the FactSet Earnings Insight report that corresponded with the end of earnings season, 95% of S&P 500 companies reported for Q3, with 76% have beating consensus EPS expectations, better than the 70% one-year average. The beat rates were running well ahead of the one year average earlier in the season, but came in line with the longer term average as Q3 reports continued to roll in. As for sales, 55% of companies beat consensus expectations, vs. the 50% average over the last year. In the economy, a second read of 3Q GDP showed a 3.2% annualized gain q/q, while corporate profits rose 6.6% in the third quarter after declining 0.6% in the second quarter according to the Bureau of Economic Analysis. As the chart below suggests, the earnings growth data can vary greatly from quarter to quarter.
An almost certain 25bp December rate hike on 12/14 is being priced in. Currently, the implied probability of the Fed raising rates to an upper bound of 75bp at the next meeting now stands at 96%, up from 71% at the end of October and 59% at the end of September. In case you are wondering, the first 2017 Fed meeting is on February 1.
With a good deal of positive news priced in, the market will be on the lookout for clarity on how expected changes will impact various sectors and equities overall. The November rally brought the S&P 500 P/E to above 20, with the forward P/E at 18.5. Anticipated policy changes and the earnings that flow from them will need to materialize to justify valuations. Still, at least in the near term, psychology matters. An improving economy and expectations of pro-growth policies are the bullish case. Continuing momentum and a desire by funds to participate in the rally through year-end could move stocks yet higher. Negatives that could play out over time would include fiscal stimulus that is less than anticipated or takes much longer to materialize, a stalling of global growth, continuing concerns with Eurozone elections or China’s currency.
The reflation trade that helped stocks to gains in November has also resulted in U.S. Dollar strength. The Dollar Index, which measures the U.S. Dollar against a basket of leading world currencies, gained 3% in November after a 3.12% gain in October. The Fed is seemingly on a path towards normalization, with a rate increase expected this December and perhaps two more in 2017. The dollar is gaining against currencies like the Euro and Yen whose governments are expected to continue accommodative policies – a return of the “divergence” trade. The U.S. Dollar gained more than 9% versus the Japanese Yen in November, its largest monthly gain in 21 years and third largest since 1971. As widely recognized, a strong dollar could be a headwind for multinational companies, emerging markets or China.
Aside from U.S. monetary policies, currencies are reacting to country-specific factors that bear watching.
While political risk in the U.S. is largely in the rearview mirror, Europe’s is on the horizon. “Populism” is on the rise globally, as evidenced first with the Brexit vote and now Trump’s win. Anti-Euro parties are gaining in polls with important votes to be held first this December in Italy, followed by French and German Presidential elections next year. A constitutional reform referendum to be held in Italy on December 4 could lead to the resignation of current Prime Minister Renzi and potentially early elections and a rise of the Five Star movement, a Euro-skeptic party.
Similarly, France will hold presidential elections in April and May. A victory by the National Front in that country is also seen as a risk to the Euro. Italy and France have much larger economies than Greece, so the risk of either leaving the currency union could roil markets. Leaving the Euro is not a simple or immediate process, but what once seemed far-fetched is now on the early warning radar of some investors. The Euro closed the month at $1.0592 and might be heading towards dollar parity if it breaks below major support at $1.05.
The Yuan also bears watching as China has been spending reserves to ensure an orderly weakening of its currency. China’s FX reserves fell ~$50B in October to $3.12T, – the biggest drop in nine months – and coincided with the offshore yuan falling ~1.6% against the dollar. A sudden devaluation could cause a repeat of the market declines of August 2015 or January 2016.
Finally, trade sanctions among key countries, if enacted, would be of deep concern.
The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. All information contained herein is obtained by Nasdaq from sources believed by Nasdaq to be accurate and reliable. However, all information is provided “as is” without warranty of any kind. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.
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