Weekly Market Commentary - Oct 13th, 2023

• The S&P 500 dipped 0.6% Friday but clung to a 0.8% weekly advance, reflecting the back-and-forth turbulence.
• Nasdaq slipped 1.1% Friday, Dow added 0.1%, but both were nearly flat on the week with just a 0.1% move in either direction.
• Small caps highlighted bifurcation as Russell 2000 fell 0.9% Friday yet eked out 0.1% gain for the week. 
• The 10-year yield pulled back, but the flattening curve points to growing recession risk.
• Banks were a mixed bag after earnings, with JPMorgan and Wells Fargo gaining post-results but PNC plunging.
• Tech lagged on downgrades to high-profile names like Netflix and Tesla, while energy stocks popped over 5% as oil spiked on Middle East tensions.

The University of Michigan consumer sentiment survey plunged to 63.0 in October, missing estimates by a wide margin. Rising inflation expectations weighed heavily on confidence across most groups, signaling further erosion of purchasing power for households. 

This disappointing data confirms nagging worries that persistently higher prices are squeezing wallets and dampening moods, if not actual spending so far. With budgets under intensifying pressure, discretionary categories seem vulnerable to cutbacks first. 

Defensive stocks appear a prudent play over risky discretionary names tied to non-essential retail spending.

Import Prices Cool

However, import prices rose just 0.1% in September, cooling markedly from a 0.6% gain in August and landing well below estimates. This encouraging sign on the inflation front offers a glimmer of hope if the trend persists. Moderating import costs would support the case for less aggressive Fed tightening which would be a tailwind for battered markets. But one month does not make a trend, and further evidence of cooling price pressures is needed before declaring peak inflation. For now, risks remain skewed to the upside on prices.

Geopolitical Tensions Resurface 

Heightened geopolitical tensions in the Middle East drove an unwelcome spike in oil prices and market volatility this week. Energy stocks in particular surged over 5% Friday as crude climbed on worries the escalating Israel-Hamas conflict could disrupt global supplies. If the situation worsens, it could spill over to dampen world economic growth. 

This external shock serves as an acute risk factor to keep investors on edge. But it also highlights the relative appeal of domestic-focused stocks more insulated from geopolitical turmoil overseas.

Earnings First Reads

The opening salvos of third-quarter earnings season this week offered first reads on the health of corporate profits. Major banks like JPMorgan Chase and Wells Fargo topped lowered expectations but cited economic slowdown signals. BlackRock also beat on earnings but reported net outflows of client assets. The reports so far affirm a weakening business climate. 

However, actual results have exceeded gloomy estimates overall. Guidance will be key to determining if markets see a soft landing or harder times ahead. Weak corporate outlooks could spark another leg in the ongoing bear market.

With conflicting signals blowing from all directions, turbulence will likely persist in the coming weeks, preventing a clear direction from emerging. However, risks remain skewed to the downside until concrete evidence surfaces that tighter monetary policy is successfully taming inflation back toward the Fed’s 2% target.

Investors want to see high confidence that aggressive rate hikes are demonstrably working before turning optimistic again. Until clear results are apparent, caution remains warranted for now. Defensive positioning and capital preservation are priorities for fund managers’ portfolios amid the uncertainty.

But given markets’ recent resilience, discounts may be emerging for long-term investors able to withstand continued volatility. Opportunities in beaten-down groups like technology and consumer discretionary seem likely to emerge, but bargain hunting may require a 3-6 month time horizon. Patience and prudence will be the key virtues needed to navigate these choppy waters in the coming months.

Financials

Major banks reported a mixed bag of results to kick off earnings season. JPMorgan Chase and Wells Fargo managed gains after both beat earnings estimates. However, their reports cited concerns over a slowing economy as rate hikes weigh on borrowing demand. Citigroup also exceeded forecasts but lacked enthusiasm. Meanwhile, PNC Financial plunged despite topping views as revenue missed, showing diverging fortunes in the sector.

Technology 

Tech lagged on Friday, with semiconductor strength unable to overcome big declines by Apple, Microsoft, and chip giant Nvidia. The group was pressured by downgrades to high-profile names like Netflix and Tesla on growth concerns. Ongoing weakness in mega-cap tech leaders continues to weigh on the sector. However, pockets of opportunities remain, particularly in cheaper small- and mid-cap software and semiconductor names.

Energy

This week, the energy sector was the clear winner as oil supply worries triggered a spike in crude prices. Major oil companies like ExxonMobil and smaller shale producers like Diamondback Energy climbed over 6% Friday. Refiners, pipeline operators, and oil services stocks also rode the wave higher. Geopolitical tensions and the potential for further oil production cuts continue to support crude prices even amid demand destruction fears.

Consumer Discretionary & Staples 

The plunging consumer sentiment underscores potential trouble for discretionary retailers if inflation cuts into non-essential spending. Companies relying on disposable income to support sales of items like apparel, electronics, and home goods seem vulnerable. Conversely, staples stocks selling everyday essentials appear better positioned if budgets tighten further. Investors may want to mitigate risk by pivoting toward defensive names like food and household goods producers.

Here are some potential perspectives for different investor profiles based on this week’s market developments:

For conservative managers focused on capital preservation:

• Staying defensive still seems prudent given ongoing risks of slowing growth. Emphasize defensive sectors like healthcare and consumer staples.
• Maintain exposure to short duration bonds to limit rate sensitivity. Keep duration on the low end.
• Hold higher cash levels to retain flexibility to buy at better levels if pullbacks deepen.

For growth-oriented managers seeking to outperform benchmarks:  

• With indexes lackluster, single stocks with secular growth tailwinds may outperform. Target innovative tech, biotech, healthcare names.
• Consider moving from Treasuries into less rate-sensitive bonds like floating rate bank loans and short-term corporates.
• Trim overvalued momentum stocks and build positions in quality companies trading at reasonable valuations after the sell-off.

For opportunistic managers able to withstand volatility:

• If oil supply tightens further, energy stocks could extend their outperformance.
• Monitor high yield bonds for rising stars if higher quality names get downgraded in a recession.
• Use options strategies to take advantage of dislocations and mispricings caused by market turbulence.

Sources:

CNBC
Investors
Reuters