SPY: Will There Be A Q4 Rally? Here’s Why I’m Ready For One (SPX)

September has not disappointed. It was the S&P 500’s (SP500) (NYSEARCA:SPY) “worst monthly performance in 2023,” as the market fell 5.1% to close September. However, should anyone be surprised after a remarkable rally that took off in the throes of the regional banking crisis in March and topped out in July before the pullback?

September has consistently been the market’s worst month, historically speaking. However, it has also consistently set the stage for a robust fourth quarter with powerful rallies in October and November before we head into Christmas, as history shows.

However, keen investors should be aware that the market doesn’t always react the same way. The BTIG technical strategy team indicated that October “has seen negative returns in 10 of the last 30 years. Moreover, in 8 of those 10 years, the returns were -1.77% or worse.”

As such, I believe it’s apt for investors to consider whether we could have a firm rally in Q4 this year or if we should anticipate further downside toward lower valuation levels before bottoming out. Let me try and break it down and discuss the headwinds first.

The Not So Good News

1. Surging Bond Yields

The resilient economy could have confused some investors on whether it represents good or bad news. So far it is good news because we aren’t expected to face a debilitating hard landing that could cause SPY to drop back to its October 2022 lows. However, bearish prognosticators argue it’s bad news because of the current Fed interest rate regime. Why? It suggests that the Fed is more likely to hold rates higher for longer.

As such, I believe astute market operators are baking in such a scenario in their assessments. Why? If you have followed the ongoing media report on the “relentless rise” in yields, you would have seen the 10Y Treasury yield (US10Y) taking out its October 2022 highs decisively, reaching 4.89% this week.

However, buyers have attempted to hold the SPX 4,300 level firmly (for now). It suggests that while they baked in higher execution risks and lower implied valuations, they likely aren’t expecting a hard landing to occur. Even if we were to see a recession in 2024, it’s not expected to be long and painful and could be the “rolling recession” thesis we experienced over the past 18 months or so.

2. AAPL’s Long-Term Bearish Signal

The tech sector (XLK) accounted for more than 28% of SPY’s weighting as of October 2. Within the sector, Apple (AAPL) was the leading constituent in the S&P 500, as it accounted for 7.1% of the index. As such, headwinds on AAPL could spook investors into selling out first, leading to higher-than-anticipated downside volatility than what was previously assessed.

Apple CEO Tim Cook’s recent large insider sell as AAPL formed a long-term bearish signal seems timely. Accordingly, Bloomberg reported that Cook “sold stock worth about $41 million after taxes.” It’s also Cook’s “biggest sale in more than two years.”

Notwithstanding the headlines, I urge investors not to read too much into Cook’s intentions (as we will never know), but focus on AAPL’s price action. Anyway, Cook still owns 3.28M shares after the recent sale.

As seen above, AAPL formed a double-top bull trap (double false upside breakout) that was validated in September 2023. The problem is that it occurred in AAPL’s long-term chart, which justifies caution. Hence, SPY buyers might want to be cautious about relying on AAPL to drive the recovery toward its all-time highs in the near term as AAPL tries to shake off the selling momentum.

The Good News

Okay, so that’s the “not-so-good news.” What’s the good news?

1. US Market Is Now Undervalued

According to Morningstar’s most updated valuation, the US market is back into the undervalued zone at levels we last saw in March. Analysts’ estimates of the S&P 500 have also been lifted during this time. Accordingly, companies in the S&P 500 are expected to post earnings growth of 11.7% in 2024, up from an estimated 1.1% uptick this year. Therefore, I believe it suggests why the market’s focus has turned to earnings optimism rather than bond yield pessimism, notwithstanding the “relentless rise” in yields recently.

Seeking Alpha Quant’s ETF grades are also supportive, with top-notch ratings for four of the five categories seen above. As such, I have confidence investors should remain vested and not be spooked by the financial media into selling out their portfolios and running for the hills.

2. Market Rotation Could Benefit S&P 500

While investors are worried about whether the mega-cap rally could unravel, as the S&P 500 hinges on its pivotal 4,300 support level, it’s important to note that the index isn’t just about tech.

The rest of the S&P 500, excluding tech, accounted for about 71.5% of SPY’s weighting. It includes the recent resurgence in energy (XLE) over the past four months. Moreover, the significantly undervalued financial sector (XLF) accounted for 12.3% of SPY’s weighting. Also, the undervalued communications sector (XLC) formed 9% of SPY’s weighting.

As such, I’m confident that underlying sector rotation from more expensive ones to less expensive ones would not be detrimental to SPY unless investors are betting on a significant downward valuation de-rating across all sectors.

However, that isn’t my current thesis, as I don’t assess a hard landing scenario.

Takeaway

The steep pullback in the S&P 500 from its July 2023 highs represents another opportunity for investors who missed buying its late 2022 or early 2023 lows.

While the risk of further downside volatility cannot be ruled out, its price action and valuation are still reasonable if you can ride out any near-term downside.

Rating: Upgraded to Buy.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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