All Aboard: VOO A Buy As Bullish Seasonality Begins

It's hard not to be bullish this time of year. Recall, it was precisely 12 months ago when the S&P 500 notched its bear-market bottom for 2022.

The low of 3491 came about following a worse-than-expected September 2022 CPI report. Selling pressure was harsh in the moments after the consumer price data crossed the wires. Equities gapped lower and trended down in the moments following the opening bell. Buyers were on the ready, though. The SPX zoomed into the late morning and afternoon of October 12, 2022, eventually settling at the highs of the week up to that point.

S&P 500 Chugging Along After an August-September Slowdown

Small caps and cyclicals would go on to outperform over the balance of the year. Of course, we all know the 2023 story – the SPX has been led by a handful of so-called “Magnificent” mega-cap tech stocks. The ‘average’ stock, as measured by the Russell 1000 Equal Weight ETF (EQAL) is actually down fractionally on the year, dividends included. The S&P 500 Equal Weight Fund (RSP) is higher by just 1.7%, while the Vanguard Small Cap ETF (VB) is not even outpacing T-bills, up just 3.3% for 2023.

VOO Railroading Smaller-Cap ETFs in 2023

I have a buy rating on the Vanguard S&P 500 ETF (NYSEARCA:VOO) looking forward into year-end. Also, I spot bullish potential over the back half of next year, if history is any guide.

For starters, let’s level set by analyzing the makeup of the SPX year-to-date. You can see in the below performance heat map that the bigs just keep getting bigger. Along with Eli Lilly (LLY) and General Electric (GE), the Mag-7 stocks just keep working and leaving so many others of the economy’s best companies in the dust. I see no reason why a chase for performance will not keep these winners running strong as the end of 2023 approaches.

I had been cautious on many of the major indexes for much of Q3 and into the early part of this quarter based on seasonal factors, but the time is ticking on the bears – late October through December tends to be quite bullish.

Year-to-Date S&P 500 Performance Heat Map

On valuation, there is no question that US large caps are not exactly a bargain, particularly given today’s loftier interest rates. Specifically, the equity risk premium (the earnings yield on the S&P 500 compared to the dividend yield on the 10-year Treasury note) is near 20-year lows.

Of course, when performing valuation work, it is important to use the earnings yield and compare that to the TIPS rate since owning stocks means having a claim on real assets, so we must inflation-adjust the Treasury rate. The ERP in that sense is still about 3% on domestic large caps.

S&P 500 With A Valuation Premium

S&P 500 Equity Risk Premium Much Lower Compared to the 2010's Range

Looking ahead, assuming next 12-month earnings per share of $241, then the S&P 500 (and VOO) trades about 18 times EPS. I generally agree with how Ed Yardeni sees things – a range between 16 and 20 is likely fair considering where margins are today and given VOO’s high 29% allocation to the fast-growing Information Technology sector.

S&P 500 Fairly Valued Between 16x-20x

Interestingly, the consensus SPX earnings outlook has been trending higher over the last handful of weeks. Normally, estimates come down as the out year turns into the current year. Corporate earnings, however, have proven to be resilient in recent quarters. A year ago, $225 of EPS for 2023 seemed like a lofty figure, but here we are talking about better than $240 for the upcoming 12 months as the “Waiting for Godot” recession just waits further.

As it stands, Q3 GDP is seen as coming in close to 4%, according to betting markets, while the Atlanta Fed’s GDPnow tool is significantly higher than that – still above 5% as we are nearly halfway into the final quarter of 2023.

S&P 500 Earnings Estimates Recovering

Kalshi Betting Market: 3.7% Q3 GDP Growth Priced In

Q3 US Real GDP Growth > 5% Per the Atlanta Fed Model

Earnings Season Begins on Friday the 13th

So why VOO? And Why now? VOO is one of my preferred funds to access US large-cap stocks. The ETF tracks the S&P 500, and it features strong liquidity, low expenses, and seasonality has gone from a headwind to a tailwind. VOO pays a 1.55% trailing 12-month dividend yield and features high daily volume near 1.6 million shares.

Notice in the 4-year election cycle chart below from Seasonax that mid-October tends to be a timely entry point on VOO. Most investors who casually glance at seasonal trends know that the November through April stretch is, on average, the best 6-month period of the year for the SPX. Looking longer-term, we find that there are often major gains to be had from late Q2 of the election year (which would be 2024) through July of the post-election year (2025). So do not confine your seasonal analysis to just the next few weeks.

Bullish Calendar Trends

What could bring about higher stock prices from here? I assert that the consumer will catch a break as the holidays approach. Pain at the pump will turn into pleasure at the pump (maybe that’s a bit too strong) as wholesale gasoline prices have retreated from near $3 two months ago to under $2.20 today. Tack on the historical 95-cent premium on wholesale to arrive at the expected retail price, and we can expect pump prices close to $3.15 looking ahead to November. That could be particularly helpful to major consumer companies.

Gasoline Futures Crater to 2023 Lows, Bullish for the Strapped Consumer

Now, the common refrain to a possible boost in consumer spending has been that the extra demand will simply cause the Fed to keep rates higher for longer. I concede that has been the case this year so far, but recent remarks by a slew of Fed officials suggest that they may be done hiking rates. After today’s CPI report, there is just a 4% chance of a November policy rate increase and less than a 1-in-3 probability that we will see an additional hike through January. Three cuts are now expected by November 2024 – stocks would love to see that.

Stick a Fork in the Rate-Hiking Cycle? 4% Chance of a November Rate Increase

A more dovish Fed comes as economic surprises continue to be to the good side, keeping the “immaculate disinflation” narrative going. The “Goldilocks” story is also alive and well following last Friday’s strong jobs report that resulted in a bond-market bid along with higher stock prices. Turmoil in the Middle East did little to upend the rebound this week, too.

Positive Economic Surprises Persist

As for another check on the consumer, BofA expects a somewhat soft September Retail Sales report to be issued next week. Total card spending has been mixed lately, so odds are that a blowout report is not in the cards. Still, the Wall Street Journal reported earlier this week that spending among Baby Boomers and retirees has been particularly robust, so that could put upward pressure on the spending gauge.

Moderate Retail Spending Seen in September

As large caps are hanging in there following a high notched back on July 31, small caps are anything but rosy. Just today, I found that the Russell 2000 small-cap ETF (IWM) is printing fresh 22-year lows compared with the S&P 500. Readers know that I have been generally favorable on small caps from a valuation standpoint, but poor relative and absolute price action lately makes the case for a near-term overweight to something like VOO.

IWM Struggles Against Mighty Large Caps

The Bottom Line

It is the most wonderful time of the year for the Vanguard S&P 500 ETF. VOO tends to perform best from mid-October through year-end with a bit more strength over the first handful of sessions in the new year. As economic growth runs firm, consumer spending possibly hangs in there, and with the Fed likely done hiking rates, long VOO looks like the right play today.