Market Commentary – Market Rotation (For Now)
By: Eric Sterner, CFA, CAIA, FRM, CIPM
Chief Investment Officer, Apollon Wealth Management and Apollon Financial
This current bull market has been incredibly resilient as it has continued to march higher through restrictive rates, trade war concerns, elevated inflation, and federal debt concerns. I remain bullish, but I do not believe we are in a complete risk on environment. Labor markets are moderating, the US-China trade talks are becoming more heated, and geopolitical conflicts remain. I think the recent rally has become a bit frothy, which is why we are starting to see a slight rotation in market leadership.
In October, we have seen more traditionally defensive sectors assume market leadership in the US markets, such as Healthcare, Consumer Staples, and Utilities. From a Factor perspective, High Beta and Momentum were the 2nd and 3rd best performing factors last month (up 5 and 4.2%, respectively, according to S&P 500 Factor Dashboard), while Quality (up 1.6%) was in the bottom half. However, last week Quality was one of the top performing Factors while Momentum and High Beta suffered losses. I believe this recent drawback is healthy as the markets have gotten ahead of themselves. We also saw more speculative investments such as Bitcoin fall over past several days.
Inflation, Labor Markets, and the Fed
We have the next US CPI report due this Friday, and I expect a small bump up, but overall, inflation is no longer one of my top concerns. It seems the Fed has similar views with most officials now voicing tariff-induced inflation is a one-time-tax-driven adjustment. Temporary import price increases do not merit restrictive policy, especially when it is not associated with tight labor markets or monetary expansion. Additionally, core goods represent roughly 35% of the Personal Consumption Expenditures Price Index (“PCE”), which is the Fed’s preferred inflation report. Approximately only one-fourth of those goods are imported, so about 8% of PCE is directly affected by tariffs. Therefore, any core goods price changes need to be large enough to overcome the smaller weighting in the inflation basket to offset the disinflationary trends that remain underway within services components.
The Fed’s bigger concern is the moderating labor markets. While we had no visibility into the September nonfarm payrolls report due to the government shutdown, we still were able to view ADP Private Payrolls report which showed job losses of 32,000 in September. Looking inside the numbers, we see the same bifurcated story of hiring between large and small companies, which has played out over the past several months. For the month, large companies (500 or employees) added 33,000 jobs while small companies (less than 50 employees) shed 40,000 jobs. Interest rates still remain elevated, which applies more financial pressure on smaller companies as do higher tariffs on small companies’ profit margins.
I do expect the Fed to cut 25 bps next week and to cut 25 bps again in December. Jerome Powell does not like to surprise markets, and he did not give any signals in his most recent speech to counter the high expectations of a rate cut at the next meeting.
Portfolio Positioning Thoughts
I do remain bullish and feel investors should continue to tilt their portfolios toward the Quality factor by focusing on companies with strong balance sheets and strong track records of earnings and cash flows. The 3rd Quarter earnings season kicked off last week with the largest banks painting an optimistic view of strong capital markets activity and a healthy consumer. S&P 500 companies are expected to produce an earnings growth rate of 8.5%, which would be the 9th consecutive quarter of year-over-year earnings growth. Additionally, S&P 500 profit margins are very healthy at 12.8%, which is above the 5-year average of 12.1%. On top of strong earnings, the stock market also has tailwinds with loosening financial conditions, falling policy uncertainty, and deregulation.
While Jamie Dimon certainly raised some investors concerns recently when he compared the bankruptcies of Tricolor and First Brands to cockroaches indicating there are probably more, I think this is just another sign of some slight frothiness in the credit markets. Although Dimon’s comments caused some investors to flock to safe collateral, which caused the 10-year Treasury to sink below 4%, high yield bond spreads remain very tight, which is evidence there are not widespread credit concerns.
As far as sectors I’m most bullish on right now, I continue to like Financials, Technology, and Utilities. All 3 sectors are expected to report year-over-year increases in their profit margins in Q3 2025 vs Q3 2024. I’m becoming more bullish on the Materials sector due to its attractive valuations and improving EPS.
On the international side, I’m most bullish on Japan. Japan’s valuations remain attractive when accounting for its equity market fundamentals and local bond yields, and it is currently bucking the broader ex-US EPS downgrade cycle. While political uncertainty had caused some volatility in the Japanese markets, the election this week of its new prime minister Sanae Takaichi is generally viewed as a market friendly development.
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