Shake It Off
Global equity markets have quickly recovered from all the angst (soft payroll report and tremors of the yen carry trade unwinding) that sent stocks careening lower two Mondays ago. All the major averages enjoyed their best week of the year last week, with an impressive improvement in market breadth to boot. The Nasdaq Composite led the charge (+5.3%), followed by the S&P 500 (+3.9%), while the Dow and small-cap Russell 2000 gained a respectable +2.9%. All these indices popped back above their 50-day moving averages, putting the onus back on the bears to prove their case. Incoming data over the last week did not support the recession view that was starting to get aggressively priced when stocks were legging lower. Nvidia led the charge as its stock spiked nearly +19% to $125, its best weekly gain since May 2023, with a meaningful catalyst awaiting on the 28th of this month when it reports its earnings.
The S&P 500 is on a seven-day winning streak coming into today. Just goes to show you how momentum, sentiment, and positioning can really change things when a trend moves in one direction or another. The rally in equity markets (along with better-than-expected data) has caused the swaps market to go from pricing in -150 basis points of rate cuts by year-end to around -90 basis points (call it almost four 25-basis-point cuts). Despite all the gyrations over the last two weeks, the Treasury market has hung in rather well and is still 20 basis points lower than (3.88%) it was just prior to the release of the July employment report.
One thing is certain, mind you, which is that interest rate relief is not helping the most interest-sensitive sectors of the economy. People may be spending at a healthy clip, but they aren’t flocking back to big-ticket items typically purchased with financing; this is especially true for the housing market. Even with mortgage rates having come down -120 basis points from the cycle highs to close to 7%, the NAHB builder sentiment index has peeled back four months in a row to the low point of the year, and housing starts are down to their lowest level since May 2020. The ineffectiveness of rate relief is otherwise known as “pushing on a string,” which was a theme espoused by Alan Greenspan in the early 1990s when the Fed funds rate was sliced -70% from the cycle peak to the fundamental low at the time.
In the commodity complex, we’re seeing copper get a bid for the first time in a while, and gold rallied more than +2.5% last week, with futures breaching the $2,500/oz mark for the first time ever. It’s funny to witness the lack of attention gold is getting as it sets all-time high after all-time high in route to it being up more than 20% on the year. I also continue to find it fascinating how I still get the eye roll or glazed-over expression when professing in client meetings the importance and prudence of having gold in a portfolio.
Without question, the U.S. dollar's weakening to its lowest level since December 2023 is boosting commodities, emerging markets, and foreign equities. If the Fed is indeed on a rate-cutting cycle that will outpace other global central banks on the downside, emerging markets could very well be a ripe opportunity for investors. Truth be told, I’ve been kicking the tires on this opportunity over the last couple of weeks and am strongly considering increasing exposure.
Take a moment to think about some the below stats put out by BofA’s Chief Strategist Michael Hartnett:
$125 trillion: value of global stock market capitalization, up almost 4x since GFC lows in 2008
U.S. accounts for 65% of the global equity market
$313 trillion: the size of global debt, now over 3x the value of world GDP
U.S. accounts for 44% of global government bond market. China is 2nd largest government bond market (14%), and Japan is 2nd largest equity market (12%).
100 days: U.S. government debt rising by $1 trillion every 100 days.
20%: Europe and Japan’s combined share of the global equity market…was 39% in 2008
-10.4%: annualized return of Chinese equities over the past 4 years (worst-performing global equity index)
+12.3%: annualized return of Indian equities past 20 years (best performing global equity index)
This week’s big event is the Fed’s Jackson Hole symposium, where all ears will be fixed on Jay Powell’s speech on Friday at 10 a.m. (ET). Beyond that, it’s a quiet week as far as economic data and earnings go. No doubt investors' attention will start to gravitate more to politics with roughly 75 days left until the November 5th election. The odds are rising that the Democrats will maintain power in the White House as the Trump campaign struggles to expand its reach beyond its loyal base and Kamala Harris builds momentum heading into the DNC. Harris did make some news last week as she begins to release details on her economic policies, and I must admit they look a lot like the Bernie Sanders playbook – price controls, debt forgiveness, caps on rental rates and groceries, not to mention higher business and personal tax rates as well as the possibility of taxes on unrealized capital gains. Also worth noting on the energy front is that she is open to a ban on fracking and all in on the Green New Deal to combat climate change risks.
Look, don’t shoot the messenger here – if you don’t like her policies. Do something about it. If you like them, once again, do something about it. The same goes for Trump and the GOP. What we do know is that gridlock will make it almost impossible for either candidate to get much of their agenda passed, let alone the most extreme parts of their agenda. No matter what, investors and markets will have to adjust and adapt to whatever the results come November 5th.
As for markets, I see us in a bit of no-mans land for the time being. The economy, while slowing, continues to show its resilience time after time. The Atlanta Fed’s GDP Nowcast model was just revised down to +2.0% annualized from a high of +2.9% a week ago, but +2.0% is a long way from a recession. Sure, the Citigroup Economic Surprise Index (see chart below) continues to show economic data is coming in below economists' forecasts, but this is as much a shortcoming of this model as it is about weaker prints. This model is mean-reverting, and I’m willing to bet forward expectations have been reset lower, which likely creates the setup for numbers to start coming in above expectations.
On the earning front, we are putting a bow on Q2 results and how anyone can get all beared up with earnings growth coming in at +10.9% (the highest reported earnings growth rate since Q4 2021) and revenue growth clocking in at 5.2% is a headscratcher to me. Well, Corey, those results are in the rearview; results over the next couple of quarters are going to be much weaker. Maybe, maybe not, but if results come in near the lofty estimates analysts are penciling in for future quarters I think stocks should hold in just fine (data from John Butters at FactSet):
For Q3 2024, analysts are projecting earnings growth of 5.2% and revenue growth of 4.9%.
For Q4 2024, analysts are projecting earnings growth of 15.5% and revenue growth of 5.6%.
For Q1 2025, analysts are projecting earnings growth of 14.4% and revenue growth of 5.9%.
For Q2 2025, analysts are projecting earnings growth of 13.9% and revenue growth of 5.8%.
For CY 2024, analysts are projecting earnings growth of 10.1% and revenue growth of 5.1%.
For CY 2025, analysts are projecting earnings growth of 15.3% and revenue growth of 6.0%.
This is saying nothing about valuation which is rich relative to history with the S&P 500 trading at a P/E of 21x on forward earnings. But rich valuations is not a new revelation. I don’t mean to come off as cavalier about the margin of safety being razor-thin in the concentrated S&P 500, but any investor making decisions strictly on historical valuation comparisons has been sitting on the sidelines watching this market move higher for the majority of the post-GFC period. Right now, investors are comfortable with the setup that while growth is slowing, its still growing. The inflation dragon appears to have been slayed, and the labor market, while showing some cracks, continues to portray a picture of an economy operating near full employment. What’s more, is that the “Fed put” is back, with investors giving the Fed the benefit of the doubt that they can engineer a soft landing, and if the approach experiences some turbulence, the Fed will act more aggressively.
Equity investors will have a complicated backdrop confronting them over the next 6 – 12 months as the Fed begins its rate-cutting cycle. Whether they ease, 25 or 50 basis points at the next meeting on September 18th is less relevant to why they are easing. An answer that won’t be apparent for some time now. If the Fed cuts because a recession is coming, then the stimulus, given the lags, cushions the blow, but the downturn is unavoidable. All twelve recessions back to 1950 had the Fed cutting rates to wild enthusiasm at the beginning before economic reality set in. When we get rate cuts into a recession, the S&P 500 declines an average of 27% to the fundamental lows. But, if we escape recession and the Fed cuts, the historical record shows the index rallying +18% over the year that follows that first volley.
One more thing I want to hit on before signing off is a thought on return expectations. I can appreciate that the mentality towards the way individuals look at savings may have changed over time. Still, I’d be remiss if I didn’t share my concern about how investors look at the stock market as the new savings account. Results over the past fifteen have proven this to be the right view, but this fifteen-year period is just after the 13 years from March 2000 to April 2013, where the equity market (as measured by the S&P 500) was flat. It wasn’t until April 2013 that the S&P 500 eclipsed for good the highs it put in back in March 2000 and briefly pushed above in October 2007. Today, I get the impression that investors in the stock market think they are entitled to double-digit returns in the equity market. Why fuss with anything else? Diversification has become a dirty fifteen-letter word. Risk management, that’s a waste of time and energy. Yes, those prior three sentences should have been read with a high degree of sarcasm.
I view savings as a pool of capital set aside for future use. Without question some of it should be deployed in a manner to overcome the impact of inflation over time and in areas that provide the opportunity for compounding. But more than ever, I see investors succumbing to the stress and pressure of keeping up with the Jones while abandoning discipline and prudence. Forget about a long-term plan that suggests an investor needs a mid-single-digit return to achieve their long-term objectives. That’s no fun, “my neighbor bought XYZ, and he/she has a new boat in their driveway.” This is the type of thinking that, at some point, humbles us all. The moral of the story is to not lose sight of the forest for the trees; the return objective for savings over time should be to outperform cash. Cash is a risk-free asset that can be easily accessible to any and all investors. Those willing to incur risks to generate a return above cash do so, knowing that is what they are doing. Stocks, bonds, commodities, real estate, private equity… these are some of the many ‘tools’ an investor has accessible to them in order to achieve their objective – I stress the word ‘tools’ as they are not the holy grail and none of them ‘entitle’ you to a return.
The articles and opinions in "Capital Market Musings and Commentary" are for general information only, and not intended to provide specific investment advice. Performance, dividends and other figures have been obtained from sources believed reliable but have not been audited and cannot be guaranteed. Past performance does not ensure future results. Investing inherently contains risk including loss of principle. Advisory services offered through Casilio Leitch Investments, an SEC registered investment advisor.
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