08/30/2024 | Press release | Distributed by Public on 08/30/2024 14:05
Stocks have been enjoying a bit of smooth sailing since mid-August, yet I wonder whether the next month or two will be as mild. The August 5 volatility spike quickly became a distant memory, but volatility often moves upwards as August turns into September and then October. In nine of the last ten years, the S&P 500 has suffered a drop of at least 5% from its August and September highs, with September historically the worst month of the year. The larger picture, however, looks promising, with the equal-weighted S&P back to all-time highs and small caps once again joining the party. Importantly, sentiment remains below peak levels and market breadth is healthy, with three-fourths of S&P 500 names trading above their respective 200-day moving averages. Meanwhile, mega-cap tech stocks are taking a break. Are you hoping an expected Fed rate cut will stave off September volatility? Going back 70 years, cyclicals generally suffer at the beginning of rate cuts, underperforming defensives by roughly 5% in the subsequent six months.
By market cap, effectively all (98%) of the S&P 500 has now reported Q2 earnings, and the results were quite good. Revenues were up 5.2% and earnings per share increased by 11.6%. Furthermore, earnings surpassed estimates by 5.6%, beating the long-term average of 4.8%. And furthermore again, three-fourths of companies exceeded their earnings projections. But strangely, reporting seasons have been particularly eventful of late, with 10% moves up or down frequently seen following earnings announcements. The big factor this year has been earnings surprises, whose market impact has been unprecedented. Hmm. What are we paying those Wall Street analysts? One source of concern going forward is the 15% increase consensus expects in next year's earnings. That's a big number and getting there would require a lot of things going right. The strong Q2 earnings show up in the revised GDP report, where Q2 corporate profits were broken out, revealing increasing profit margins. This is key and should keep layoffs in check. Indeed, initial jobless claims for the week ending August 24 inched lower to 231K and the four-week moving average dropped to 232K. A recessionary number would be around 300K. Perhaps the August labor report will be more encouraging than was July's.
The US central bank has yet to move, but global short rates have already fallen 70 basis points from their peak, led by declines in emerging markets. In the US, mortgage rates are down to 6.4% versus 7.2% at the beginning of May. Ten-year Treasury yields have fallen nearly 40 basis points since late July. Since the August 5 S&P lows, the spread between the 2-year yield and the effective fed funds rate has widened (from -141 bps to -147 bps today). This as the stock market reaches new highs. Historically, 85% of the time a wave of 6% inflation appears, another such wave will follow (tough odds). This is because declining real wages prompt further wage pressures, making everyone unhappy, leading central banks to give in too quickly. Is Jerome Powell a lucky man? The market is anticipating 225 basis points of rate cuts between now and the end of 2025, with projected earnings growth of 10% this year and 15% next year. Since 1971 it has been quite rare to have more than 100 bps of cuts together with double-digit earnings growth. The only time was 1984, a year that gets little mention but one with parallels to today's economy. Back then, a bull market was underway, GDP growth was strong, unemployment and inflation were low, and consumer confidence was high. The country had finally emerged from the Volcker-induced double recession that broke the back of the inflation seen in the 1970s. And 1984 was the year I got married. Spectacular year!
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Where will the dry powder go? Assets in money market funds remain at record highs. With rates set to fall, though, some of that money seems bound to move. The big question will be, does it go into the stock market, the bond market - or somewhere else?
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