August was a roller coaster for stocks. Moves lower in a roller coaster market can be terrifying, and in the first three trading days of August, investors had to contend with economic data showing what looked like a sharply decelerating economy and the unwind of the yen carry trade. But then the market stabilized. By the end of the month, economic data looked less ominous, and the Fed all but confirmed a rate cut in September.
For the month, the S&P 500 was up over 2%, led by the broader market. The Mag-7 no longer have the front seat. Other sectors and stocks are stepping up to take the lead. The transition hasn’t been smooth, but the more stocks participating, the merrier.
Who said markets are dull in summer?
“The time has come for policy to adjust.” That was Fed Chair Powell at Jackson Hole. He added that inflation developments are now less important for the Fed than labor market conditions. He added, “we don’t seek or welcome further labor market cooling.”
We expect a 25 basis point cut at the Fed’s September meeting, not 50 basis points. Why? The current backdrop of resilient equity markets, stable high-yield spreads, rising ISM services, and rising payrolls are not consistent with the sort of emergency environment that tends to prevail when rates are cut by more than one notch.
We don’t like to see overly bullish investors, even in the heart of a bull market. Sentiment is a contrary indicator. If everyone is bullish, who is left to buy? Investor sentiment has been anything but skeptical lately.
Bulls have outnumbered bears in the AAII sentiment survey (American Association of Individual Investors) in 42 of the last 43 weeks (including the last 18 straight), marking the most resilient retail investor sentiment in over 20 years. However, this persistent optimism is not as worrisome as excessive To summarize, current sentiment readings are elevated, but not historic.
OUR (A)TYPICAL BULL MARKET
Typically, a new bull market begins during or near the end of a recession, forcing the Fed to ease interest rates and boost the money supply to restore economic health. The combination of Fed easing and moderating inflation enhances the outlook for economic activity. This bull, however, has been quite different from the one described above. It started even as the Fed continued to raise interest rates as inflation started to fall and growth slowed. This resulted in just a few stocks, Nvidia and the rest of the Magnificent-Seven, rising while most everything lagged. But it was a new bull market nonetheless.
It is hard to call this a “classic” bull market, even though the market’s current behavior could be seen as typical – climbing a wall of worry, valuation concerns, sector rotation, changing leadership, non-belief, etc.
Our biggest concern is the trend of the economy. Here are a few economic statistics that worry us:
– The manufacturing sector is weak, although we recognize industrial activity in the U.S. has been increasingly less important with respect to the entire economy.
– The employment sector is spotty, although jobless claims have ticked modestly lower. Jobless claims are a real-time employment indicator, so this is encouraging.
– Housing is showing negative momentum. Homebuilder sentiment remains extremely weak given the decline in housing starts and building permits.
Maybe this is our own wall of worry because these are certainly positive signs in the economy, including consumer demand holding up and strong consumer credit performance.
In spite of these concerns, we still see a steadily growing economy with support from fiscal deficits and strong consumer balance sheets. And with lower interest rates, the housing market could reverse course and be a tailwind.
We would argue that while the coming easing cycle is correctly anticipated to start in September, current restrictive rates need to decline in order to preserve the current backdrop of solid growth given slowing inflation. We are comfortable that the bull has legs and could last for quite some time.