The Markets and Economy vs. November U.S. Elections

By Victor Sperandeo with the Curmudgeon

U.S. Elections – Uncertainty Reigns Supreme:

The significance of the November U.S. elections cannot be overstated. Politics under current conditions are of primary importance to the Fed, U.S. economy and financial markets.

As expected, U.S. President Joe Biden announced Sunday he’s dropping out of the 2024 race and endorsed Vice President Kamala Harris to be the Democratic party’s new nominee. He wrote in a letter to fellow Americans that “It is in the best interest of my party and the country for me to stand down and to focus solely on fulfilling my duties as President.”

VP Harris vowed to “earn and win” the nomination, while Biden said he’d address the nation later this week in more detail.

Biden will now have to release his 3,896 pledged delegates, but it’s not certain they will all pick Harris as their party’s nominee for President. There are an estimated 3,933 pledged delegates and 739 super-delegates, according to NBC.

There are no definitive rules for who will be chosen as the Democratic Presidential nominee at the Dems August 19-22, 2024 convention. The Curmudgeon discussed several scenarios in this post: Will Chaos at the GOP and Democratic Conventions Disrupt Financial Markets?

One new suggestion is to have former U.S. Presidents Clinton and Obama oversee debates with the top Democrats (about eight well known politicians) and vote on a nominee. However, there’s no guarantee Biden’s pledged delegates would accept such a vote.

These are all questions that are going to be made up on the fly by the Democratic leadership. Therefore, the outcome is totally unknown at this point in time. However, does it really matter?

Donald Trump is a very heavy favorite to win the U.S. Presidency in November. According to BetMGM UK, Trump has a 55.80% chance of winning compared to Harris’ 26.87%.

However, the elections for U.S. Congress are a big question mark. The Senate is leaning towards the GOP, while the House is a 50/50 toss-up. If the Democrats win one of the two branches of Congress, Trump’s agenda means very little.

Now, let’s focus on the markets…………….

Is the Small-Cap Rally the Real Deal?

The small-cap Russell 2000 enjoyed a historic six day winning streak of 1%+ gains each day with the index closing up more than 3% on Wednesday, July 17^th. That left the Russell 2000 (and the IWM ETF) at an astonishing 4.42 standard deviations above its 50-day moving average. Over five days, the ratio of small-cap total return to large-cap total return jumped by nearly 10%. That's one of the largest shifts in nearly 100 years!

Sentimentrader says that Federal Reserve easing cycles have generally helped smaller stocks over larger ones, with peaks in the Fed Funds Rate roughly coinciding with some crucial bottoms in the ratio of small caps to large caps. As investors anticipate the next easing cycle, they have kick-started this shift dramatically. The adjustment was so substantial that there are few precedents, so “there seems to be a good chance that it can last for several months at least.”

According to Bespoke, it's the most overbought that ANY of the major US index ETFs has ever been! Since 1928 for the S&P, 1900 for the Dow, and 1971 for the Nasdaq, none of these indices have ever been more overbought than the Russell was at Wednesday’s close.

Victor believes the rally in the small caps (which started on 7/7/24) was mainly due to short covering. If that’s true, he believes that rally is over!

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Market Sells Off on Taiwan-China Worries?

The U.S. stock market had a minor sell-off in the last three days of the past week. Mega cap tech stocks were hit hard, and several pundits say that the AI stock rocket ship is out of fuel. The previously hot Nasdaq (big tech) and the S&P 500 (Magnificent 7) cooled off this week (-3.65% and -1.97% respectively). Yet the S&P is down only -2.8% from its all-time high on 7/16/24.

Victor attributes the sell-off to a Donald Trump comment that he would not necessarily defend Taiwan against China if he were re-elected U.S. President in November. That set off a decline in semiconductor stocks like AI darling Nvidia, which spread to other Magnificent 7 stocks. Taiwan is of utmost importance for the semiconductor industry because it’s the home of Taiwan Semiconductor Manufacturing Company (TSMC) -the world's largest foundry. TSMC is a top producer of cutting-edge semiconductors for major tech companies like Apple, Qualcomm, and Nvidia. TSMC manufactures over 50% of the world's semiconductors and over 90% of the world's leading-edge logic chips.

-->If China invaded Taiwan, it could redirect TSMC chip making for domestic consumption and restrict semiconductor exports to the U.S.

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U.S. Economy and the Fed:

The U.S. economy is deteriorating very quickly. Initial and continuing unemployment claims rising and home sales falling. That’s despite the latest Atlanta Fed's GDPNow model estimate of 2.7% for the 2^nd quarter 2024 on a seasonally adjusted annual basis. Most of the GDP growth is due to U.S. federal government spending and hiring.

The U.S. employment situation is weakening with unemployment rate rising from 3.7% in March 2024 to 4.1% in June 2024. Expect that number to increase to at least 4.2% in the next BLS Employment report, which will be released on August 2^nd. Vanguard expects a 4.6% unemployment rate by 2024 year’s end.

The Sahm rule, named after a former Federal Reserve economist, is triggered when the unemployment rate three-month moving average increases by half a percentage point above its 12-month trough. A 4.2% unemployment rate in the July jobs report would activate this rule, which in the past was a signal of an impending recession.

More importantly, the Conference Board’s Leading Economic Indicators (LEI) for June fell to its lowest level since April 2020. The index declined 0.2% from the previous month to 101.1. June’s decline in the LEI was led by consumer sentiment, new orders, yield spread, and unemployment insurance claims. Over the first half of 2024, the LEI fell by 1.9%, a smaller decrease than its 2.9% contraction over the second half of last year.

Economist David Rosenberg noted that recessions are always associated with long periods of negative LEI readings. One can clearly see that in the chart below.

Victor believes the Fed will cut rates at its July 31^st FOMC meeting. That’s despite the CME Watch Tool forecasting a 96% probability of no rate cut at that meeting. He forecasts that the Fed will also cut rates 25 bps at the September 18-19^th meeting.

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Inflation Watch:

The CPI increased +2.97% YoY in June, and it’s been declining. Victor’s favorite gauge that measures rising prices is the “Truflation index,” which has been below 3% all year and below 2% since July 1st.

Chart Courtesy of Truflation

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Victor’s Market Positions:

I’m long only Gold and 5-year T-Note futures. However, if stocks fall by 5% to 10%, he would be a buyer of the S&P 500. His plan is to be flat except for Gold after the Fed’s September meeting.

It should be noted that commodities, due to the weakness in the global economy, are up only 6.27% YTD. Victor’s seasonal grain trade did not work out this year. It was a loser this season.

Victor’s Conclusions:

The Federal Budget next year is projected to be $7.3 Trillion. That plus control of the U.S. military is enough power to buy anything the people in power wish. The cost is the public’s liberty, and its net worth, as inflation’s base comes from government spending which erodes the purchasing power of Americans.

Many liberties are eroding daily, as the U.S. government controls more of what residents can and cannot do. It is becoming more authoritarian than the U.S. Constitution permits. For more on this theme checkout this article.

End Quotes:

“Our Constitution was made only for a moral and religious people. It is wholly inadequate to the government of any other.” John Adams was an American statesman, attorney, diplomat, writer, and Founding Father who served as the second president of the United States from 1797 to 1801.

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“A man's natural rights are his own, against the whole world; and any infringement of them is equally a crime; whether committed by one man, or by millions; whether committed by one man, calling himself a robber, or by millions calling themselves a government.” Lysander Spooner was an American abolitionist, entrepreneur, lawyer, essayist, natural rights legal theorist, political philosopher, Unitarian and writer often associated with the Boston anarchist tradition.

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Stay calm (easier said than done), good health, success and good luck. Till next time……………………………………………

The Curmudgeon
ajwdct@gmail.com

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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