U.S. Stocks Stage a Huge Recovery as Recession Fears Suddenly Fade

By the Curmudgeon with Victor Sperandeo

Market Week in Review:

U.S. stocks posted their best gains since November last week, defying previous widespread recession concerns. The S&P 500 gained 3.9%, the Nasdaq rose 5.3% and the Nasdaq 100 advanced 5.4%. Since the market bottom on August 5^th, the S&P 500 is up more than 7% while the Nasdaq 100 has gained more than 9%.

The VIX (volatility fear gauge) has retreated from its 65.73 intra-day high on August 5^th to close at 14.8 on Friday, August 16^th.

Credit spreads have tightened (i.e. junk bond prices have recovered even as Treasury’s have rallied) and momentum is clearly on the side of riskier assets. Yet it’s quite puzzling that many risk-off assets are also rallying at the same time (much more below)!

“The market’s really in knee-jerk mode right now to incoming data,” said Liz Ann Sonders, chief investment strategist at Charles Schwab.

“A lot of the fear and trepidation has been taken out,” said Joe Mazzola, head trading and derivatives strategist at Charles Schwab.

Here are two charts depicting 1] U.S. stock indexes this past week and 2] the S&P 500 weekly change (+ or -%) since November 2023:

Overseas, stocks rallied strongly.

· Japanese stocks — which bore the brunt of the global sell-off at the start of August — surged 3% on Friday for a weekly gain of 7.9%.

· The Stoxx Europe 600 index added 0.3% to close the week 2.4% higher.

· The MSCI World index of global developed market stocks — calculated daily — also had its best week since early November.

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Intermediate Term Stock Market Assessment:

U.S. equities aren’t quite all the way back to their mid-July highs when the perceived “great rotation” -- from big tech to small stocks --kicked off. Yet they’ve recouped all their losses since the disappointing August 2^nd BLS jobs report and the BoJ rate hike to defend the yen (which stimulated the unwinding of the yen carry-trade, which sparked the subsequent global sell-off in risk assets).

However, the “great rotation” isn’t happening – at least not yet. Big tech, large cap growth and high beta equities are outperforming other stocks with small caps lagging once again. It’s highly unusual that big tech – the leaders in the last several stock market advances – continues to be on top after each pullback or correction.

Victor’s Stock Market Outlook:

The equity market just had what is called an “ABC pattern,” where a high is made, then a sell-off occurs (A) followed by a test of the highs (B), then a decline to the lows (C). If the lows hold that is bullish, but if the market breaks those lows it signals a change of the intermediate trend from bullish to bearish.

According to Dow Theory, If the Dow Jones Industrials makes a new high and that’s confirmed by the Dow Jones Transports, the trend is still up.

-->Personally, I believe the top is in. The S&P 500 has been up seven days in a row and doesn’t seem to have the “fire power” to make a new all-time high.... we will see shortly.

Risk-Off Assets Also Rally:

Also confounding is that several risk-off assets are still maintaining solid strength.

· Gold keeps pushing to new all-time highs as investors anticipate the start of the Fed’s rate cutting cycle in September. The long-term outlook for Gold is bullish, according to our good friends at the Aden Forecast (we strongly recommend you subscribe!).

· REITs and utilities are strong while long-term Treasury yields continue to trend lower as they’ve been doing since late April. REITs and utilities are bond substitutes, so they rally when intermediate/long term interest rates drop significantly.

· According to a report from DataTrek Research, REITs are the best performers since the end of June, rallying 9%. Utilities are next, with an 8.8% gain. Financials are third best, up 5.7% in the 3^rd quarter to date.

· Lumber prices, which traditionally tend to rise in risk-on environments, instead have been stagnant. This may be due to a weak housing market.

· This past week, housing starts tumbled to their lowest level since hitting an annual rate of 1.053 million in May 2020. Single-family housing starts led the way lower, plummeting by 14.1% to an annual rate of 851,000 in July after edging down by 0.1% to 991,000 in June. Building permits also fell 3.8% to 1.386m, from 1.440m, surprising economists who expected a rise to 1.450m.

U.S. Unemployment and Layoffs Increase:

“I don’t think the labor market in its current state is a likely source of significant inflationary pressures,” Fed Chair Jerome Powell said in his post-FOMC meeting news conference on July 31^st. “So, I would not like to see material further cooling in the labor market.”

Yet the unemployment rate is now 4.3% and layoffs continue unabated, especially in the tech sector.

Large cap tech companies including Cisco Systems, Intel and Dell have cut tens of thousands of jobs in August, the latest in a year that began with layoffs at companies such as Amazon and Google. As of August 17^th, 2024, a total of 404 tech companies have laid off 132,498 workers this year, according to layoffs.fyi, a website that tracks tech industry job cuts. This includes major tech companies like Amazon, Google, Microsoft, Tesla, TikTok, and Snap, as well as smaller startups and apps.

“The data are showing that the U.S. economy is slowing, but that’s to be expected two years into a rate-hike cycle. It’s just when [a slowdown] starts to actually manifest itself [that] people get nervous.”

-->Obviously, investors and traders are NOT at all nervous now!

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September FOMC Meeting Looms Large:

One consequence of recent solid economic data (especially retail sales) is that investors have scaled back bets that the Federal Reserve will cut interest rates by a larger-than-normal half a percentage point (50 bps) at its next meeting on Sept. 17-18^th Traders now forecast that the Fed will cut rates by at least 25 bps (more below), in what would be the first such move by the U.S. central bank since it raised rates to a two-decade high in July 2023.

Many analysts think conditions in the economy and markets would need to deteriorate further for the Fed to deliver a 50-bps rate cut in September. “There are two main paths to a [half point] cut in September,” says Goldman Sachs GS chief economist Jan Hatzius. “The first is another downside surprise in the next jobs report. The second is renewed sharp tightening in financial conditions and/or a rise in financial stress that creates greater economic risks.”

Hatzius expects the Fed to cut rates by a quarter of a percentage point (25 bps) at all three of its remaining meetings in 2024, as do Morgan Stanley’s chief U.S. economist, Ellen Zentner, and Rick Rieder, BlackRock’s chief investment officer of global fixed income.

San Francisco Fed Chair Mary Daly, who is a voting member of the FOMC, agreed. She told the Financial Times that the U.S. economy was showing little evidence of heading for a deep downturn, so the Fed should take a “gradual approach” to cutting rates. “Gradualism is not weak, it’s not slow, it’s not behind, it’s just prudent,” she said, adding that the labor market — while slowing — was “not weak.”

A half-point Fed Funds rate cut in September could be counter-productive, says Antulio Bomfim, head of global macro for the global fixed income team at Northern Trust Asset Management. “It could send a message that policymakers are panicking about the economy, that they are seeing something that we are not, and then it becomes a self-fulfilling, perverse cycle,” he said.

For the real economy, the difference between a quarter-point and half-point reduction in the fed-funds rate in September isn’t make-or-break. But it is psychologically significant in the message it sends to markets and consumers.

Interest Rate Futures and the U.S. Bond Market:

Interest-rates futures (i.e. the CME Fed Watch Tool) now forecasts a 75% chance of a 25-bps rate cut vs a 25% chance of a 50-bps cut, down from ~50% a week earlier.

That shift has had mixed implications for the U.S. bond market, with investors easing up on short-term Treasury’s but buying more longer-term bonds as a possible hedge against another downturn in stocks.

The 2-year U.S. Treasury yield fell from about 4.34% at the end of July to about 3.65% on August 5^th, before recovering to around 4.1%. It settled at 4.064% Friday, up from 4.054% a week earlier, according to Tradeweb.

Fed’s Jackson Hole Shindig - August 22-24, 2024:

Fed Chairman Jerome Powell’s keynote address on August 23^rd at the Kansas City Fed’s annual Jackson Hole Monetary Policy Symposium will lay the groundwork for the coming shift in rates, spurred by the deceleration of inflation in the past two years toward the central bank’s 2% annual target and policymakers’ desire to get ahead of a softening labor market.

Fed officials, economists, and policymakers will descend on Jackson Hole, Wyoming, in just a few days for the aforementioned Fed shindig. They will discuss this year’s very relevant symposium theme, “Reassessing the Effectiveness and Transmission of Monetary Policy.”

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Jackson Hole Wyoming with Grand Teton mountains in the background.

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“Our expectations are for [Fed chairman Jay] Powell to more clearly (?) signal that we’ll see a September cut and offer greater context for what the Fed envisions for the pace of forward rate reductions,” said Ian Lyngen, head of US rates strategy at BMO Capital Markets.

Your authors expect Powell to reiterate that the Fed’s decisions are “data-dependent,” while confirming Fed officials’ dovish stance.

->If the Fed’s decisions are data dependent from one FOMC meeting to the other, why then is there the continued forward guidance “talk the talk” by Fed officials in between meetings? Why can’t they just shut up?

Victor’s Conclusions:

1. U.S. government fiscal spending is over the top, which causes huge budget deficits. Those deficits are monetized and are the core driver of higher inflation.

Currently, the U.S. Federal Deficit for this fiscal year (which ends Sept 30^th) is ~$2 trillion. It’s now ~123% % of GDP compared with 34.65% in 1980, according to the U.S. Debt Clock website.

2. The Fed has made stalling into an art form. Recall that after the December FOMC meeting Powell hinted the Fed would be cutting rates in 2024. Eight months later, there hasn’t been even one Fed Funds rate reduction.

The Fed never mentions an inflation measure that is below its 2% target (like Truflation). Instead, they use the personal consumption expenditures (PCE) price index as their primary measure of inflation saying it's more comprehensive than other indexes (like the CPI) and accounts for changes in shopping habits during inflation. Thereby, they are timing Fed Funds rate cuts just before (and one day after) the November elections.

-->The FOMC members are nothing more than con men pretending to be central bankers!

3. According to Pew Research, Americans remain deeply distrustful of and dissatisfied with their government. Just 20% say they trust the government in DC to do the right thing just about always or most of the time. 65% of poll respondents say most political candidates run for office “to serve their own personal interests.” We agree!

-->The greatest error Americans make is trusting and believing their government, which is actually the enemy of the average U.S. resident.

End Quote:

A “Letter from John Adams to Massachusetts Militia,” October, 11, 1798“ states:

“Our constitution was made only for a moral and religious people. It is wholly inadequate to the government of any other.”

Morality and virtue are the foundation of our republic and necessary for a society to be free. Virtue is an inner commitment and voluntary outward obedience to principles of truth and moral law.

->John Adams was the second U.S. President (1797-1801), after serving as the first Vice President under President George Washington.

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Be well, success, good luck and 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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