What We're Talking About This Week!

• Weekly Market Reset

• Key Economic Reports This Week

• Dividend Landscape

• Market Outlook

Weekly Market Reset

Powell gave the markets exactly what it wanted at Jackson Hole this week. He cemented that a September rate cut is on the way, leaving only the outstanding question of whether the cut will be 25 or 50 basis points. The Fed had maintained the stance that inflation was still a little too high or the labor market was still in good shape or growth was still healthy. Now, with inflation now below 3% after cooling in July and Powell acknowledging that the labor market has weakened, the deck has been cleared for perhaps a sustained rate cutting cycle. The market is currently pricing in 100 basis points of cuts in 2024 and another 100-125 in 2025.

The markets reacted as they did in mid-July, which is to say that stocks broadly reacted positively, but the strongest gains were reserved for cyclicals, small-caps and value stocks. I don’t think stocks are gearing up for another rotation similar to the one we saw a month ago, but this could mark the beginning of the end for tech and growth as market leaders. A weakening labor market (which may actually be much weaker than we thought given last week’s annual negative revision) is usually the one thing that signals broad economic health. Given how it’s trending, we’re likely to see investors start to balk at paying premium prices for stocks. That’s bad for tech, growth and the magnificent 7, but better for value, low volatility and defensive sectors.

The positive reaction by stocks isn’t unusual at this stage of a new rate cutting cycle. Investors are initially optimistic about the prospect of looser financial conditions. The turn lower for stocks typically happens shortly thereafter. Barron’s notes that stocks on average have declined about 5% in the three months following the first rate cut. Meeder Investment’s research shows that the average time frame from first cut to S&P 500 bottom is about 9 months and the average decline is about 20% (although the range of returns & time frames on an individual basis is very wide). The general point is that the Fed’s first rate of a new cycle tends to be bad for stocks over the intermediate- to longer-term.

This could be an opportunity for high quality bonds though. Long-term Treasury yields have been trending lower since May and the 10-year is down 90 basis points over that time. If we’re in for a major rate cutting cycle, which seems more likely than not given deteriorating consumer behavior and a slowing jobs market, there’s a lot of room for yields to go lower. Treasuries look like the better play since we’ll probably see better performance from flight to safety beneficiaries. Short-term high quality corporate bonds may hold up OK, but corporate credit often sells off in these scenarios. Junk bonds, in my opinion, look like a strong “avoid” here. Credit spreads indicate that risk is massively underpriced right now and that’s likely to correct violently as current trends persist.

Key Economic Reports This Week

In the United States, Thursday’s 2nd read on Q2 GDP is unlikely to result in any meaningful revision and probably won’t be a market mover. Friday’s PCE data is likely to confirm what we’ve seen in other inflation data, which is to say that price increases are modest and contained. The narrative is already that inflation is going to be slowly trending lower and we’re unlikely to hear anything that will change that story.

The more interesting report will be personal income & spending. For as much as consumer debt loads and delinquency rates are on the rise, personal spending and retail sales figures have managed to hold up well. Should this be interpreted as consumers are still buying, but need to accumulate debt in order to do it? That’s not the worst situation, but it’s also not a positive one. Households ultimately need cash to pay off their debts & bills and it’s looking like they’re still coming up short. If these figures start moving lower, we’ll know that the consumer has hit its ceiling and recession is probably upon us.

Elsewhere, Eurozone inflation is likely to show that the ECB will be on track to lower rates again later this year. China’s manufacturing PMI is unlikely to deliver any surprises, but we’ll need to watch if it reframes the arguments around government stimulus. It seems likely that the PBoC will need to do something in order to stimulate the economy, which may have trouble hitting its 5% GDP growth target this year.

Dividend Landscape

In July, the big large-cap to small-cap rotation resulted in the best run for dividend stocks since the 2nd half of 2022. We got some of that again last week with gains spread pretty evenly across the different dividend strategies. If this latest shift is sustainable and investors don’t just default to going back into tech stocks, there’s finally a roadmap in place for dividend stocks to lead for an extended period. In the case of another market correction, that may mean falling less than the S&P 500, but it would be a downside cushion nonetheless.

I don’t want to get too overoptimistic about the prospects for dividend payers because we’ve been burned multiple times in the past. If, however, economic conditions are changing - the jobs market is finally cracking and consumers are running out of gas - there’s a clear path for dividend stocks to finally demonstrate their value again.

Market Outlook

The markets to this point have responded pretty enthusiastically to the idea of a Fed pivot. Now that we’ve got a little more clarity on the timeline, I could see U.S. stocks extending their rally for at least a little while longer before starting to indicate caution. I don’t think tech & growth will be the play though. During a similar set of conditions in July, value, dividends and small-caps outperformed for nearly a month before the rally started to fade. The difference then was that it was driven in large part by the reverse yen carry trade. The markets probably won’t have that to deal with again, so any potential losses might be more muted.

I think the major averages probably hold up, but cyclicals and small-caps are better positioned. I noted on Twitter than if the 10-year yield can break below 3.8% that 3.5% will be in play. I think that eventually happens and Treasuries look positive.

Looking better for: Treasuries, industrials, small-caps

Looking worse for: growth, junk bonds, China