What We're Talking About This Week!

• Weekly Market Reset

• Key Economic Reports This Week

• Dividend Landscape

• Market Outlook

Weekly Market Reset

The markets finished the first half with one overarching theme - the bigger the stock, the better the performance. Of course, this is led by NVIDIA and the rest of the magnificent 7 stocks, but the lack of breadth is a real concern. June featured a remarkable lack of depth where tech & growth were the only asset classes that led the way. Cyclicals had a run for a while before they sharply reversed. Utilities was the best performing sector year-to-date as recently as a few weeks ago, but it’s back to a middle of the pack performer. Defensive sectors, including consumer staples and healthcare, have been stuck in neutral all year. If this market rally from the first half is to sustain in the second half, I really think the gains need to broaden out. That includes defensive issues and, more importantly, small-caps.

The latter is being priced as if a global slowdown will continue into the second half of the year. That makes some sense given the trends in corporate bankruptcies, credit and consumer sentiment, but it runs counter to the general direction of interest rates. Long-term Treasury yields have drifted lower over the past month or two and that’s likely to continue when the Fed cuts rates later this year. Since small-caps are more debt-dependent than large companies, that should beneficial at the margins, but we haven’t seen that happen. I think there’s one of three reasons for this: 1) small-caps are in such bad shape that they’re being avoided altogether, 2) the markets truly believe that a further slowdown is imminent and are positioning themselves in a risk-off manner under the surface or 3) investors are simply being blinded by the outsized returns of mega-cap stocks. It would seem safe to say that #3 is the reason and that’s not healthy over the long-term.

From a sector analysis standpoint, high yield dividend stocks are still outperforming dividend growth, as they have since March, which would indicate risk-on sentiment. The one thing I am watching here is the high beta junk bond/low beta junk bond ratio. It’s been falling since April, albeit with some choppiness, and that could signaling that the party is nearing its end in the junk bond market. Spreads are still historically low, so I don’t think we’re looking at any kind of imminent blowup, but I do think it’s important for forward risk positioning. Homebuilders and transports are badly underperforming the market and have been for a while, signaling that investors are indeed betting on an economic slowdown even if it’s not showing up in the S&P 500.

Key Economic Reports This Week

It’ll be a loaded week both in terms of economic data and comments from the Fed. The latter first, we’ll get the meeting minutes from the FMOC’s June gathering, but it’s unlikely to yield much new information that we didn’t already here from Powell’s post-meeting presser. The markets are currently pricing in rate cuts in September & December and they won’t want to hear anything that dissuades them from that idea. The better bet for direction might come from Powell’s Tuesday speech at the ECB’s central banking forum. With last month’s inflation numbers showing easing price pressures, it will worth watching to see if Powell confirms that a September cut is on the table.

Friday’s non-farm payroll number is likely to come down quite a bit from May’s blowout number, but it’s unlikely to indicate any major cracks in the labor market yet. The unemployment rate of 4% is more than 0.5% above its cycle low, which market watchers usually watch as a signal that conditions may be turning. I doubt we’ll see that with NFP, but Tuesday’s JOLTS job opening number could be telling. Job openings have dropped sharply over the past two months and they’re expected to shrink again. Labor demand does look like it’s softening here and I’d be concerned if this number misses expectations again.

Finally, we’ll get June PMI, which will likely show at least sustained activity on the services side, but continued contraction on manufacturing. The lower demand for goods looks like it’s a worldwide phenomenon and the weakened state of the consumer, the notion of which is being supported by the troubles at Nike and Walgreens (in addition to other retailers), might not result in an reversal any time soon. As has been the case throughout the post-COVID economic cycle, services is propping up the global economy, but a slowdown in spending and confidence will be a headwind.

Dividend Landscape

Dividend stocks are still struggling to pick up any momentum and only one ETF, the AB U.S. High Dividend ETF (HIDV), managed to top the S&P 500 in the first half. The latest inflation data should support the idea that rate cuts are more likely in the 2nd half of the year and that will keep sentiment firmly in favor of risk assets, including growth & tech. I’ve said for a while that a slow, drawn out economic slowdown is unlikely to deter investors from what has worked over the past couple years and I still believe that’s the case now. It’s only if something sudden and severe were to occur, such as a breakdown in Japan, some other geopolitical event or even the turmoil surrounding the presidential election, would dividend stocks begin outperforming again.

High yield has consistently been outperforming more defensive strategies, including the dividend aristocrats, which is in line with the idea that investors are favoring riskier stocks at the moment. It’s also worth noting that one of the top performing dividend ETFs of the first half was the WisdomTree U.S. Large Cap Dividend ETF (DLN), a fund that simply invests in the broad large-cap dividend stock universe. Sometimes, thematic targeting doesn’t matter. Investors are piling into the S&P 500 for outsized returns with market beta risk. It seems the same thing is going on with dividend stocks as well.

Market Outlook

I’ve talked about individual events threatening higher volatility a lot in this space, but they’ve never really come to pass. If investors are just steadily buying the S&P 500 and Nasdaq 100, maybe the impact of economic reports, earnings reports and other events doesn’t matter as much. I would say that Friday’s non-farm payroll number would be one of those events, but I don’t think it will cause a major shockwave absent a huge miss.

The summer months tend to see lower volatility as it is and the steady gains in mega-caps along with daily VIX readings that are often failing to break into the double digits, it’s a favorable environment to see stock prices continue to drift higher. As far as whether returns are positive of negative, it might all come down to Friday’s jobs number, which tends to be a market mover. While a number of economic reports are meaningful for the overall market narrative, they are individually unlikely to cause a jump in volatility. The NFP number might be more consequential to the bond market than the stock market, where I still think that yields want to push lower.

Looking better for: short-term Treasuries, growth, Eurozone, real estate

Looking worse for: retail, mortgage-backed securities, value