What We're Talking About This Week!

• Weekly Market Reset

• Key Economic Reports This Week

• Dividend Landscape

• Market Outlook

Weekly Market Reset

U.S. stocks enjoyed one of their best weeks of 2024 following the election win by Donald Trump. The catalyst is quite clear. Trump’s policy platform includes tax cuts, deregulation and a more pro-business environment. The tax cuts would help bolster corporate profits, as they did back in 2017, while the elimination of certain regulations would result in fewer hurdles for businesses to clear and more favorable operating conditions. Those companies that would, in theory, stand to benefit more strongly from these policies, including banks, oil producers, blockchain companies, chipmakers and aerospace & defense companies, all performed exceptionally well, while clean energy, cannabis and shipping stocks badly underperformed. Small-caps also had a great week, boosted by the idea that they’ll also be able to take advantage of such policies.

Those policies, however, don’t come without risks and we’re seeing this play out in the bond market. There’s a huge bear steepener happening that’s closed the 10Y/3M Treasury yield spread from -157 basis points to just -33 in the past three months. This environment that has the Fed lowering rates on the short end of the curve while the market prices in higher inflation risk on the long end isn’t healthy for the markets long-term. We’re not at the point of a policy error yet since the 10-year yield is still below the Fed Funds rate, but a couple more rate cuts along with ongoing bearishness in long-dated Treasuries and suddenly we’re in a position where monetary conditions are too loose for what the market is saying is happening. While equities are taking advantage of the prospect of pro-business conditions in the future, the bond market is worried about the consequences of those policies.

The Fed cut rates by a quarter-point this past week, which was entirely expected. I don’t think we really heard anything that would have caused a market reaction one way or the other, so we can expect that the central bank is still on pace to cut rates several more times over the next year. The futures market, however, is removing rate cuts. In just the past month or two, it’s pricing in a 2025 terminal Fed Funds rate that’s 50 basis points higher than it was before. I think this is the right reaction. The Fed can continue to ease here and deem it “normalization”, but the possibility of a $1-2 trillion budget deficit, major tax cuts and tariffs is likely to keep putting pressure on rates and inflation. The Fed won’t be able to cut for much longer with that in the background and I think the markets are picking up on that.

The ETF industry as a whole is on pace for $1 trillion of net inflows in 2024. On the equity side, large-cap, growth and tech are by far the most popular with investors, but the biggest individual ETFs for new money are still the big S&P 500 and total market funds. On the fixed income, the picture is a little more curious. Bond ETFs are enjoying a similarly proportional inflow relative to stocks, but a lot of its flows are heading into two opposite ends of the market - Treasury bills and long bonds. Despite their issues this year, Treasury ETFs still command the lion’s share of new money. Perhaps that’s a lot of people buying in anticipation of a risk-off turn, but flows have been pretty consistent all year.

Key Economic Reports This Week

After an eventful week featuring an election and a Fed rate cut, the action doesn’t really slow down. The highlight of the week will be the October inflation reading. Expect to see a continued moderation in the headline inflation number (although a modest uptick is expected), but the core rate, forecasted at come in a 3.3% again, remains unable to budge. Considering that we’ve lifted the veil of uncertainty surrounding the election and we know that heavy fiscal spending and tax cuts will be a big part of the agenda, there may not be a significant reason to expect the core rate to make progress towards 2%. The Trump policies are largely inflationary and that will likely play out as we go through 2025.

U.S. retail sales will be worth a watch, but probably not market moving. The retail sales number out of China is more interesting, in my opinion, since it could shed some light on the state of consumer demand. The number is expected to pick up nicely and, when combined with the below expectations inflation reading, could be considered a good outcome overall. Deflation risk is still high and it could be months before we see any tangible impact of China’s announced stimulus efforts.

Dividend Landscape

Dividend stocks were a mixed bag again. In an environment where the S&P 500 is up 5% in a week, that’s usually a good sign that dividend payers aren’t in favor. While that’s the case broadly, high yield strategies tended to benefit more from the leadership of cyclicals. As long as energy and financials are leading, two areas that figure heavily in the high yield universe, dividend ETFs will experience some degree of strength. Given what we saw last week and by historical precedent, we’re likely to find ourselves in a risk-on environment for a while longer. That’s good, again, for high yield strategies, but long-term dividend growers might have trouble keeping up.

Market Outlook

The only real question in my mind is whether we see a breather from last week’s market action. With no economic data likely to get in its way this week (unless there’s a major unexpected change to inflation), I suspect we’ll continue to see the good times roll. I seriously doubt we’ll see anything like last week, but another ~1% gain for the S&P 500 wouldn’t surprise me.

I would like to see an extension of the small-cap rally though. Too many times we’ve seen strong outperformance from small-caps only to watch it prove temporary and investors revert back to large-caps. The set of conditions presented by another Trump presidency should be good for small-caps, but I want to see that play out in the markets first.

I just don’t like what I’m seeing from Treasuries and I think that’s unlikely to change too. We may or may not see gains in long bonds, but I expect volatility to continue, which makes it a stay away for me.

Looking better for: bitcoin, high beta, financials, junk bonds

Looking worse for: consumer staples, China, Treasuries, low volatility