What We're Talking About This Week!

• Weekly Market Reset

• Key Economic Reports This Week

• Dividend Landscape

• Market Outlook

Weekly Market Reset

It was more confirmation that the U.S. economy is heading in the wrong direction. We got another series of disappointing manufacturing readings, but the bigger concern is still the labor market. The non-farm payroll number that everybody watches came in weaker than expected, but ADP employment, JOLTS job openings and Challenger job cuts all came in worse than expected as well. The markets were willing to drive share prices higher as long as investors believe that the soft landing narrative was intact. Now that the labor market is showing signs of breaking down, investors seem to be resigning themselves to the fact that recession is becoming a real risk.

The unwind of the yen carry trade looks like it was the catalyst that’s turning everything around. Tech stocks managed to claw back about 75% of their losses during that correction, but they never re-established a new high and never recaptured the momentum they had during the first half of 2024. The tech sector is now trailing the S&P 500 by 8% year-to-date and is the 4th worst-performing of the 11 S&P 500 sectors. What’s more interesting is that the equal-weight tech sector is now outperforming the traditional cap-weighted sector year-to-date. Sure seems like the magnificent 7 trade has run out of steam.

One of the biggest faults in this market over the past 2+ years has been the inability of Treasuries to act as a counter-risk asset to equities. 2022 was a year where we saw long bonds and the S&P 500 drop more than 20% at the same time. The performance of both asset classes was heavily tied to the direction of interest rates and what the Fed was going to do with monetary policy. Those days seem to be over. Treasuries are rallying ahead of the Fed getting ready to lower rates and the indications of a coming economic slowdown. Stocks are no longer rallying on rate cut hopes. I think this is a genuine change of sentiment that is seeing previous winners turn into laggards and boring defensive sectors moving into the lead. The clear evidence of an economic slowdown suggests that this trend could continue as the election cycle begins to add some volatility.

Key Economic Reports This Week

Last week was definitely a disappointment in terms of the data that the markets had to deal with. This week has similar potential. Most notable are the CPI and PPI readings for August. Both are excepted to show continued cooling and that should 1) keep the pressure on interest rates to move lower and 2) increase the odds that the Fed considers making a 50 basis point cut later this month. The fact that Powell says the Fed is focusing more on the labor market than inflation suggests they know that the economy is in trouble. This week’s numbers should give them more ammunition to ease.

The ECB is going to make its rate decision ahead of the Fed and an expected quarter-point trim would continue the trend towards looser conditions for the Eurozone, albeit at a very deliberate pace. The region’s economy could certainly use the assist given that growth is still mostly stagnant, yet trying to improve. Inflation is still a modest concern that hasn’t been solved yet and that’s going to prevent the ECB from being more aggressive. Shouldn’t be any surprises and I don’t expect any significant market reaction.

Dividend Landscape

Dividend stocks as a whole didn’t outperform the S&P 500 by much, but those ETFs that emphasized defensive sectors over cyclicals did particularly well. Many dividend growth or low vol strategies outperformed the broader market by 200 basis points or more. This is a trend that I see potentially continuing as we head into fall. High yielders have been outperformers for a while as investors have bought into the soft landing narrative. As sentiment deteriorates, however, I think utilities and consumer staples stocks are going to take over as leaders.

Overall, I don’t think this is the time to be chasing yield. You might find some opportunities in funds, such as the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD), but for the most part you probably want to consider staying cautious. SPHD, specifically, has 40% of the fund invested in the utilities/staples combination, offers a 4.1% yield and keeps volatility below average. That sounds like a good mixture for this environment.

Market Outlook

I wouldn’t bet on a market reversal yet. As I mentioned above, if inflation comes in cooler as expected, yields are probably going to trend lower and that’s going to be favorable for Treasuries more than anything. Whether you look at the performance of tech stocks or where the money is flowing within the ETF universe, it looks like investors are a little rattled here. When nervousness sets in, there’s a chance that this negative momentum starts snowballing.

Don’t sleep on the potential for another yen carry trade unwind. The yen is back to levels where it was during the August VIX spike. If we assume that the unwind potential has been cleared out up to this point (which is a big question mark), any further move higher in the yen could motivate traders to cover their shorts again.

Looking better for: Treasuries, real estate, quality, dividend stocks

Looking worse for: momentum, magnificent 7, China