We Are In The Period Of Hot Air And Blue Skies, But The Month Of September Is Ahead!
Welcome back loyal readers. Hope you have had a good and profitable week in the markets and in life. We closed out yet another positive month of returns for 2024 as investors are encouraged seeing the softening occurring in the economy which will likely give the Federal Reserve room to lower rates at their upcoming September meeting.
Wishing you and your families a happy and healthy Labor Day Holiday.
I grew up in a small town about 40 miles west of Cleveland. During my youth the city was dominated by major manufacturing and raw material providers. This included a Ford Motor Assembly plant (Thunderbirds and Vans), one of the largest US Steel plants, National Gypsum (they manufactured walls) and American Ship Building Company which produced large freight ships. This dry dock known as the “Lorain Yard” was built in 1898 and closed in 1984 over labor disputes.
American Ship was owned by George Steinbrenner who eventually decided to put his interests in baseball with his purchase of the New York Yankees. My father saw George at lunch once or twice a week and they were friends.
I tell you all this because my life from an early age was filled with “labor” and our town eagerly anticipated “Labor Day” and there were parades and festivals. Later in life I became an investment consultant to quite a few Taft-Hartley Labor Unions and found myself once again in the crosshairs of important Labor Day festivities.
Most people are unaware that Labor Day originated to celebrate the laborers in our country who built this country from the ground up. These were the people who made our economy go and who also built the housing, bridges and office towers. Here is the description of how Labor Day began:
Labor Day pays tribute to the contributions and achievements of American workers and is traditionally observed on the first Monday in September. It was created by the labor movement in the late 19th century and became a federal holiday in 1894. Labor Day weekend also symbolizes the end of summer for many Americans and is celebrated with parties, street parades and athletic events.
We have a different economy now.
Even though we still celebrate the same holiday, our work force has changed dramatically. Instead of all the labor performing most of the economy’s vital tasks, we now have programmed robots building our cars and moving goods around at the thousands of Amazon distribution centers. Also, we now have coders, programmers and electrical engineers doing much more of the economy’s heavy lifting. I would certainly include these important workers among the list of Laborers that we will celebrate this coming Monday. For without them, not many industries would be able to function with the efficiency and profitability we are experiencing today.
“Both optimists and pessimists contribute to society. The optimist invents the aeroplane, the pessimist the parachute.”
- George Bernard Shaw
Hot Air
I probably do not need to remind you that we are in an election year with divisive political rhetoric at the local, state and most especially, federal levels. So far most of this rhetoric has not overly influenced the stock market (see corporate earnings below), but it may begin to as the markets begin to factor out who might be the next President and start to let their policies begin to influence corporate America.
An imminent reduction in Fed borrowing costs?
Jerome Powell and the Federal Reserve began hiking rates in March 2022. They went on one of the most aggressive hiking campaigns in over 23 years. The chart below shows how dramatic this rising rate cycle has been:
While many Wall Street pundits believe that a 0.50% is warranted given the length of time that rates have stayed higher for longer coupled with significant signs of slowing in the economy (unemployment quickly rising) and the CPI and PCE both coming down towards the Fed’s targets.
This writer does not buy that narrative and given pockets of sticky inflation (rents, insurance and service industries), one could make the case that the Fed should wait. However, given this is an election year and they hear the many complaints from bankers, consumers and small company borrowers, they are likely to reduce rates. My call is no more than 0.25% (I have been known to be wrong many times). We covered this in detail in last week’s Market Outlook. If you want to review it or have not yet read it, you may go here.
How might the stock market react if/when the Fed cuts rates? See graph below.
Corporate profits continue to drive the markets.
In this column throughout 2024 we have emphasized that good corporate earnings are holding up stock prices in the face of higher for longer interest rates. Fed fund rates remain at 23-year high, but the stock market forges ahead mainly because corporate earnings have been so good. The 2nd quarter earnings season is drawing to a close with Nvidia’s earnings this past Wednesday. What we have experienced is an S&P 500 earnings growth rate of 10.9% marking the highest earnings growth rate since the 4th quarter of 2021. But the difference is that period of time had a growth rate so high because of the government COVID stimulus which began in 2020. See the corporate earnings chart below:
Corporate profits. "You can put this in the 'no recession' column ... U.S. corporate profits rose to a new all-time high in the second quarter."
Another area that we like to watch, that is often telling of just how well corporations are doing, is the high yield bond market. (We have a high yield bond strategy that we use for investors that has beaten a traditional bond market investment every year going back 5 years. If you would like more information about using it and/or having us manage $ for you, please reach out to my partner Ben@MarketGaugePro.com)
The following chart is a good example of just how well corporations are currently doing by using their profits and free cash flow to cover their borrowing costs.
Blue Skies
Many investors refer to “new highs” as blue skies. This is because making a new high in a stock or a stock market index implies that there is no overhead resistance. This is why many investors and investment managers like to buy stocks when they hit a new high. I worked for 23 years for such a firm. They might own a stock for a while, but with a new high they might add more of it to their holdings.
We find ourselves in that period right now where many stocks are seeing new highs and the indices as well. This past week the equal weight S&P 500 index (RSP) hit a new high further emphasizing that we are continuing to see a broadening out of stocks participating in this move higher. See the following charts:
Growth versus Value
Most of 2024 has been dominated by the 15 largest growth stocks. As you would expect many of these are the technology companies fueling America’s growth. See the daily influence the mega cap stocks have had on the daily moves of the cap weighted S&P 500 index.
We are beginning to see a rotation into more cyclical and small-cap stocks.
This is fairly typical with the expectations of reduced interest rates. As we have covered in previous Market Outlooks, the area of the market that tends to do better after a reduction in the Fed Funds is small-cap stocks. Other participants include cyclical stocks which are the areas of financials and industrial stocks. Again, these past few weeks we are starting to see the rotation into these areas. We are presenting a few charts to show you this more clearly.
The first one is a comparison of Vanguard’s Growth ETF (VUG) compared to Vanguard’s Value ETF (VTV). The YELLOW arrows show outperformance from Growth and the BLUE arrow shows outperformance from Value. See below:
Technology stocks versus Financials.
The second chart, below, shows the technology ETF (XLK) compared to the financial ETF (XLF). When the yellow arrow is going up that means technology stocks are dominating against financial stocks and when the blue arrow is going down that illustrates that financial stocks are outperforming. You can clearly see that recently, with the expectations of rate reductions, financial stocks are doing better and coming into favor.
US sector fund flows. "By sector, investors shed consumer staples, healthcare and utilities sector funds of a notable $528 million, $337 million and $208 million, respectively. The financials sector, meanwhile, gained a third weekly inflow, worth about $783 million."
Large versus small cap stocks.
And the last chart, below, shows large-cap stocks as exemplified in the top 100 S&P company ETF (OEF) as compared to the Russell 2000 smallest company ETF (IWM). The yellow line illustrates when the biggest capitalized S&P companies are most in favor and the blue line shows them losing steam and small-cap stocks doing better and coming back in favor. You will notice that the past two weeks have once again seen the smaller companies doing better as we get closer to a possible rate reduction cycle. See below:
Consumer sentiment is positive towards the stock market.
One of the factors that may be driving the stock market higher is the fact that many retail investors in the US are feeling good about the prospects that the economy will avoid a recession and can stay on solid footing. This shows up in how many of them are investing $ in the stock market with the expectations that they are going to see higher returns in the future. We illustrate this by showing the following consumer sentiment chart. This is often an important future predictor of the stock market’s performance going forward.
However, I caution this by saying there are many economists and analysts who still believe we could see a recession later this year or early 2025 which might send stocks lower.
Consumer stock sentiment. The net percentage of consumers expecting stocks to increase minus decrease crossed above 25% in July for just the 13th time since 1987. This is a bullish indicator and the chart below shows the performance of the S&P 500 after this indicator hits a new high.
This positive investor bias looms large with the election year cycle. This can be seen from the election year equity flow chart below:
Election year equity flows. YTD flows into equities are outpacing 4 out of the last 5 election years.
Welcoming September
Unfortunately, the worst month for investors lies before us. Typical behavior after the Labor Day holiday is portfolio managers return from their extended summer vacations and then “clean house” in September. Since 1950 September has been the worst performing month of the year for the Dow, the S&P 500, the Nasdaq (since 1971), the Russell 2000 (since 1979).
September was creamed four years straight from 1995-1998 during the dot.com bubble. More recently, these indices have been down seven of the last ten Septembers and the last four straight. Average losses over the last ten years range from -1.5% for the Dow and -2.9% for the Nasdaq.
Election years.
Election years have historically seen solid performance but has no real impact on the negative September performance as cited above. While the September performance is slightly better it remains in the bottom third of months. Average performance for September in election years remains negative with the small exception that the Russell 2000 has been positive (0.4%) on average since 1980.
This is likely a reflection of small corporation enthusiasm which often coincides with the “Hot Air” rhetoric trying to win over small businesses. See election year seasonal pattern chart and election year performance of the major market indices since 1980, both below:
Thank you for reading. Have an enjoyable extended holiday weekend. Be cautious as we enter the September period and make sure to let us know if we can assist you in any way. As always, we remain grateful for the opportunity to aid your knowledge of the markets and ways that we can help you achieve better investment results.
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