Part IV with Stephanie Link – Her Current Views on Markets and the Economy

Five Things You Should Know

1. Equity Markets –  moved lower this week with U.S. stocks (S&P 500) down –2.12% and international stocks (EAFE) falling –3.03% 
2. Fixed Income Markets – finished mixed with investment-grade bonds (AGG) up 2.04% and high yield bonds (JNK) moving lower -0.78% 
3. Stocks slump – The selloff in stocks continued this Friday (8/2) as concerns deepened over the health of the US economy and the outlook for technology companies during a downbeat earnings season. Futures contracts for the Nasdaq 100 dropped -1.6% after a considerable decline on Thursday, while internationally, Japan’s benchmark index sank by the most since 2016 and Europe’s Stoxx 600 index fell -1.5%. 
4. Fed questions – The selloff partly reflects worries that the Federal Reserve has left it too long to make the first cut in interest rates. Traders are now betting that officials may need to move faster to catch up and see the Fed delivering three consecutive quarter-point cuts in September, November and December. Markets are also pricing a greater-than-30% chance that one of those reductions will be 50 basis points and Treasuries have proved a big beneficiary of that narrative. 
5. Key Insight –[VIDEO] In the last installment of this popular series, we discuss with Stephanie Link her thoughts on the current market as well as her economic outlook moving forward. [ARTICLE] In the spirit of this week’s video, we take a deeper look at some current factors impacting the market and the economy at this time, including some seemingly contradictory sentiment readings.

Insights for Investors

As Stephanie and I discuss during last week’s video (see link to video here), sentiment and investor expectations are an often-overlooked variables that are critical to understand as part of one’s decision-making process. Stephanie summed up her approach by saying she’s rarely done as well when she’s on the same side of a trade as the “crowd” or “what’s popular.”

While sentiment around certain stocks has been sky-high of late, this week’s turbulence among some popular tech names illustrates the sudden danger that can occur in such names when even “good numbers” fail to live up to hyped-up expectations.

Furthermore, as market commentator Lance Roberts recently pointed out people’s expectations are getting disconnected. As he states, “While consumers are not very confident about the economy, they are highly optimistic about the stock market. In that same consumer confidence report from the Conference Board, the expectations for rising stock prices over the next 12 months are near the highest on record.” (see accompanying chart)

Source: Real Investment Advice, 7/27/24

He goes on to point out the common danger of sentiment, namely “herding” or rushing into the “popular” trades or recent successes, contrary to what Stephanie advised as a “best-practice” last week. The graphic below highlights, 9 Common Errors that can hurt investors based on a 2016 Dalbar study (see article here).

Source: Dalbar, RIA Advice 7/27/24

All of us are prone to the array of emotions that occur over the course of market cycles as investors. The difference is not based on strength, intelligence or being special, but rather as Roberts nicely put it “In the end, we are just human. Despite the best of our intentions, it is nearly impossible for an individual to be devoid of the emotional biases that inevitably lead to poor investment decision-making over time. This is why all great investors have strict investment disciplines that they follow to reduce the impact of human emotions.”

Step One is to really reflect on the above dangers and ask yourself, have you been “guilty” of any of them in the past (hint: we all have), where might you be engaging in them today and how could you improve your process to reduce your odds of engaging in one of them.

With investor sentiment and markets both near all-time highs what market an economic data points might help us frame up the current environment and where caution may be warranted.

While this week’s early volatility around tech earnings highlights the need for companies to deliver big results to justify current sentiment, also reflected in the current data point showing the S&P 500’s price-to-sales ratio at approximately 2.75x, the market remains fixated on inflation data and the Fed’s next move.

Recent Core PCE data (the Fed’s supposed preferred measure of inflation) came in at 2.6% year-over-year in June according to the Bureau of Economic Analysis. While not at the Fed’s stated goal of 2%, markets see it as sufficient to give the Fed cover to begin reducing the Fed fund rate in September with expectation near 100% for a rate at that time.

However, some, such as the folks at Stategas, countering that rate cuts are not needed at this time given recent GDP still showing solid growth at an annualized rate of 2.8%.

The key distinction here again is between some data macro data this is reasonably encouraging (e.g. the aforementioned inflation and GDP data) and current market expectations and valuations, especially among many of the more popular trades. Put simply, good may not be good enough for markets over the near-term.

As Louis-Vicent Gave, CEO of Gavekal Research recently stated, “It does seem that an unwinding has begun of popular trades that brought valuations to stupid levels.” His takeaway for investors today “Putting it all together, it is hard to avoid the conclusion that the past few weeks have seen some important developments, with markets reacting through higher volatility in equity markets, higher volatility on the yen exchange rate, and a bidding up of gold. To be blunt, this is not the best of set-ups.”

Similar to absolutes as compared to expectations, is the issue of evaluated rates of change in data. Data that may be weak but is strengthening can lift related assets, while data that is still positive but slowing usually has a negative impact on related assets’ prices.

To that end, Torsten Slok of Apollo encouraged investors to keep an eye the broader economy’s trend noting that “if the economy starts slowing down, the speed of the slowdown becomes essential. A faster slowdown would have negative implications for earnings and increase the probability of a selloff in stock markets and credit markets.”

Those who look to the bond market as a bellwether for the economy and future equity market movements would argue based on the recently weaking 2-year Treasury yield that the slowdown Slok is highlights above about might be more than many investors are expecting. Since peaking over 5% in late April it has dropped steadily to around 4.35% this week. Weakening bond yields has historically been seen as a sign of a similarly weakening economy.

The team at Strategas isn’t ready to get on board with a bearish outlook just yet stating their view of the current U.S. economy can be defined as “(s)till small cracks, not big cracks.” They cite U.S. initial jobless claims data as evidence for their position (also cited by Stephanie Link in this week’s video as a key indicator for her as well) noting that while “U.S. initial jobless claims moved higher to 243,000 last week. Still, we’ve been using 260,000 (roughly last year’s peak level) as the number that would raise our antennae – so far, no alarm here.”

While it is all interesting and important to keep apprised up, ultimately as long as an investor keep their emotions and portfolios balanced whatever lies ahead does not need to be a cause for concern.

As always, we are here to partner with you to help with either.

Have a wonderful weekend,

Tim and the team at TEN Capital

Data, Just the Data

• U.S. Initial Jobless Claims – rose by 14,000 to 249,000 on the period ending July 27th. This far surpassed market expectations of 236,000.

• U.S. Mortgage Application – fell by 3.9% in the fourth week of July. This extended the -2.2% drop in the earlier week to record the sharpest weekly decline in mortgage demand in nearly two months.

• U.S. Chicago PMI – fell to 45.3 in July 2024 from a seven-month high of 47.4 in June. Although this landed slightly above market forecasts of 45, the latest reading indicated a substantial contraction in Chicago’s economic activity. 

• U.S. Factory Orders – fell by -3.3% from the previous month to $564.2 billion in June of 2024. This was a bigger contraction than market expectations of -2.9% and marked the sharpest decline since January. 

• U.K. Manufacturing PMI – was revised higher to 52.1 in July of 2024. From a preliminary of 51.8 and compared to 50.9 in June, this marked the sharpest expansion in the manufacturing sector since July of 2022.