Houston, We Have Turbulence
- The S&P 500 fell 2.0% last week, declining for the third consecutive week, but unlike the past few weeks, this time the selling was across the board.
- Economic data last week showed the economy slowing more than expected, adding to worries about a potential recession.
- We still think a recession can be avoided, but risks have increased.
- The Federal Reserve (Fed) decided against cutting rates last week, but the stage is set for the first cut in September. The big worry now is the Fed may be behind the curve.
- Monthly nonfarm payrolls came in weak, adding to the worries about the overall strength of the economy.
We will discuss the Fed and the economy below, but the reality is the Fed should have cut rates last week in what could end up being a meaningful policy mistake. As a result, stocks sold off quite hard on Thursday and Friday, but all is far from lost.
This is only the second 5% mild pullback of the year and investors need to remember that most years see more than three of these pullbacks on average. Even last year, as great as it was for stocks, we saw a 10% correction from late July until late October, followed by a huge end of year rally. We like to say volatility is the toll we pay to invest and last week was quite the reminder of this.
From Washington drama, to geopolitical risks, to renewed concern about a slowing economy, the worries are no doubt building and investors have a lot to think about right now. In times like this it’s important to remember that all years have scary headlines and things to worry about. Here’s a chart we made going all the way back to 1900 that shows how stocks tend to go higher over time, even amid horrible headlines.
August Isn’t Always Bad
This has been one of the worst first two days to a month ever, but all hope is not lost. August is known for volatility and rough sledding. The S&P 500 has averaged a negative month in August since 1950 as well as over the past 10 years, something only February and September can match. But here’s the catch, and there’s always a catch. Stocks have historically done quite well in election years in August.
Here’s a chart we’ve shared a lot lately and it was one reason we expected a surprise summer rally when so many were telling us the yield curve and LEIs were reasons to be bearish, a narrative that is now several years old. The bottom line is June, July, and August are historically the best three months for investors in an election year and this year has again rewarded them so far.
Here are two charts that show other angles on how stocks historically do well in August of election years, again showing if you are looking for a big drop this month, it might not happen.
The Fed Stays Pat, Increasing Worries of a Policy Mistake
We’ve been on record that inflation is last year’s problem. Lately we’ve been seeing major improvements in the data, justifying our stance. If inflation is under control, do we need rates up over 5%? We don’t think we do and this is why the Fed likely should have cut last week. Higher rates are clearly impacting the housing market and we aren’t seeing as much small business investment as we’d like. Lower rates could provide a jump to the economy on both fronts.
The Fed has two mandates, to keep prices under control and maintain full employment. Well, for the longest time they’ve been worried about inflation and not the economy/employment, but those times are changing and potentially quickly. One of our worries lately has been a Fed mistake here and it could be happening. The good news is all hope isn’t lost, as they can cut in September and hopefully right the ship, and before then even signaling their intentions more clearly could help stabilize the market.
The bond market though is calling the Fed’s bluff, as yields across the curve have crashed lower. What do lower yields mean to investors? Lower yields mean higher bond prices (they are inversely related), so if you owned some stocks AND bonds last week you didn’t do as badly as you might think. Bonds had a big week, easing the pain you felt from your stock holdings. It wasn’t that long ago that both bonds and stocks would go down together, so it is nice to get back to a time where bonds act as a buffer when trouble hits.
Source: St. Louis Fed 080224
July Jobs Data Disappointed
Right after the Fed didn’t cut on Wednesday, we saw an influx of worrisome data. Thursday’s set of economic data saw initial jobless claims rise to their highest level in a year, alongside a weak manufacturing ISM number. Stocks fell and bonds rallied as yields fell. Unit labor costs came in below expectations as well, indicating continued fading inflationary pressures. Missed in this news flow was a stronger-than-expected productivity number reported Thursday, something we’ve been expecting all year.
Friday’s non-farm payroll number missed expectations at only 114,000 jobs versus expectations of 175,000, with the prior month revised lower as well. Healthcare and government, which had dominated prior reports, showed less of an impact in July. While 114,000 jobs created was below expectations, the number was still positive and not the lowest we’ve seen in the past year (April came in at 108,000 jobs). There are also indications that hurricane Beryl impacted the number based on how the data is collected. Lastly, the increase in construction jobs was interesting, coming in at a solid 25,000 jobs added.
Source: Bureau of Labor Statistics 8/2/2024
All eyes were on the unemployment rate in this report, which has been creeping higher over the past several months. The unemployment rate came in above expectations at 4.3%, the highest level since early 2022. With the benefit of two days of data and hindsight, all signs indicate that the Fed should have cut last week.
Source: St. Louis Fed 080224
While the initial reaction to the news has not been positive for risk assets, the world isn’t ending quite yet! Bond markets are doing the Fed’s job on its behalf, with interest rates across the curve falling substantially, easing overall financial conditions. Data this week on employment costs and hourly earnings have come in cooler than expected, and real time rent prices has been negative for nearly a year now. Inflation is no longer an issue and with signs of a cooling labor market, the Fed has every reason to cut interest rates. September is all but certain, and now many are pointing to the potential for a 0.50% cut to play catch up. Friday morning showed market-implied odds of more than a 70% chance of a 0.50% cut in September, up from the teens the day before.
While the very hot labor market has now cooled some, the economy is still on good footing as we saw in the preliminary GDP numbers earlier last week. There are very few, if any, signs of economic excesses in the economy and corporate America is in a strong financial position. The biggest issue currently is overly tight monetary policy, and the Fed has plenty of ammunition to make that adjustment and do so quickly. The Fed’s Economy Policy Symposium in Jackson Hole, Wyoming later this month will be the next major event to watch. Historically, monetary policy shifts have been strongly signaled at this meeting, and any statements potentially signaling the size of the September interest rate cut will be highly scrutinized.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
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