- Stocks followed up the best week of the year with more solid gains last week, with the S&P 500 less than 1% away from new all-time highs.
- Friday saw historic levels of volume to the upside, which is consistent with longer-term higher prices.
- Be aware September and October can be volatile and we expect that potentially to happen again.
- Fed Chair Jerome Powell confirmed in his Jackson Hole speech Friday that the Fed is now more focused on risks from a slowing labor market than with inflation turning higher again.
- While this is not a big surprise, the change in language is sigificant and the S&P 500 responded with a solid rally with strength in small cap stocks in particular.
A Nice Week
On the heels of a 4% gain two weeks ago, which was the best week of the year for the S&P 500, we saw more broad-based gains last week. Incredibly the S&P 500 is less than 1% from its all-time high, something that even the most optimistic bulls probably didn’t expect this time three weeks ago when global markets were crashing, but here we are.
The big rally two weeks ago was sparked by further confirmation the US economy isn’t headed straight into a recession, but more likely is just seeing a standard midcycle slowdown. Remember, not all slowdowns lead to a recession and unless we see signs the consumer and labor market are indeed breaking, we do not expect a recession to occur.
Sparking the rally this week was optimism the Federal Reserve (Fed) would indeed finally begin long-awaited interest rate cuts. We will discuss that in more detail below, but Friday saw huge moves from small caps and midcaps, areas that historically do better when interest rates are low. The bottom line is we are seeing broad-based participation in the rally with many sectors and stocks going higher. There was a time many were worried that only large cap tech stocks were really driving market gains, but that isn’t at all what we are seeing now, as all 11 S&P 500 sectors are higher on the year.
On Friday we saw nearly 11 times the amount of advancing volume at the New York Stock Exchange (NYSE) as we did declining volume. What does that mean? The last time we saw a day with a higher proportion of advancing volume was mid-October 2022 when the bear market was ending. These kinds of buying thrusts are clues higher prices are likely coming. The bulls are still in charge and should we see any volatility in the historically weak months of September and October, we believe it will likley present an opportunity ahead of a price move higher.
Using data from Ned Davis Research, we found 47 other times that advancing volume outpaced declining volume at the NYSE by more than 10x (using the first signal in three months to avoid clusters). The near-term returns can suggest things might be stretched, but going out a full year stocks were higher 85% of the time and up a very impressive 12.8% on average. This is another clue we are still in a bull market and higher prices are likely coming.
Let’s Not Forget the Calendar
Yes, we still think we are in a bull market, just as we said three weeks ago when markets were down big amid global currency chaos. But it’s important to remember that even the best years have some bad days, weeks, and even months.
With the election on the way and more potential geopolitical events on the horizon, investors need to be aware that September and October historically tend to be weak. Think back to 2016 and 2020 for example. Both years saw scary headlines and volatility ahead of elections, only to see big year-end rallies after the uncertainty of the election was over. We expect to see a similar scenario this year, so get ready for some perfectly normal seasonality.
As we noted at the start of this month, August is known for volatility and geopolitical events, but also known for being green in an election year. Well, the month isn’t over yet, but we absolutely saw the volatility. Now the bulls have come back as well. As this chart shows though, investors should buckle up for some rough sledding at some point before the election, which would be perfectly normal.
The Time Has Come for Policy to Adjust
Federal Reserve Chair Jerome Powell gave a short address Friday at the annual Economic Symposium run by the Federal Reserve Bank of Kansas City in beautiful Jackson Hole, Wyoming. Jackson Hole has been the location of the symposium since 1982, when it was anecdotally chosen to help entice then Fed chair Paul Volcker to come, since it was near a favorite fly-fishing spot. It has been a mainstay since. While not in any way a formal policy meeting, Jackson Hole has often provided the Fed chair with an opportunity to communicate policy shifts, and this meeting did not disappoint with a significant policy pivot.
Powell was unambiguous in his messaging, captured summarily in the simple statement, “the time has come for policy to adjust.” There’s a lot to that, but the main idea is that Powell and the Fed are increasingly confident inflation is moving organically toward their 2% target (by some measures it is already there) and is shifting their focus to supporting full employment, the other half of their dual mandate. As Powell put it, “We do not welcome further cooling in labor market conditions,” and “we will do everything we can to support a strong labor market.”
When the Fed was fighting inflation, they were unwavering in prioritizing inflation over supporting the job market, although they had a lot of leeway because the job market was strong, and in fact the economy stood up very well to the most aggressive Fed tightening cycle in over 40 years. (Remember, back in 2019 a fed funds rate of just 2.5% was judged more than the economy could handle and rates were cut a total of 0.75 percentage points, although there was plenty of room to lower rates since inflation was low.)
Fast forward to the most recent Fed policy meeting on July 30-31, where there was a small pivot. The new assessment was that “the risks to achieving its employment and inflation goals continue to move into better balance.” While it was a pivot, and Powell was somewhat more dovish in his press conference, we believed the Fed was behind the curve.
The new stance is that with inflation basically under control and the job market softening, the full employment side of their mandate is now the higher priority. Powell called the recent easing in labor market conditions “unmistakable.” He all but assured markets that unless there’s a major unexpected shift in the data, a rate hike would be coming in September. While that’s not a surprise to anyone, Powell’s reframing of the current policy outlook was a significant change.
In addition, there was no talk of cuts being “gradual.” While Powell in no way showed that he favored a 0.50 percentage point cut, he also in no way signaled that it was off the table. The absence of a reference to gradual rate cuts was meaningful. That means the 0.25 versus 0.50 percentage point debate is live and will be—you guessed it—data dependent. All else equal, we think that Fed will be biased toward a more “normal” 0.25% cut, but a 0.50% cut will be considered if needed and Powell has left the Fed the option. This is a more dovish take than we’ve seen from other recent Fed speakers who seemed to be trying to anchor expectations at a 0.25% cut. We expect that tone to shift somewhat in the coming week.
Markets certainly cheered the pivot. The S&P 500 was up 1.1% on Friday, a solid day, but the Russell 2000 Index of small cap stocks was up an impressive 3.2%. Smaller cap companies use floating rate debt much more frequently than large cap companies and therefore have been more sensitive to rising (and now falling) rates. They are also typically more sensitive to the overall economy. If the Fed cuts rates to support the job market and economic growth, small caps may benefit on both fronts.
We also saw Treasury yields come down across the board. The 10-year Treasury yield fell from 3.86% to 3.80%, not far from its August 6 low of 3.78%. The 2-year Treasury yield retreated from 4.01% to 3.91%.
We have always liked Powell’s pragmatic approach as Fed chair. He faced some communication challenges early in his tenure and was behind the curve on fighting inflation, something he acknowledges in the speech Friday. But he has the chance to accomplish twice what many Fed chairs have not done even once—pivot from a rate hike cycle without being so far behind the curve that it allows the economy to fall into a recession. Powell’s Fed did it in 2019, with some (in hindsight correct) goading from President Trump, although we did not see the full outcome because of the start of the pandemic. If the Fed follows through on Powell’s Jackson Hole policy shift, we think it likely we’ll see it again in 2024.
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.
S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The NASDAQ 100 Index is a stock index of the 100 largest companies by market capitalization traded on NASDAQ Stock Market. The NASDAQ 100 Index includes publicly-traded companies from most sectors in the global economy, the major exception being financial services.
A diversified portfolio does not assure a profit or protect against loss in a declining market.
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