Anytime the market does anything, the media and talking heads start yakking about what caused it (since they have to talk/write about something). In many cases it seems completely made up, like on days when sharp intraday reversals occur despite no “new news” happening. I’ve even seen headlines attribute a stock market move in one direction to some event and then later attribute a move in the exact opposite direction to the very same event. Since we are not asked to fill out a survey whenever we buy or sell, it’s only speculation, which is why I don’t waste much time wondering about the “whys.” However, in this case it seems the breakdown in the yen carry trade would be the most likely culprit behind the severe sell off two weeks ago. For background context, a carry trade involves borrowing in a lower-yield currency and investing in assets of a higher-yielding currency; the yen is a popular “funding” currency since Japan yields are significantly lower than in the U.S., Europe, and other markets, providing a cheap source of funds to then leverage. The other reasons I have seen discussed just don’t make much sense. As I mentioned earlier, the US economy has been weakening for a while now and consensus was already that the Fed would wait until September to cut rates. So, it just seems odd that all of a sudden at 3 pm on a Wednesday everyone collectively decided that now growth is something to worry about. No matter the reason, we have to react and adjust because whatever the reason, the move in prices was real, it did happen, and for this we must remain crystal clear.
Strangely enough, I was actually sort of relieved by the sharp correction. This may seem a bit masochistic, but in looking at past markets, corrections within uptrends tend to be sharp and short. This was just that. What it also does is it gives us a new point of reference to ask a couple of questions:
- What leaders dropped and when the broad market dropped?
- Did the leaders stop at logical support levels or did they freefall?
- Did they come down to again reverse at or close to the lows from the April / May pullback?
- When they bounce, are they bouncing more or less than the broad market indexes?
- Which are the first ones that are approaching their old highs that they were trading at before the cliff dive?
The following is from a recent Bloomberg Report:
A few weeks ago, Wall Street was panicking. Now, the US looks to be in soft-landing territory with inflation falling below a crucial threshold as the country nears the end of its battle back from the pandemic’s economic aftermath. While the US economy is cooling by design, consumers are still spending and more upbeat, further cementing the unmatched status of America’s resilience following the 2020 recession. After close to two years of historically low unemployment and more recently rising wages, the Federal Reserve’s oft-criticized caution continues to bear fruit as the central bank is poised to start lowering interest rates. But the process is still a balancing act. With pandemic savings largely gone and wage growth cooling, many Americans are increasingly resorting to credit cards and other loans— raising questions about the sustainability of consumer spending, especially as more people are falling behind on payments.
Let me respond to some of the points Bloomberg makes in the above paragraph. First, consumers are indeed still spending. You can see that by just walking around where you live. It is also true we have historically low unemployment and wages are rising (read: strong economic tailwinds). However, I have, and remain, in the camp that says the Fed may not lower interest rates by any great amount. I think after seeing what happened when Japan raised their rates by only 1/4 of 1% the shock waves that hit global markets, that Fed Chair Powell will continue to "talk" rates lower for the most part. Maybe one or two rate reductions, but not a succession of interest rate cuts. What I disagree with is that consumers’ pandemic savings arenot“largely gone” and wage growth may be slowing but it is not stopping. I also do not see the evidence that “Americans are increasingly resorting to using more credit cards and taking out other loans.” Those that were given free money have essentially run out of this cash hoard and are out continuing to spend, to their eventual credit demise, but those that are prudent consumers are still quite healthy. Moreover, I do not believe people are falling behind on their loan payments. At least not enough to signal an imminent recession. The concern that I do have is that according to Jon Johnson, global debt just topped at $315 Trillion. Remember, if you printed $1/ second, in order to print $1 Billion, you would have to start in 1981. At $1 / second, to print $1 Trillion you would have to start over 15,000 years BC. To me, our current level of debt as it is being calculated is almost incomprehensible.
Once again, it just seems odd that late last week the market finally decided economic growth is a concern when there have been signs of slowdown for a while now. With the "will they or won't they" debate after every economic release, the Fed has dominated the news flow and daily trading action of late. Now that the dust has settled on the Japan Carry Trade Issue, market prices seem to suggest that the bull market has not been derailed, but simply jolted in the short-term.
Ari Wald brought up an important point last weekend in his weekly piece that measured how markets tend to perform when interest rates are cut. He differentiated between them being cut when there is an imminent slowdown vs. being cut when the economy is experiencing a soft landing (which it currently appears we are approaching). In the case of the non-recessionary environment, markets are super charged by the rate cut. While the entire bull case now seems to hinge on rate cuts, I will remind you that rates are "normally" cut because the economy is moving in the wrong direction. Whereas this time, rates are considering being cut because there was an overshoot to the upside of rates being tightened and a series of cuts that are being expected are intended to "normalize" the current rate structure. As can be seen in Ari's table below, I have circled the average forward returns when "Cut + Positive" vs. "Cut + Inverted." The first one is a positive economic environment, and the latter is when there are cuts that are chasing a declining economy to get it to hopefully reverse back to health.
What becomes most important now (as I had bullet pointed in the beginning of this note) is the quality of the rally we are currently experiencing. The leaders should be both large companies and high-momentum companies if this recovery in price levels is to have stickiness. This is because this is where institutional capital is most highly concentrated. According to Ari, this is most highly concentrated in the NASDAQ 100. If the Russell 2000 should come back to life as well, this would be a continuation of increased breadth and be even more healthy. Looking at the Magnificent 7 vs. the other 493 companies of the S&P 500, this is what year over year change in income is expected to be like. Clearly 2023 was a barn burner due to the Pandemic money, but 2024 and 2025 seem to still be quite respectable. Should the Fed make money a bit cheaper this could add a catalyst.
In closing, I want to bring up two articles from the weekend press. Jeff Sommer authored both. The first came out August 11th, titled, "How to Cope When the Markets Panic." Here is the link:
https://www.nytimes.com/2024/08/09/business/stock-market-bonds-recession-panic.html
The second is from this past weekend and I feel should be read by EVERYONE, "The End of Fabulous Money Market Rates Is Near." Investors have been able to earn solid returns by parking money in fairly safe places, but Sommer feels that with the Fed beginning a rate cutting cycle, these lofty rates could quickly fade. Here is the link:
https://www.nytimes.com/2024/08/16/business/money-market-funds-rates-inflation.html
As always, should you have any questions we are all here at the ready to help you in your individual situation. Have a great week.
- Ken South, Newport Beach Financial Advisor
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