Wall Street Exclusive: A Story Of Two Different Markets (NYSEARCA:IWM)

“Don’t give up at half time. Concentrate on winning the second half.” –

Paul Bear Bryant

My View of Wall Street

Economy Has Been ‘Riding A Wave’ Of Strength

Despite the most aggressive tightening cycle in four decades, the economy has been riding the wave of consumer strength since the post-COVID recovery. But with the consumer showing signs of fatigue (e.g., rising delinquencies, slower discretionary spending, fewer splurges), the labor market starting to slow, and inflation taking its toll (particularly for lower-income consumers), mainstream analysts and economists are pounding the table for the Fed to start dialing back some of its policy restraint to keep the recovery going.

Of course, one might argue that the lumpy economic data, which sometimes indicates slowing and then some areas with resilience, suggests that Fed policy isn’t restrictive.

The Fed’s trick will be to cut interest rates in time to avoid an economic wipeout (aka recession) without further stoking inflation pressures. Consensus calls for this year’s end and some additional easing in 2025. The idea is to keep GDP growth near the trend of 2.1% in 2024 and 2.0% in 2025. Just like the first couple of 25 basis point hikes didn’t make any difference for months, one or even two 25 basis point rate cuts won’t move the needle on the economy. The Fed is also looking over its shoulder at the cost of paying for America’s national debt, which crossed the 1 trillion dollar mark in 2023, driven by high interest rates and a record $34 trillion mountain of debt. One has to wonder if that will also factor into their decisions, leaving inflation a secondary concern and opening the door for round two of inflation. Suffice it to say the Fed is in a VERY difficult situation now.

Growth initiatives and maintaining the present competitive tax rate structure will be necessary to keep corporate America resilient. In turn, the economy can remain in decent condition as we head into 2025. The strong correlation between a strong corporate scene and a strong economic scene is indisputable.

The bond market is guided by two key dynamics—growth and inflation- and faces the challenges of record government debt issuance, the Fed’s balance sheet, and demand unease. If the gurus are correct, inflation and the economy will cool for the remainder of the year, and that should keep a lid on the 10-year yield. We may have seen the highs for the year when the 4.7% level was struck in April. Cash remains an attractive alternative, with short-term (3-month CD) yields still hovering above 5.0%. While rates won’t rocket higher, it’s doubtful they will crash. Therefore, if you believe inflation is dead, it is prudent to slowly lock in a longer duration ahead of the Fed’s easing cycle.

Equities Should Keep ‘Climbing’ – but not without volatility.

The S&P 500 has scaled to new heights in 2024 (34 record highs YTD/ 3 this week), despite climbing a wall of worry—successfully navigating recession fears, elevated valuations and higher-for-longer interest rates. The AI revolution has trumped all of those concerns, leading to what has turned out to be the tale of two markets. Stocks may encounter more volatility in the months ahead, particularly as growth slows, earnings enter a more challenging environment, and as the Presidential election nears. Volatility will also be heightened with the expectation of “normalization.” A scene where mega caps slowdown and other market areas begin to perform. That analysis is based on the earnings picture. A composite of mega-cap tech stocks (MAGMAN) has strongly outperformed the overall market YTD, but earnings growth for the rest of the market will catch up and even outpace MAGMAN’s earnings later this year.

Performance MUST broaden beyond just tech as the rest of the index and smaller company earnings accelerate. If that occurs, the primary trend can stay in control. Sectors that should remain on our radar lists include Technology, Industrials, Energy, and Health Care.

The unanswered question is how much has already been priced in based on the expectation that artificial intelligence will ramp up earnings for the entire corporate scene.

A Tale of Two Markets

It is no secret now that the “average diversified” portfolio has underperformed this year as investors have flocked to “anything AI.” While we can’t dismiss the performance of the AI-related MAG 7, the picture below shows what everyone has been referring to.

That has made for a more difficult backdrop for investors and, to some degree, has ramped up investor anxiety. The opening quote states that the game isn’t over after the first half. That confirms the strategy that avoids making major portfolio changes.

Quality will always be in demand. While the Magnificent Seven ETF (MAGS) stocks possess many quality attributes (low/no debt, above-average cash flow, etc.), other sectors will join the uptrend as the MAG trade slows. That is based on earnings improvement spreading to different sectors, in turn, broadening the market as the year unfolds.

At some point, a simple reversion to the mean always occurs.

The rush to get into anything AI continued. The week ended with AMZN, AAPL, GOOGL, META, etc., making new all-time highs and NFLX reaching a 52-week high. That pushed the S&P to finish the week with three consecutive days at all-time highs and four straight days of new highs for the NASDAQ. Meanwhile, the average stock remains in a sideways pattern.

The Trading Week

On Monday, the S&P 500 flipped between gains and losses, but a rally in the day’s final minutes left the index 5 points higher. That was enough to mark the fourth straight day with a new high. The Nasdaq outperformed with a 0.28% gain leaving it at its fifth straight day at an all-time high.

The small-cap Russell 2000 (IWM) finally got some attention and recorded a 0.59% gain. Breadth was mixed with five sectors higher and the other six falling. Tech was the best performer, with a 0.72% gain, while Communication Services fell over 1%.

It was more of the same on Tuesday. Another day, another record high. Six straight days of gains and five straight days with a new high being recorded for the S&P 500 (#36). The Nasdaq rose 0.14%, extending the index’s new high streak to six straight days. Financials outperformed with a 0.65% rally, while Materials was the worst performer with a 1% decline. Small caps keep running in place, with the Russell 2000 dropping 0.45%, offsetting Monday’s gain.

We are at a point where an analyst can write the same daily script and simply change the numbers.

Another day, another record high (#37). Seven straight days of gains and six straight days with a new high being recorded for the S&P 500. Instead of a modest gain of four points on Tuesday, the index added 56 points, closing at 5633 today.

The NASDAQ gained 1.1%, extending the index’s new high streak to seven straight days. The DJIA broke its two-day losing streak, adding 1%, while the small caps bounced and kept up with the other indices, adding 1%.

Breadth improved on Wednesday, with all eleven sectors rallying—Technology (XLK), Materials (XLB), Consumer Discretionary (XLY), Communications Services (XLC), and Utilities (XLU) were the leaders.

Thursday brought about a noticeable reversal. The Russell 2000 small caps (IWM) were the focus, rallying 3.5%. The S&P gave back 0.88% of its recent 7-day rally, closing at 5584. Its new high streak was snapped at six. The (MAGS) momentum trade took a well-deserved breather and took the NASDAQ Composite down 1.9%, breaking its seven-day new high streak. The magnificent seven ETF lost 4.3%, as AMZN, AAPL, GOOGL, MSFT, META, NVDA, NFLX, etc., were down between 2 and 5%. The 10-year dropped to the early June lows at 4.19%, while Gold, Silver, and Uranium rallied.

The final trading day of the week produced a strong across-the-board rally, with every index and sector participating. The S&P has now recorded weekly back-to-back gains. It has been positive in four of the last six weeks and eleven of the last thirteen. Meanwhile, the NASDAQ Composite made it six straight weeks with a gain and has produced positive results in eleven of the last twelve weeks.

The Economy

Inflation

The big report on Thursday was CPI, which came in lower than expected at a negative 0.1% month-over-month level. That’s the lowest print since May 2020. On a core basis, CPI increased 0.1%, the lowest level since February 2021.

What has been interesting lately is that we’ve witnessed multiple instances of a positive inflation report preceded by positive price action with seemingly no catalyst. Thinking back to the surge into yesterday’s close, did somebody know something (again)?

The late afternoon buyers who pushed the S&P and NASDAQ up to new highs on Wednesday didn’t get the desired result this time around. The indices sold off sharply after the report, giving back all of the previous day’s gains and more.

Friday’s PPI report didn’t confirm the CPI data when it overshot estimates in June with gains of 0.2% for the headline and 0.4% for the core after upward May revisions. The mixed June inflation reports still leave a net moderation in inflation risks into the back half of 2024.

Sentiment

The NFIB’s small business sentiment report came in higher than expected. At 91.5, it was the year’s highest reading in June, a one-point increase from last month.

NFIB Chief Economist Bill Dunkelberg;

Main Street remains pessimistic about the economy for the balance of the year. Increasing compensation costs has led to higher prices all around. Meanwhile, no relief from inflation is in sight for small business owners as they prepare for the uncertain months ahead.”

Four years later, small business optimism remains near pandemic lows and just above the GFC recession lows.

The preliminary Michigan sentiment report revealed a July headline drop to an 8-month low of 66.0 from prior lows of 68.2 in June and 69.1 in May.

Over the past three months, Michigan sentiment has fallen below the early pandemic bottom of 71.8 in April 2020 after a four-month stint above that level. Current conditions fell to a 19-month low, while expectations fell to an 8-month low.

The data doesn’t lie; the average consumer isn’t thrilled with the current economic backdrop.

Macroeconomy

This section presents a series of issues that may not necessarily impact the market today but can pose problems for the MACRO scene.

Inflation remains a key topic.

While the media is focused on the .01%-0.2% month-over-month data that rolls in, the point that most everyone is missing is the cumulative effects of inflation that are embedded in prices. People aren’t celebrating the month-over-month changes or, for that matter, the headlines that inflation is coming down. Consumer confidence has been at near record lows for months because prices are still much higher than in early ’21.

That is illustrated by reports such as the “Chapwood Index,” which uses the actual costs of the “top 150 items that Americans buy in the 50 largest cities,” which was up between 7.8% and 13.6% over the past year. That seems more in line with anecdotal experience than the CPI or PCE indicate. It also better reflects the risk of the Fed cutting rates too soon and keeping such year-over-year price increases as a rule rather than the exception. Regardless of how that plays into the entire rate discussion, it is a moot point; it plays into consumers’ pocketbooks, which are the heart of the US economy.

In addition to other issues currently playing out in the US, this is the main reason consumer sentiment is near historic lows.

The Courts start to bring equilibrium and reinforce a BALANCE of POWER.

Two recent rulings by federal judges have dealt a significant near-term blow to the administration’s SAVE income-driven student loan repayment program, impacting millions of borrowers ahead of the scheduled July implementation. The decisions temporarily block the Education Department from implementing key provisions of the program, including the further reduction in monthly payments for millions of borrowers and canceling additional debt under the program.

From a market perspective, the SAVE income-driven repayment program (which has already enrolled over 8 million borrowers) is the most impactful dimension of President Biden’s student loan agenda. The SAVE plan is designed to be an affordable federal student loan repayment option, with provisions for lower monthly payments and faster debt forgiveness. The program had already canceled $5.5 billion of debt for 414,000 borrowers, with more cancellations planned. The Supreme Court has already ruled that only legislation passed by Congress can forgive any debt. That confirms the adage outlined in the Constitution that Congress (and only Congress) has the “power of the purse.”

In another recent ruling that didn’t get much coverage, the Supreme Court overturned the 1984 Chevron precedent in a monumental decision that is set to shake up the federal regulatory landscape across all industries. This ruling could have massive implications, particularly for highly regulated industries like healthcare, energy, and technology. The ruling curtails the power of federal agencies to interpret the laws they regulate when a dispute arises. In essence, an “agency ” proposed and then administered regulations. They were the governing body that ruled on any dispute on the same regulations they imposed. Cutting through the legal jargon – this means that future legal challenges against federal regulations will be more likely to succeed.

This autocratic nightmare was first struck down in the West Virginia clean air case, in which the Supreme Court ruled against the EPA, citing that it overstepped its bounds and did not have the authority to regulate greenhouse gas emissions. This shift will slowly strip unauthorized power from unelected bureaucratic agencies and bring it back to Congress where it was intended. That’s a win for Corporate America.

Finally, the war on fossil fuels was dealt another blow when a court ruled that the administration did not have the authority to halt liquefied natural gas projects. The initial ban was controversial, as it allowed Russia to overtake the US in shipping Nat Gas to Europe.

The Global Economy

During the week, Germany released two very rough reports on factory orders and industrial production. The chart below shows that both continue to fall off their post-COVID peaks. Excluding the COVID shock, factory order volumes were the lowest since November of 2012, while industrial production (extraction, utilities, manufacturing, and construction) was the weakest since 2006, excluding the two major global shocks over that period.

The German economy remains fundamentally very, very weak.

The Fed

The cool CPI report has investors pricing at a 90% chance of a rate cut in September. I’ll continue to play devil’s advocate and say, “Be careful what you wish for.” History shows that the FED typically cuts rates at the start of an economic decline — NOT at what is now believed to be a SOFT landing.

Is this time different? Maybe so. Nothing has followed the economic script for the last four-plus years. I’m in the camp that says the initial and perhaps subsequent rate cuts won’t do much, just like they didn’t do much when they were raised.

Onerous regulatory conditions and an anti-business stance at the current FTC hamper the economy more than a 25—or 50 basis point change in rates. High energy costs slow the economy down more than the current 4.5% Fed funds rate, which is BELOW the historical norm. If we want to see rate cuts spur the economy, then we’ll also have to see changes take place that is geared to strengthen corporate America.

Political Scene

As much as investors want to avoid this political backdrop, the ramifications of what has developed are unprecedented, hard to ignore, and may already be impacting the markets.

We are on a collision course in DC between President Biden and Congressional Democrats over each of their desire to stay in power, with an uncertain future. President Biden’s performance at the June debate with President Trump has created a crisis for the Democratic Party, with a growing concern that if President Biden stays in the race as the Democratic nominee, former President Trump is increasingly likely to win and increases the probability of a Republican sweep.

President Biden issued a letter to Congress indicating his intentions to remain in the race, as growing pressure from Congress and Democratic allies advised him to withdraw. If Biden steps aside, Vice President Harris appears to be best positioned for the nomination (especially as she can inherit the Biden-Harris fundraising haul). However, questions over her viability as a candidate also loom large. When she dropped out of the presidential race in 2020, she garnered only 1% of the DEMOCRATIC vote. Her high water mark was 3%.

Getting back to the market implications, most analysts see a Trump victory ushering in a period of lower regulations and, at the very least, keeping the low tax backdrop in place. Concerns over a more aggressive stance on tariffs are also being surfaced. From a market perspective, no one envisions a significant variance between the current high regulatory/higher taxes Biden policies and a Harris candidacy.

The extension of the 2017 tax cuts and former President Trump’s potential deregulatory agenda are starting to get priced into the market. That’s why we have seen renewed interest in financials, as JP Morgan hit a new all-time high on July 3rd. After the 2016 election, financials (XLF) staged a 52% rally in 2017. In addition, there will be an expectation of more M&A approval in a Trump presidency.

Many conversations have been had regarding the potential for more inflationary policies from a Trump presidency. Tariff policies (10% worldwide and 60% in China) have been the source of near-term angst. However, I’ll remind everyone that the initial round of Tariffs imposed by Trump in 2018 did NOT result in an inflationary spiral.

PLEASE remember that the PRIMARY factor in performance in any stock/ sector or the market itself ALWAYS depends on the individual fundamental picture. Specifically what the Earnings scene and overall economic backdrop look like. These are only suggestions or ideas, and with 3+ months to go before the election, anything can still happen. Therefore, there is NO reason to start getting positioned for any outcome.

Furthermore, what happens with Congress will be of the utmost importance and will set the tone for the first two years after the election.

Earnings

The earnings season officially started on Friday, with a few large central money banks reporting. Savvy investors get competitive daily updates on EPS reports, including companies that are not only beating estimates but, more importantly, raising guidance.

That report is a MUST for all looking for opportunities that can produce outsized results.

The Daily chart of the S&P 500 (SPY)

On Thursday, the streak of six straight sessions with new all-time highs for the S&P 500 was broken. A rebound on Friday followed the one-day dip, leading to the index hitting a new intraday high at 5655.

The strong, pristine BULL trend remains in place, and the good news is that the overall market has broadened. On Thursday, the ratios of advancers to decliners and up-to-down volume increased to nearly 5-to-1 on the NYSE. On Friday, all indices and sectors participated in the rally.

Investors should look higher, not lower, until there is a definitive break in the first support trendline.

Final Thoughts

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Best of Luck to Everyone!