First round of squeeze trades — Week of July 22, 2024
| index | wtd | ytd | 1-year | 3-year | 5-year | index level |
|---|---|---|---|---|---|---|
| S&P 500 Index | -1.95 | 16.30 | 23.20 | 10.07 | 14.92 | 5,505.00 |
| Dow Jones Industrial Average | 0.73 | 8.01 | 16.70 | 7.47 | 10.50 | 40,287.53 |
| Russell 2000 Small Cap | 1.69 | 8.56 | 12.69 | 1.24 | 8.55 | 2,184.35 |
| NASDAQ Composite | -3.65 | 18.55 | 27.08 | 7.81 | 17.82 | 17,726.94 |
| MSCI Europe, Australasia & Far East | -2.39 | 7.92 | 11.75 | 4.98 | 7.53 | 2,360.51 |
| MSCI Emerging Markets | -2.95 | 8.42 | 10.08 | -3.07 | 3.44 | 1,089.61 |
| Barclays U.S. Aggregate Bond Index | -0.33 | 0.49 | 3.72 | -2.98 | 0.01 | 2,172.57 |
| Merrill Lynch Intermediate Municipal | 0.08 | 0.03 | 2.85 | -0.69 | 1.12 | 314.99 |
As of market close July 19, 2024. Returns in percent.
Investment Insights
— Steve Orr
For real
Nine trading days ago we had our first negative print in the consumer price index in this cycle. That small negative one-tenth of a percent drop spurred hopes of a Fed rate cut in September and again in December. Traders ignited an impressive short-covering rally in Small Cap stocks and anything not big tech or semiconductors.
For the last two years, the easy hedge trade was to go long big tech triple Qs and short the Russell 2000 Small Cap ETF IWM. Hopes for a Fed Rate Cut thanks to falling inflation spurred a massive unwind of this trade, creating a short squeeze. The rally in Small Cap stocks had enough energy to push 80% of the Russell 2000 members to a new one-year high last week.
Friday’s option expiration added to the volatility. And Sunday we got the political news that was the worst kept secret in D.C. Looking over the past six weeks, markets have witnessed a surprise inflation reading, an assassination attempt and Biden stepping down. Markets appear to have absorbed these three “black swan” events and taken them in stride.
The down, up, down choppiness of the past nine days has led to some interesting effects. Remember, Microsoft, NVIDIA and Apple each had their market capitalization grow north of $3 trillion. The entire Russell 2000 Small Cap index was less than $3 trillion. The Magnificent 7 grew to over 34% of the S&P 500 backed by those three. In six trading days, that group’s 3% drop took their concentration down to 31%.
Since their last high on July 7, the Magnificent 7 as a group are down 8%, but thanks to every other sector rallying, the S&P 500 is only off 2%. What if the hopes for a rate cut are letting the air out of the AI bubble? That would give the broader stock market room to run into next year.
Longer-term we expect big tech to be fine; the sector has earnings and a reasonable outlook. That is opposed to the Russell 2000 Small Cap index in which 43% of the members have no earnings. Perhaps a future rate cut will help some of them turn profitable.
Big moves in Small Cap though also help the big indices too. Remember our earlier comment that 80% of the Russell 2000 hit new one-year highs last week? Every time that has happened, six months later the S&P 500 was higher. That would be a nice post-election Christmas present.
Wrap-Up
- All bullets this week. 106 days away from the election. That is like a year in political terms. Biden stepping down is the third Black Swan event in last six weeks. What’s next?
- Stocks still near all-time highs. Last week’s Small Cap squeeze smacks of late Bull cycle action, but breadth thrusts suggest higher levels a year from now. Headline and geopolitical risk puts us on the side of more choppiness into September.
- Decent, if unspectacular, earnings so far for the second quarter. We are very early in the second-quarter earnings season, but estimates are holding up. Tesla and Alphabet (“Google”) represent the Magnificent 7 this week. Older familiar names on deck: IBM, UPS, AT&T, Coke, Union Pacific and Colgate. S&P 500 members reporting this week total 131, and 173 next week.
- 95% odds in the Fed Funds Futures pits that the Fed cuts a quarter point at the September 18 meeting. In our experience, a lot can happen in the 74 days until that meeting. With two CPI and job reports before then, a rate cut is not a sure thing.
- Labor Market at 4.1% unemployment pretty good. Expect softer readings in the coming months as government hiring runs out of gas. A 4.5% reading by next spring would give the Fed some ammunition to continue with rate cuts. It would not mean a recession.
- The 10-year Treasury sits 80bp below its recent 5% high. We think the longer maturities are waiting on growth and Congress this fall. Will federal spending continue? If so, then an increasing supply of Treasury bonds will pressure yields higher.
- GDP growth still hovering around 2%. We think the economy improves slightly in the fall. Still in second gear, problem pockets like housing and coming commercial real estate loan issues. U.S. domestic activity likely slowed somewhat in the second quarter but remains in okay shape.
- Stay invested. Be patient.
Steve Orr is the Managing Director and Chief Investment Officer for Texas Capital Bank Private Wealth Advisors. Steve has earned the right to use the Chartered Financial Analyst and Chartered Market Technician designations. He holds a Bachelor of Arts in Economics from The University of Texas at Austin, a Master of Business Administration in Finance from Texas State University, and a Juris Doctor in Securities from St. Mary’s University School of Law. Follow him on Twitter here.
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