Investment Insights

 — Steve Orr 

Fooled

Usually, the sloppy September would have us down in the mouth, ah market value, about now. Nothing doing, as last week the S&P 500 and NASDAQ posted higher readings every day. That made the second perfect week for 2024. Weird Wednesday led the parade, seeing the S&P 500 register a 1.5% drop before rallying to a 1% gain by the close. That large of a swing is fairly rare. Bespoke Research reports that only nine times since 1993 has the big index swung down then up in such a manner. Performance was mixed in the weeks following those moves, but a year later stocks were higher.

Please do not be fooled by the perfect week. Two drivers to watch for are Wednesday’s Fed rate cut and Friday’s option expiration. These are short-term market events that are usually gamed in the four or five trading days before the news. In other words, markets are getting set for what they believe is the most likely (or desired) outcome. Stocks would like a half percent rate cut and rising stocks into option expiration.

Stock indices have not broken out to new highs to restart the current Bull cycle. Looking back to July’s all-time highs, stocks are taking a breather and consolidating. Never say never, but our charts say no breakout until markets have clarity around third quarter earnings and the election. History tells us the worst two weeks for stock performance are just ahead of us. Just because the recent rally has not pushed index levels to break above July highs does not mean the market is in trouble. Quite the opposite. Technically, all of the indices are in good shape. Breadth remains strong with gainers outnumbering losers and moving averages in uptrends. August 8 and 10 markets posted 10:1 up days. Returns six and 12 months later are nearly always higher after these breadth thrusts. 

High and rising 

What is high and rising? Unfortunately, parts of the consumer price index are stubbornly higher than the Fed would like. The headline CPI is rising at a 2.5% annual rate. The CPI has steadily declined since its 9% peak in June of 2023. In speeches, Fed members seem to believe prices will continue to drop toward their magic 2% level. Our observations of grocery and other necessities show price increases may have moderated but are not going down. The CPI calculation can be changed by the BLS at any time, and older measures of the CPI calculation sit closer to 5%. The shelter component is running above 5% per year for the 29th month in a row.

The Fed prefers a stripped-down measure of the CPI they call “supercore.” It is basically goods, healthcare and services without food, energy and housing. That measure continues to run above 4%. With apologies to the BLS, we like our food, home and gas cheaper. Used car prices will pressure inflation higher the next few months. Rents have been coming down in several metro areas around the country as apartment inventory comes online. Apartment rent surveys for the shelter calculation are done on a rolling six-month basis, so we expect those prices to slow this coming spring.

The Fed has abandoned the inflation fight to focus on jobs. Unemployment remains quite low, between 4% and 4.3%. The unemployed series (U-6) is rising, and surveys show jobs are becoming harder to find. Those readings are consistent with a “soft landing,” not a recession. We wonder if the real reason is government funding costs. Taking Treasury debt from around 1% to 4.75% in two years has pushed Federal interest expense well beyond CBO budget estimates. Our high and rising Federal interest costs are now north of $1 trillion per year, well above the defense budget and national parks combined. 

Elevator down

Last Friday, someone placed articles in The Wall Street Journal and Financial Times laying out the case for both half and quarter percent rate cuts. Rates markets interpreted the unusual timing as someone pushing for a half percent cut and promptly pushed those odds to nearly 70%. We think the Fed is about six months late on a rate cut if they are only focused on interest expense. We also think there is no need for a rate cut right now if their only focus is on inflation and a steady 2.5% GDP growth.

Since 1994 when the Fed has cut by a half of a percent, the S&P 500 has averaged a gain of 1%. So, here’s hoping the Fed “goes big” and does not send the message that a big cut was necessary because the economy is collapsing into recession.  

9/30

Please be aware that Wednesday’s Fed Day is not the only brick in the Wall of Worry. Friday is quarterly expiration of options and futures, always a fun (volatile) day. The UK and Japanese central banks will meet later this week and likely continue the easy money parade. Once again, Congress’ inability to actually lead and govern will be on display for the following week as they struggle to avoid a shutdown. We gave up counting the number of shutdowns when they reached 90 a few years back. Finally, the International Longshoreman Association is set to strike starting October 1. The ILA represents dockworkers from Maine to Houston. They have had 10 successful contract negotiations over the decades and no strikes since the 1970s. Shipping prices were already higher thanks to drought around the Panama Canal and Houthis using tankers for missile practice in the Red Sea. Here come cost increases in time for Christmas.