Welcome, readers. Let’s jump right in.I could write about so many topics this week, as there were more than a handful of macro-economic and newsworthy items. But given the amount of time, space, and energy that the media has been giving to whether or not the Fed will lower interest rates, I thought I would weigh in here.There are many reasons for lowering rates, and many reasons against doing so. Whether you are a hawk (fiscal conservative), or a dove (looser monetary policy), you have retreated into your corners.The very essence of hours and hours of dialogue about this is, a) is the economy slowing? b) has inflation retreated? and c) can we get rates down to help certain sectors of the economy improve (mortgages, credit card debt, and financing of our own debt)?Most sophisticated analysts keep their views centered on the spread between the Fed overnight lending rate (5.25%-5.50%) and the rate of inflation, which most believe is in a downward trajectory. Their belief is that the spread between the Fed’s rate, the 10-year (4.5%), and an inflation rate of 2.8%-3.2% is too wide.
Everyone Says There is Room to Lower Rates – Or Don’t Wait too Long
One piece of evidence that some analysts use is the angle and trajectory of the 20-year bond, as represented by the ETF TLT.
I worked in asset management through the 1994 fixed income bear market. Most people in the business said afterwards that they hoped they did not experience that pain again for a long time. They were correct, they did not as the US Government instilled quantitative easing and we saw rates decline to almost zero.Then, inflation kicked in post-Covid, the Fed began raising rates dramatically starting in 2022, and another bad, fixed income market came back. It turned out 1994 was nothing like what we have gone through from 2022 to the current period.The majority of working Americans have a big exposure to the fixed income markets through their IRAs, 401k plans, their company’s retirement plans, and/or Public retirement fund’s asset allocations. It may surprise you to see that from January 2022 to May 10, 2024, the areas of the fixed income markets (total return without income) have produced these returns:
Last week’s outlook included a chart of the April 2024 bond market, illustrating how badly the fixed income market treated bond investors. Let me repeat that, most Americans have quite a bit of exposure to an asset class that has produced a negative return in the past 30 months. A zero, nada, zilch return on a big part of their asset allocation.It is the reasons above, along with financing our debt ($35 trillion), which has produced an insurmountable deficit that costs the US Government over $1 trillion dollars a year. Which is now more than our defense budget.This is one of the important reasons people are urging the Fed to lower rates sooner rather than later. Additionally, numerous experts are screaming that if the Fed waits too long, they are going to break the system and that regional banks, currently holding underwater bond securities, are going to begin to go out of business. Or, that the Fed will throw us into a recession.
The Reasons Not to Lower
I could easily spend many pages giving you the reasons why the Fed should not lower rates anytime soon. Most of you probably won’t want to hear that argument. But if you are a frequent reader or you follow Mish, you likely know that we have both been strongly suggesting that inflation was sticky and would trend back up before heading down. That is exactly what has occurred.But let’s explore the other reasons besides higher inflation that might eventually motivate the Fed to hike, not lower (Jerome Powell recently said the Fed does not see any reason to raise rates further, which the market took positively and led to the positive market bias recently):
In other words, we could easily give you the validation that the Fed should be hiking rates right now and not lowering them. However, given this is an election year, they are most likely to lower rates and do that as soon as this fall. But if they are truly “data dependent,” they should maintain a neutral reading and hold off.
Positive Market Action Started in Late April
Contrary to many of the “seasonality gurus” who claim you should “sell in May and stay away” from the markets, the S&P started May off very strong. See chart below:
And the Dow Jones Industrial Average has had an impressive winning streak these past two weeks. See charts below:
This Can’t Be a Bear Market
After a 5% pullback, the markets turned around on cue in the latter part of April. You may recall the charts we included in the outlook from April 28 that showed the market pattern during a Presidential election year. This current turnaround seems to be playing out well, even when considering higher interest rates and slowing growth.The S&P closed Friday near its all-time high, established a few weeks ago. This price behavior, along with the NYSE Advance-Decline establishing a new high, conveys a positive upward bias, which doesn’t occur in a bear market.
After the short correction in April, as technology stocks (Nasdaq 100) sold off the most and we saw a rotation out of some of the mega-cap names, the S&P has come roaring back. We provide the following scorecard to show various asset classes and various market performances. This will likely surprise you. See chart below:
After this turnaround in the S&P 500, it is surprising to note that it continues to defy gravity by avoiding a big down day, which has not materialized during this recent market weakness. This helps give evidence to the bears that this is forthcoming. See chart below:
Bear markets also don’t typically occur when the VIX trends down, which demonstrates an absence of risk. See chart below:
This recent favorable market action has swung the AAII bulls back to positive. See chart below:
Negative pundits may be quick to point out that the markets are setting up for big decline from areas that are making new highs: Utilities and Consumer Staples. These sectors are both considered defensive sectors. However, study the chart below closely to see what has happened the one and only time this occurred before:
Why are These Sectors Moving Up?
Bearish analysts will share with you that a positive utility market usually precedes a market decline. In Mish’s bestselling book, “Plant Your Money Tree,” she refers to Utilities to describe the important members of the economy and different areas of the stock market.The reason utility stocks are rallying is not in “defense” of deteriorating market conditions and the often-linked interest rate decline. They are having their positive day in the sun because of several positive factors linked to Utilities, including but not limited to the following:
We knew that Utilities were beginning to be an attractive area for investing when one of our main stock strategies rotated to two big utility stocks recently. They have both been good winners for us.Here is a list of the Utility stocks that have been winners so far this year (most of these stocks, as you can see from the table below, are indicated to be either extremely overbought or overbought according to the metrics used by Bespoke. Be careful if you are invested in these or thinking about investing in any of them):
Consumer staples stocks are benefiting from price increases and are seeing higher profitability from consumers paying more for these products. Additionally, this industry has also created new efficiencies from data sciences, advanced distribution centers, and managing their businesses more effectively. Earnings are good and may continue to be for the foreseeable future, given positive employment trends.These are positives and don’t currently belong in the negative category. This is why the chart above about the new highs for Utility and Consumer Stocks is so important as to what comes next.
In Summary, It’s All About the Earnings
Despite the Fed’s aggressive approach of keeping interest rates higher for longer to combat inflation, the stock market has remained resilient. With 80% of S&P 500 companies reporting results, the index is on track for a healthy 5% growth in earnings per share for the first quarter of 2024. This exceeds analyst’s expectations for earlier forecasts of 3.2% growth, marking the biggest year-over-year increase since mid-2022.“Higher interest rates usually hurt U.S. stock valuations,” notes Jean Boivin, head of the Blackrock Investment Institute. “Yet, strong Q1 earnings have cushioned stocks, even as rising rates and expectations potentially dampen market optimism.”What are analysts’ expectations for Q2 earnings? We will begin to cover this next week.In Memoriam: We want to provide a brief note on the loss of James Simons of Renaissance Technologies who passed away this week at the age of 86.
James was a pioneer in Quantitative Investing and had produced eye-popping results during his years running Renaissance. His flagship Medallion Fund produced a 66% annual return for investors for the years between 1988 and 2018.Firms like ours have patterned our investment methodologies and processes with a similar vision that Mr. Simmons had during the years he was running his firm. Our hats are off to him in remembrance of the extraordinary work that Mr. Simmons and his firm have accomplished.
“We decided that systematic trading was best. Fundamental trading gave me ulcers.”
– Jim Simons (RIP)
We will now turn it over to Keith to summarize other aspects of the market that may have played a part in the week’s trading. Thank you for reading. Have a good, profitable, and enjoyable week.
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More By This Author:The Fed, Interest Rates and Jobs Sway the Markets. Which Direction Are We Headed?Markets Snap Back – But Uncertain Economic Conditions PersistUnexpected Inflation Headline – Who Should You Believe?
