“Please fasten your seatbelts; we’re expecting turbulence ahead.” Most flyers know exactly what this announcement over a plane’s intercom means and know to brace for some turbulence ahead. But what causes turbulence? Extreme changes in the altitude of terrain, intersecting wind currents, and storms are the most common reasons. With expectations mounting for the first drop in interest rates from the Fed in over three years, the collision of Republican and Democrat rhetoric as we head into the November election, and storm clouds gathering over earnings from highflying economic bellwether giants like Amazon, Tesla, Alphabet (Google), and McDonald’s, to name a few, it may be time to fasten your seatbelts. Markets showed how quickly they can lose altitude with the quick mini correction that began in mid-July. Fears over a hard landing for the economy, exacerbated by heavy leverage, caused theS&P 500 and the tech-heavy NASDAQ to decline nearly 10% and 16%, respectively, over a short three-week period.
How the Markets Fared
The Seatbelt Sign Has Been IlluminatedInterest rates may have worked their way down after the start of Q3, but for the bulk of Q2, the street kept upward pressure on rates across the yield curve. With labor markets still strong, many wondered how long it would take for theFed to reverse course on keeping short-term lending rates high. The result was that rates rose just enough to cause price declines to offset coupon payments for most intermediate high-quality fixed income. Once again, cash was king, followed by net returns in high yield bonds, both netting a bit more than 1% during the quarter. Emerging market debt saw similar returns due to their higher coupons. The only exception was modest losses in developed market international bonds, which saw small declines due to currency weakness against the U.S. Dollar.
Equities saw very narrow leadership once again as the Magnificent 7 and related tech-focused companies gained continued interest from investors. AI chipmaker NVIDIA’s stock jumped another 35 percent during the quarter, now finding itself running neck and neck with Microsoft as the second-largest public company in the world behind Apple. These tech names helped the S&P 500 add another four percent to its gains for the year. In large caps, growth stock outpaced value indices by over ten percentage points. The rest of the U.S. market saw modest declines during the quarter, with mid caps and small caps all sliding around three percent. International developed markets all saw fractional declines during Q2. The only bright spot overseas was Asian emerging markets (EM), which saw gains led by Taiwan Semiconductor’s continued advance. Latin American stocks fell sharply during the quarter to offset much of Asia’s gains in EM.
Inflation Ablation Many will celebrate that inflation has continued to moderate, but we believe it’s way too early to break out the champagne.In July, headline CPI increased by 2.9% year-over-year, while core inflation (excluding food and energy) held firm at 3.2%.As a reminder, the Fed continues to target 2% long-term inflation. Shelter costs stubbornly fueled most of the increase,suggesting that housing costs remain a persistent thorn in the side of renters and home buyers alike. While inflation islower than in recent months, the CPI data is far from accommodative to meaningful interest rate cuts from the Fed.
It’s on the House In addition to rent inflation increasing expenses for younger and lower-income Americans, those looking to buy a home forthe first time are looking at higher and higher entry costs. Existing home sales rose in July, further driving median priceshigher by 4.2% year-over-year. The inventory of unsold existing homes continues to be tight at 4.0 months of supply, basedon current volume. And inventory may tighten even further from here. Purchase activity should accelerate further, asmortgage rates are now down below 6.5% for a 30-year fixed conventional loan for the first time since May of 2023, afterhitting nearly 8% less than a year ago.
Laboring On There was a mixed reaction to the U.S. labor report for August 2024, which showed the jobs market cooling off a bit. Someinvestors interpreted the increase in the unemployment rate to 4.3% as a harbinger of a coming “hard landing” for theeconomy, while others saw it as a positive—giving the Fed rationalization to begin lowering interest rates. Sure, job growthfor the month slowed to just 114,000 new positions in July, well below recent monthly averages, but we’ve seen these onemonth declines before. Just last April, job growth fell to 108,000 from 310,00 in March, only to rebound the following month.With Hurricane Beryl impacting Houston and much of the mid-south in early July, perhaps we should allow for another datapoint before we pronounce the post-COVID labor boom D.O.A. We urge readers not to lose focus on the JOLTS Report (chart below), which still shows over eight million unfilled jobs inthe U.S. An unemployment rate of 4.3% is still incredibly low. Even with the one-month slowdown, wage growth remainedstrong at 3.6% year-over-year, still enough to outpace inflation. Those expecting further slack in the jobs market, asubsequently weakening consumer and economy, and a resultant stimulus from the Fed may be setting the stage fordisappointment. Only time (and a little more data) will tell.
“Prediction is very difficult, especially if it’s about the future” … of the Economy
(original quote by Niels Bohr)
For a peek into the crystal ball of future economic activity, the Institute of Supply Management® Report on Business®(ROB) is often a good forecaster. At the moment, the picture is cloudy. Purchasing manager surveys in the manufacturing end of the economy are decidedly weakening. The ROB Manufacturing PMI decreased to 46.8% in July 2024 (with readings below 50% suggesting contraction). However, manufacturing represents only one-third of business-to-business activity in the U.S. presently. The Services ROB rose to 51.4% in the July report, returning to expansion territory. This latter area now accounts for two-thirds of the business sector. Both are predictors of the economy approximately six months from now and are painting a very mixed picture of the looming economy. With a resurging services sector and the Advance GDPReport showing that real GDP increased at an annual rate of 2.8% in Q2, those expecting a slowdown in the economy for the second half of 2024 may be premature in their forecasts.
Piering Ahead
Capital markets have seemingly moved in unison around the changing expectations for the economy, inflation, and interestrates of late. The financial press moves quickly around (or even leading) these changes, often harmonizing like a choir. Themini-correction of late July is strong evidence of how quickly opinions can turn, seemingly on very little data. As such, until aclearer pattern in the indicators substantiates a change in the economic cycle, we at North Pier suggest exercising cautionin building expectations for meaningful rate cuts from the Fed. The chances of modest Fed action are clearly building, with Chairman Powell on August 23rd signaling a likely rate cut atthe September FOMC meeting, “The time has come for [monetary] policy to adjust.” However, North Pier notes that thoughhe stated that “the direction of travel [of the Fed discount lending rate] is clear,” he qualified these remarks by adding:
“[T]he timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
Many market pundits now expect over 100 basis points in Fed rate cuts in the coming year. Our PIERspective is that this is anything but certain. Much is still left up in the air, such as labor markets, the economy, the election, and geopolitics. If the market doesn’t get interest rate cuts of the magnitude and timing it’s expecting, the resulting disappointment could lead to a correction… and this time, a longer-lasting one than the mini-correction we saw in July.
Summer 24 Market and Economic Commentary
“Please fasten your seatbelts; we’re expecting turbulence ahead.”
Most flyers know exactly what this announcement over a plane’s intercom means and know to brace for some turbulence ahead. But what causes turbulence? Extreme changes in the altitude of terrain, intersecting wind currents, and storms are the most common reasons. With expectations mounting for the first drop in interest rates from the Fed in over three years, the collision of Republican and Democrat rhetoric as we head into the November election, and storm clouds gathering over earnings from highflying economic bellwether giants like Amazon, Tesla, Alphabet (Google), and McDonald’s, to name a few, it may be time to fasten your seatbelts. Markets showed how quickly they can lose altitude with the quick mini correction that began in mid-July. Fears over a hard landing for the economy, exacerbated by heavy leverage, caused theS&P 500 and the tech-heavy NASDAQ to decline nearly 10% and 16%, respectively, over a short three-week period.
How the Markets Fared
The Seatbelt Sign Has Been IlluminatedInterest rates may have worked their way down after the start of Q3, but for the bulk of Q2, the street kept upward pressure on rates across the yield curve. With labor markets still strong, many wondered how long it would take for theFed to reverse course on keeping short-term lending rates high. The result was that rates rose just enough to cause price declines to offset coupon payments for most intermediate high-quality fixed income. Once again, cash was king, followed by net returns in high yield bonds, both netting a bit more than 1% during the quarter. Emerging market debt saw similar returns due to their higher coupons. The only exception was modest losses in developed market international bonds, which saw small declines due to currency weakness against the U.S. Dollar.
Equities saw very narrow leadership once again as the Magnificent 7 and related tech-focused companies gained continued interest from investors. AI chipmaker NVIDIA’s stock jumped another 35 percent during the quarter, now finding itself running neck and neck with Microsoft as the second-largest public company in the world behind Apple. These tech names helped the S&P 500 add another four percent to its gains for the year. In large caps, growth stock outpaced value indices by over ten percentage points. The rest of the U.S. market saw modest declines during the quarter, with mid caps and small caps all sliding around three percent. International developed markets all saw fractional declines during Q2. The only bright spot overseas was Asian emerging markets (EM), which saw gains led by Taiwan Semiconductor’s continued advance. Latin American stocks fell sharply during the quarter to offset much of Asia’s gains in EM.
Inflation Ablation
Many will celebrate that inflation has continued to moderate, but we believe it’s way too early to break out the champagne.In July, headline CPI increased by 2.9% year-over-year, while core inflation (excluding food and energy) held firm at 3.2%.As a reminder, the Fed continues to target 2% long-term inflation. Shelter costs stubbornly fueled most of the increase,suggesting that housing costs remain a persistent thorn in the side of renters and home buyers alike. While inflation islower than in recent months, the CPI data is far from accommodative to meaningful interest rate cuts from the Fed.
It’s on the House
In addition to rent inflation increasing expenses for younger and lower-income Americans, those looking to buy a home forthe first time are looking at higher and higher entry costs. Existing home sales rose in July, further driving median priceshigher by 4.2% year-over-year. The inventory of unsold existing homes continues to be tight at 4.0 months of supply, basedon current volume. And inventory may tighten even further from here. Purchase activity should accelerate further, asmortgage rates are now down below 6.5% for a 30-year fixed conventional loan for the first time since May of 2023, afterhitting nearly 8% less than a year ago.
Laboring On
There was a mixed reaction to the U.S. labor report for August 2024, which showed the jobs market cooling off a bit. Someinvestors interpreted the increase in the unemployment rate to 4.3% as a harbinger of a coming “hard landing” for theeconomy, while others saw it as a positive—giving the Fed rationalization to begin lowering interest rates. Sure, job growthfor the month slowed to just 114,000 new positions in July, well below recent monthly averages, but we’ve seen these onemonth declines before. Just last April, job growth fell to 108,000 from 310,00 in March, only to rebound the following month.With Hurricane Beryl impacting Houston and much of the mid-south in early July, perhaps we should allow for another datapoint before we pronounce the post-COVID labor boom D.O.A.
We urge readers not to lose focus on the JOLTS Report (chart below), which still shows over eight million unfilled jobs inthe U.S. An unemployment rate of 4.3% is still incredibly low. Even with the one-month slowdown, wage growth remainedstrong at 3.6% year-over-year, still enough to outpace inflation. Those expecting further slack in the jobs market, asubsequently weakening consumer and economy, and a resultant stimulus from the Fed may be setting the stage fordisappointment. Only time (and a little more data) will tell.
“Prediction is very difficult, especially if it’s about the future” … of the Economy
(original quote by Niels Bohr)
For a peek into the crystal ball of future economic activity, the Institute of Supply Management® Report on Business®(ROB) is often a good forecaster. At the moment, the picture is cloudy. Purchasing manager surveys in the manufacturing end of the economy are decidedly weakening. The ROB Manufacturing PMI decreased to 46.8% in July 2024 (with readings below 50% suggesting contraction). However, manufacturing represents only one-third of business-to-business activity in the U.S. presently. The Services ROB rose to 51.4% in the July report, returning to expansion territory. This latter area now accounts for two-thirds of the business sector. Both are predictors of the economy approximately six months from now and are painting a very mixed picture of the looming economy. With a resurging services sector and the Advance GDPReport showing that real GDP increased at an annual rate of 2.8% in Q2, those expecting a slowdown in the economy for the second half of 2024 may be premature in their forecasts.
Piering Ahead
Capital markets have seemingly moved in unison around the changing expectations for the economy, inflation, and interestrates of late. The financial press moves quickly around (or even leading) these changes, often harmonizing like a choir. Themini-correction of late July is strong evidence of how quickly opinions can turn, seemingly on very little data. As such, until aclearer pattern in the indicators substantiates a change in the economic cycle, we at North Pier suggest exercising cautionin building expectations for meaningful rate cuts from the Fed.
The chances of modest Fed action are clearly building, with Chairman Powell on August 23rd signaling a likely rate cut atthe September FOMC meeting, “The time has come for [monetary] policy to adjust.” However, North Pier notes that thoughhe stated that “the direction of travel [of the Fed discount lending rate] is clear,” he qualified these remarks by adding:
“[T]he timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
Many market pundits now expect over 100 basis points in Fed rate cuts in the coming year. Our PIERspective is that this is anything but certain. Much is still left up in the air, such as labor markets, the economy, the election, and geopolitics. If the market doesn’t get interest rate cuts of the magnitude and timing it’s expecting, the resulting disappointment could lead to a correction… and this time, a longer-lasting one than the mini-correction we saw in July.
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