US economics, inflation, and the Fed

The Federal Reserve maintains a “high for longer” interest-rate course. The Federal Open Market Committee (FOMC) kept the federal funds target rate steady at 5.25% to 5.50% during its June meeting but also took a slightly more hawkish stance on monetary policy. Specifically, the central bank reduced its outlook for interest-rate cuts in 2024 to just one, down from its March projection of three reductions. The Fed statement also showed that four senior voting members now see no interest-rate cuts this year.

Meanwhile, Wall Street has taken a more dovish position on near-term monetary policy. Such sentiment gained steam after the Labor Department reported weaker-than-expected May readings on consumer and producer (wholesale) prices, which may indicate that inflation is easing. The Street now anticipates two rate reductions by year’s end, with the odds of a cut as early as the September FOMC meeting building. This consensus view was the primary reason why Treasury yields did not spike on the Fed’s June monetary policy prognostications and Chairman Powell’s remarks according to Value Line.

The state of the U.S. economy will likely determine the Fed’s monetary policy course during the second half of the year. To date, the economic data, which include a still-resilient labor market, have put minimal pressure on the central bank to reverse course short of achieving its goal of bringing price growth closer to its 2% target rate. Market participants view a “soft landing” scenario as the most plausible, and if certain parts of the economy don’t come under significant duress, particularly the consumer sector, the lead bank is likely to keep rates sufficiently restrictive in the near term.

Professor Siegel notes:

“Recent economic data slightly underperformed expectations, though nothing dramatically concerning. Jobless claims dipped just below the 240K level, which is something to watch closely. Claims above this threshold have historically been indicative of labor market weakness, which could influence Federal Reserve (Fed) policies. Interestingly, similar trends occurred last year during this period, suggesting a possible issue with seasonal adjustments rather than fundamental economic weaknesses. Additionally, changes in state policies regarding jobless claims might be artificially inflating these numbers, so the real situation could be less concerning than the raw report implies.

On a brighter note, recent manufacturing data and S&P Global’s preliminary Purchasing Managers’ Index (PMI) numbers were encouraging and indicative of underlying strength in the U.S. economy. This offset concerns raised by the weaker sectors, such as housing, where both starts and sentiment were soft. This of course is impacted by high mortgage rates, which continue to hover above 7%.”

Global economy

A key call in JP Morgan’s global outlook for this year has been that the expansion would gradually slow under the pressure of sticky inflation that kept financial conditions tight. In the event, inflation has proven even stickier than the bank had expected, leading to a significant delay in the anticipated easing cycles of central banks. Broader financial conditions have taken this repricing in stride and not overreacted, but they also remain a damping force on activity. Despite this, global GDP is still on track to advance 2.7% annually in 1H24, nearly half a percentage point stronger than potential and even stronger than the bank’s 2.1% annual rate forecast at the start of the year. It is against this backdrop of ongoing resilience in the expansion that the latest soft patch in the data needs to be viewed. On balance, the data is consistent with the outlook for global GDP to decelerate in the coming quarter but also expand at a trend-like pace of a 2.2% annual rate in the second half of 2024.

JP Morgan remains confident that the global consumer will perk back up given healthy fundamentals, including strong job growth, solid wage gains, softening inflation, and robust wealth effects. A solid 0.4% gain in US retail control spending for May along with a stronger-than-expected 1.4% jump in China’s real retail spending suggest these supports are helping. Continued signs of an acceleration in global capex add to the sense that global final goods demand should bounce back and support the lift in the global industry.

Stock market concentration

While the stock market has been dominated by familiar names so far this year, we at Signet believe that broader participation in the market ascend will be in order sometime in the near future. However, the IT mega caps still produce the prodigy of cash and are super profitable. Our proprietary multi-factor framework still looks favorably at those names but also points to many more profitable companies beyond the magnificent bunch as promising plays. In support of our view, Empirical Research Partners note in their recent research: “The top five contributors to the performance of the S&P 500: Nvidia, Alphabet, Microsoft, Meta, and Amazon, have sourced 57% of the S&P 500’s +15% return this year, and last year the same companies accounted for almost half of the index’s +26% total return. Those are just two of the nine years since 1952 in which the five leading issues contributed more than 40% of the market’s result. This year Nvidia alone was responsible for nearly 30% of it, the most impressive contribution by any company in a big up year in the last century. Those extremes prompted us to examine the precedents, to see if they prescribe a course of action.

In the year following the periods of exceptional concentration (i.e., 40% or more of returns from the top five firms), all of which occurred since 1970, the market has produced trend-like returns. The leadership in all of them was either Big Tech or Big Oil. Following 1999 and 2007 there were losses when the narratives that had underpinned those eras (i.e., the New Economy and housing boom) came undone. That’s again the risk this time. In the subsequent years long rates often declined and undervalued issues usually led, by somewhat more than usual, with low-P/E stocks in the lead. On the other hand, the companies with the best top-line growth rates lagged, and price momentum strategies faltered. Stable stocks more often than not produced some alpha, and our Core Model’s results were better than usual.

The precedents are of limited value because they don’t inform the critical issue: how long the era of AI excitement will go on, and if the narrative (i.e., a profitable AI revolution) will prove correct. It’s simply too early to tell, and the market is giving the leading companies the benefit of the doubt. While analysts are trying to forecast the shape of the demand curve, we doubt they have any edge in doing so. To get a timing signal we’re watching the controversy variables used in our Failure Model, looking for evidence that disbelief is creeping into investor behavior. That’s often an early warning sign that trouble lies ahead, particularly for stocks with Big Stories. We don’t see indications of that yet, and we did at some earlier critical junctures, in both 2000 and 2020. Today only a handful of the momentum leadership stand out as controversial, and that leads us to believe it’s too early to run from good news, that’s probably still good.”

Moreover, even the popular notion of “sell in May and walk away” might not work that well this year. Just take a look at the election year averages versus regular years:

With corporate earnings getting stronger not only in the IT sector but in a broader market, we should expect the markets to stand their ground! Have a great summer!

The information and opinions included in this document are for background purposes only, are not intended to be full or complete, and should not be viewed as an indication of future results. The information sources used in this letter are: WSJ.com, Jeremy Siegel, Ph.D. (Jeremysiegel.com), Goldman Sachs, J.P. Morgan, Empirical Research Partners, Value Line, BlackRock, Ned Davis Research, First Trust, Citi research, HSBC, and Nuveen.

IMPORTANT DISCLOSURE

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