Jurrien Timmer: What did I miss?

by Jurrien Timmer, Director of Global Macro, Fidelity Investments

I managed to completely unplug for the last few weeks, and upon my return after Labor Day I was a bit concerned by the sense of gloom out there following the price action last week.  Yesterday I updated all my charts preparing for the worst, but frankly I am not seeing very much that is different from where I left off in mid-August.  Let’s review.

First off, clearly something has changed in recent weeks, with the market pricing in more rate cuts and bonds once again becoming the star of the show (performance-wise).  We can see from the periodic table below (which shows 12-month returns taken over 3-month intervals) that long-term Treasuries are on top (LT).  They have not been in that spot since 2020.

The narrative is clearly evolving from focusing on the inflation side of the Fed’s mandate to the growth side, and this comes at a time when the seasonals are reaching their weakest point and the mega growers continue to wobble.

The next easing cycle is only a week or so away, and the main question is whether the Fed goes with jumbo (50 bps) cuts or the garden variety 25 bps.

No matter how you slice it, the Fed has plenty of room to cut rates here, with all iterations of the Taylor Rule heading south.

But at a forward curve of sub-3% and inflation at 2.6% (core-PCE), the market is pricing in a future real rate of near zero. It’s not quite a full easing cycle but it’s more than a return to neutral (which in my view would justify a real rate of +100 bps).

History shows that easing cycles are more often bullish than bearish for equities, aside from the super-bears of 2000 and 2007.

The other big development (relating to market expectations for the rate cycle) is that the nominal 2y10y curve has now un-inverted.

Again, this is creating some worry that another downturn is looming.  I don’t know if that’s correct, but with the market having dodged the yield curve bullet for so long, the chart below (which shows the S&P 500 following “peak inversions”) does give some chills.

Following another soft jobs report last Friday, the focus is squarely back on growth.  The JOLTS report shows that all of the excess labor demand from the pandemic has now been corrected.  The question of course is whether it stops here.  If the drawdown in the “vacancy rate” continues, a recession seems likely to follow.

For equities, I was prepared to see a lot of internal damage in the charts, but I’m not seeing it.  The monthly chart for the S&P 500 equal-weighted index remains a thing of beauty.

The weekly chart of the cap-weighted index looks fine to me, with 72% of stocks in uptrends.

And the Russell 2000 remains in a base building breakout mode.

At 23 months old, this bull market does not seem old enough yet for me to conclude that it’s over.

Meanwhile, the rotation out of the mega growers into everything else continues, with the Mag 7 now underperforming the S&P 500 equal weighted index by 9% over the past 3 months.

The main risk from my perspective continues to be the “math” of what happens to the overall index when its largest components are passing the baton to the smallest ones.  Can the market advance in that scenario?  Recent history suggests no.  So, we may well be in a market cycle in which most stocks go up while the index doesn’t.  These are the unintended consequences of mega cap dominance.  Per the chart below, mega cap valuations still have some catching up to do.

If the Mag 7 are “done” (which is not a conclusion I am prepared to make just yet), it will be tough for the headline indices to advance at the rate that they have since the October 2022 lows.

Meanwhile, the “rest of the market” seems to be doing just fine.  Below we see the S&P 500 low vol high dividend index back at the cycle highs.  There is plenty of value in this market once you look past the glamour stocks of this cycle.

There’s an old saying that this is a market of stocks, and not a stock market.  Below we see that while the top 10 stocks continue to churn, the bottom 490 remain in an uptrend.  My sense is that for investor to enjoy this ongoing bull market, they will need to find a way for their holdings not to be counterbalanced by the behavior of a few outsized stocks.

On the earnings front, things still look decent here, with 2024 expected earnings hanging in there at 9.5% and 2025 estimates holding up at 14.5%.  Margins are back to the 2021 highs.

One potential earnings tail wind is a lower dollar, which continues to follow rate differentials.

All in all, despite the narrative shifting from inflation concerns to growth concerns, I don’t see much new in the charts that causes me great concern.  The biggest risk in my view is less fundamental and more technical, in that the largest stocks are so large that whatever they do, the headline indices will follow and defeat much of the progress that is made by the broader market.

This information is provided for educational purposes only and is not a recommendation or an offer or solicitation to buy or sell any security or for any investment advisory service. The views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Opinions discussed are those of the individual contributor, are subject to change, and do not necessarily represent the views of Fidelity. Fidelity does not assume any duty to update any of the information.

Copyright © Jurrien Timmer, Fidelity Investments