Before our break, we discussed the need for upcoming data. Well, that data came in.
The strong data helped equities rally to end August – the S&P 500* rose 3.4% from Aug. 24 through this writing. Data clarity seemed to bring investor comfort, at least temporarily. One good news report after another fought the popular narrative of more potential tightening from the Federal Reserve.
For several months, backwards-looking inflation remained stubbornly high. But the economic data finally experienced some bullish developments (as we predicted with our forward-looking data). So, now there is data to back up the idea of Fed pivot sooner than expected.
For instance, rental prices continued aggressively slowing in August. Both annual and monthly rent growth turned negative. Nationally, apartments are now 1-2% cheaper than they were last year:
Also, according to Apartment List, the vacancy index has now increased for 22 consecutive months and sits at 6.4%, which is slightly above the pre-pandemic average. With a record number of apartments under construction, the vacancy figures should remain elevated.
The Job Openings and Labor Turnover Survey (JOLTS) showed 8.83 million unfilled jobs in July – down from 9.58 million in June. Declines that began in March continued:
Analysts expected about 9.5 million job openings. Coming in under 9 million is a big deal. The July figure was the lowest since March 2021 and down from the all-time high of more than 12 million.
Finally, services inflation data eased for a sixth month in a row to 5.69%, which is the lowest in more than a year and continues a downward trend:
This is extraordinarily good news for consumers, especially as volatile energy prices increased in August.
After this data was released, both the 20- and 10-year Treasury rates began to fall. That was a pressure point on stocks in August as yields neared the 4.35% level, a danger we’ve mentioned before.
The falling Treasury rates support our thesis that opportunities in longer duration bonds will begin to become apparent as we go into the end of this year and early 2024:
Consider that the last time the federal funds rate traded at the Fed’s “2% target” was in summer 2022. Compare that to now, where the exchange-traded fund (ETF) iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)# is paying close to 4%:
That spread would signify a price of $115 versus $105. That’s a 20% return if the Fed gets us down to 2%. We don’t think the “2% target” is realistic, but the Fed is saying that’s the goal.
Still, investors are generally cautious on equities in September, historically. This weakness was obvious at the beginning of last week, which would undoubtedly strengthen those concerns as we start out the new month.
Headwinds and Tailwinds, But Which Wins?
Our base case, which is reliant on data, remains that we can be optimistic, probably around mid-September. We expect continued softer inflation along with further evidence of a softening labor market. If that happens, the consensus view on future rate hikes will change, which is supportive of equities.
But first, let’s talk about two headwinds to this data-reliant outlook.
Last week Fed Governor Chris Waller said the data from two weeks ago was “a hell of a good week of data,” though he also hedged:
We must be conscious of the potential for more (unnecessary) hikes.
The second headwind is the rise in crude oil prices. WTI crude rose almost $10 last week:
This is a direct result of the production cuts from Saudi Arabia. And since the U.S. hasn’t rebuilt its strategic petroleum reserves, we can’t release oil to artificially hedge this decrease in supply. A continued run like this can create short term headwinds for equities.
So, there are headwinds to monitor. That said, we believe the tailwinds will probably win out.
For example, we expect to see “core” inflation – costs that don’t include food and energy purchases – to continue to be softer than expectations. This could lead the market and the Fed to re-price the future path of rate hikes.
Also, headline inflation will see a boost from higher oil prices, as this is a predictable outcome. But those rises don’t feed “core” consumer price index (CPI) data or “core” personal consumption expenditures, which are the Fed’s preferred inflation measures.
More important to the Fed are housing and auto prices. Shelter and autos account for 57% of the core CPI basket:
The next two biggest items are health care and education/communication services, neither of which are sensitive to monetary policy. Thus, it's really housing and autos that matter most at this stage of the cycle. We continue to believe they’ll fall swiftly over the next three months or so.
What about a recession? Historically, recessions at the end of an inflation fight are caused by subsequent shocks (e.g., in 2008 it was the Great Financial Crisis).
But we've already had multiple shocks. One was the oil surge in 2022 from the Russia/Ukraine war. Two more Silicon Valley Bank’s demise and the 27% stock market decline in 2022.
Thankfully, the equity market and the economy already endured these.
To get a recession at this point in the cycle would require a seismic shock we cannot see. The news has suggested student loan payment resumptions, a government shutdown, and an automotive strike as possible candidates. However, we’d argue those issues are small, comparatively.
The key is that inflation is still course correcting off a cliff. Our short-term technical data indicates a low in mid-September with weakness in the first two weeks or so before reversing, which would be consistent with the timing of August inflation reports coming this week. In the near term, we want to see U.S. yields continue to decline, which would also decrease the federal funds rate probabilities.
We think analysts are putting the pieces together since quarterly earnings estimates are being revised up for the first time since 2021:
Looking for further data support, MAPsignals’ trusty Big Money Index (BMI), a 25-day moving average of “big money” investor buys and sells, has been in a downtrend. But that should reverse in the coming weeks based on current data and as the expected seasonal lift takes hold:
Even better, the quality of growth stocks being bought again by “big money” is evident as technology has regained the top sector spot:
Furthermore, ETF selling is drying up:
And there’s been a slight uptick in stock buying:
It’s too soon to call this a bullish trend. But we could be in the beginning stages of one (we’ll know if this continues within another week or two). If so, that would coincide nicely with our overall thesis of a strong year-end push.
At this point, a bit more data and a bit more patience could be all that’s required.
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* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
# Daniel Milan does not own LQD personally. Cornerstone does own LQD in client accounts.
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