Last week was a hugely important week for the month of August because of the symposium in Jackson Hole, Wyoming, and more specifically, Fed Chair Jerome Powell speaking on Friday. We noted recently how markets began to shift to a “risk on” sentiment based on the benign consumer price index reports of late.
Building upon this momentum was Powell’s dovish Friday commentary, which further supported equity market gains. In previous blog posts, we noted how Tokyo Black Monday from earlier this month would prove to be a “growth scare,” while keeping in mind that market bottoms take time.
Since then, there's been a strong equity comeback, even as many investors remain sidelined due to pessimism around the economy:
That's why we believe Jackson Hole is important for creating additional upside opportunity. Looking at the most recent history, in just the past three years it’s clear that markets react to Chairman Powell's words in the 10 days that followed:
In 2021, a 2% rally followed Powell’s Jackson Hole remarks. After he warned of “pain ahead” in 2022, stocks fell 8%. And last year, the market rose 4% as Powell noted positive inflation progress.
We expected Powell to be dovish for two simple reasons:
- Inflation continues to track better than consensus.
- The labor market is softening as unemployment rises.
So, why would the Fed be hawkish?
Keep in mind, we often forget the stock market isn’t the main audience of Fed policy communications – corporate executives, small businesses, and consumers are affected most because they base future plans on Fed narratives. A hawkish Fed would chill expansion strategies and add to labor market softness, possibly causing contraction, which is not what the Fed wants.
Moreover, leading up to Jackson Hole, multiple Fed members set the stage for a dovish stance. Three Fed members spoke out in support of rate cuts:
With the Fed’s dovish stance, there's a high likelihood that bearish folks who remained on the sidelines due to the “carry trade” unwinding will become incrementally positive post Jackson Hole. The bottom line is the combination of inflation reports and the Jackson Hole developments allow markets to show signs of regained footing and shaking off the dread.
Supportive Macro Data
Turning to some macro level data and concepts, let’s all remember pullbacks like the one that took place in the beginning of August are perfectly normal from a historical standpoint. Volatility is the price investors pay for outsized gains.
Most of the time, stock market dips are short and shallow. For example, the S&P 500* has seen 240 declines of 5% or more since 1927, with an average decline of 11.8% and a median decline of 8.3%.
Still, drawdowns are never fun. Volatility often catches us off guard, appearing suddenly after extended rallies, like the one since the October 2023 lows.
That said, let’s turn now to four supportive macro data points that add more weight to the case we made last week about extreme situations producing extreme results.
Market History
It turns out that volatility is perfectly normal and happens every year. It's a healthy cleansing process that resets expectations. Volatility is the price we pay for juicy returns that only stocks can provide.
Since 1980, the S&P 500 has averaged a 14% peak-to-trough decline annually while still chalking up a healthy 10.3% average annual gain, plus dividends.
There's no free lunch. We all must live with volatility.
Strong Economic Outlook
As the news reminds us so often, recession fears have made a comeback. But before we assume the fear-based media narrative as gospel, let’s take a deep breath and look at the data.
The job market is widely seen as the best indicator for gauging the health of the U.S. economy. While it's true the four-week average of initial jobless claims ticked up recently to 241,000 from its cycle low of 200,000 in January, the labor market remains fundamentally healthy from a historical perspective – the current 241,000 four-week average is 34% below the 60-year average of 364,000.
Additionally, the third-quarter gross domestic product forecast from the Federal Reserve Bank of Atlanta is a strong 2.9% as of this writing. Plus, the Fed’s preferred inflation measure (the core personal consumption expenditures index) now stands at a low 2.5%.
Obviously, things can change. But as we sit here today, this economic outlook should continue to cushion stocks as the Fed finally begins cutting rates, especially with consensus expectations of a federal funds rate of 3.75% by next April.
Earnings! Earnings! Earnings!
In the wake of 2023’s shallow earnings recession, S&P 500 12-month forward per-share earnings growth has now ramped up to 11% after a robust second-quarter earnings season.
Earnings matter. And when earnings improve, stock prices follow suit.
Valuations
On the higher end of the equity valuation spectrum, technology stocks have now reset lower, remaining slightly above average at 28.5 times 12-month forward EPS. However, this can be justified by big tech’s continued amazing profit growth of around 20%.
What about the rest of the stock market? Well, as earnings continue to ramp up, valuations are becoming increasingly reasonable relative to history:
Encouragingly, when interest rates fall more, these relative value areas will be set for even brighter days.
“Big Money” Buying
All in all, the data is becoming more supportive of the recent growth scare being a head fake.
Falling inflation and lower interest rates should keep earnings humming. Add in the downward valuation resets and it’s no wonder that “big money” professional investors are once again stepping up to the plate to buy stocks:
As we know, “big money” moves markets. Right now, the trajectory over time is promising.
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