History shows volatility will surface before elections. We mentioned how risks linked to the 2024 version of this phenomenon could be front loaded, and last week we received a macro data point – the August consumer price index report – that was better than it appeared on the surface.
Core CPI, which excludes volatile food and energy prices, came in 0.28% higher on a month-over-month basis. Coming in above Wall Street’s consensus of a 0.20% increase was not negative once you eliminate the headline nose.
See, despite the monthly rise, inflation is cooling overall. Core CPI is up 3.2% year-over-year, which is below the 60-year average (3.7%), and only slightly above the 40-year average (2.8%):
Most importantly though, five largest contributors to core CPI’s rise were:
- Shelter (ex-hotels) 0.21%
- Airline fares 0.04%
- Lodging 0.03%
- Auto insurance 0.02%
- Tuition 0.01%
The acceleration of shelter, airlines, and lodging collectively added 0.13% versus July, accounting for the entire sequential monthly increase.
At Cornerstone, we think this is most likely to be seasonal adjustment noise primarily when acknowledging that auto insurance inflation is continuing its long slowdown. The worst component is finally fading.
Our analysis is supported by federal funds rate futures odds. The probability of a 50-basis-point decline dropped from 33% on Tuesday to 20% after the CPI report (more on that later).
Nonetheless, in the short term we’re still in the “bad eight weeks until Election Day,” during which we expect stocks to be range-bound, with the S&P 500* stuck between 5,300 and 5,700.
Still, the August lows should hold.
Mid-cycle Breather
Knowing to expect some choppiness allows us to focus on data, not fear.
The two main narrative-driven headwinds lately are the path of interest rate cuts and election uncertainty. Let’s dissect these items with data.
Remember when rate cuts were bullish? Now some are trying to flip the script. But the data doesn’t agree.
Yes, growth is slowing due to manufacturing weakness. But the services sector, which equals about 2/3 of the economy, remains healthy thanks to labor market resilience and strong upper middle class income consumers (who make up 50% of spending).
This resembles a mid-cycle breather more than a recession. The latest GDPNow forecast from the Federal Reserve Bank of Atlanta concurs, currently showing steady 2.5% growth:
Listening to recessionistas, who’ve been yelling since October 2022, would have been dangerous to your wealth.
What does this all mean for the Federal Reserve? Rates will almost certainly fall starting Sept. 18, which will help cushion growth as monetary policy normalizes. The key though is that when easing is slow and steady, stocks tend to benefit:
The chart above is why the recent potential for a 50-basis-point cut spooked investors. If the Fed cuts quickly, there’s usually a crisis and the economy needs rescuing. But that’s not the case today.
Another contributory factor is election uncertainty. Markets hate uncertainty. It’s a big reason the S&P 500 averages losses of 0.5% and 0.3% in September and October, respectively, during election years.
Markets can price in any outcome. From an investor perspective, getting electoral uncertainty out of the way is more important than who wins. It’s no surprise the S&P 500 enjoyed significant rallies after elections historically, with average gains of 1.2% and 1.5% in November and December, respectively, in election years:
The data shows cashing out of stocks over electoral jitters consistently is a losing strategy.
Money Doesn’t Leave Markets, It Rotates
Even with all the immediate uncertainty, the media says stocks are stagnant. That’s partially true, though the “blanket macro belief” is misleading.
We’ve written about how money doesn’t leave markets, it rotates. There’s been a recent monumental shift into high-quality, income-focused dividend growth stocks. We at CFS watched it unfold live as our dividend growth models began to significantly outperform our other growth strategies.
Back in June, when the crowd was focused on AI mania, we said it was just a matter of time before “dead” stocks would reawaken.
Well, the June CPI report sparked the massive move from mega-cap tech into drastically underperforming small-cap stocks. Check out the relative performance between the Russell 2000 (using the exchange-traded fund iShares Russell 2000 ETF (IWM) as a proxy) and the NASDAQ 100 (using the Invesco QQQ Trust (QQQ) as a proxy) after that report:
Money then began piling into dividend growth areas too. Since July 11, income-oriented assets have been accumulated heavily.
A look at S&P 500 snapshots from July 3 and Sept. 4 shows a healthy rotation under the surface.
On July 3 – just two months ago – the S&P 500 was up 16.92%. However, only 20.5% of its stocks were outperforming and the average stock’s return was just 5.22%.
Fast forward to early September and the S&P 500 is up 16.83% – it’s seemingly gone nowhere. But there have been massive breadth improvements.
Over a third of stocks are now outperforming the index. Even more interesting, the average stock’s return has doubled. This is healthy market action.
The “big money” view confirms the rotation. Dividend-rich sectors began to thrive with significant new money.
It’s happened in real estate (using the Real Estate Select Sector SPDR Fund (XLRE) as a proxy):
Utilities (using the Utilities Select Sector SPDR ETF (XLU) as a proxy):
Financials (using the Financial Select Sector SPDR ETF (XLF) as a proxy):
In consumer staples, where the steady-eddy names your grandparents know and love (using the Consumer Staples Select Sector SPDR ETF (XLP) as a proxy):
And finally, in high quality health care (using the Health Care Select Sector SPDR ETF (XLV) as a proxy):
This “big money” view shows that even with a flat index, there’s still opportunity. Let’s look at a specific health care example – Eli Lilly & Company (LLY)#.
In the last year, LLY soared with significant “big money” support:
Why has LLY been so attractive to us and institutions? Its fundamentals.
Eli Lilly’s revenues and net income have soared and are projected to continue that trend moving forward:
With numbers like that, dividends and dividend growth are sure to follow. They have:
LLY exemplifies the power of fundamental analysis and dividend growth as an investment strategy. Don’t listen to the media telling you stocks have gone nowhere. They're just looking in the wrong place.
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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.
# Some Cornerstone client accounts own LLY. Daniel Milan does not own it personally.
Securities sold through CoreCap Investments, LLC. Advisory services offered by CoreCap Advisors, LLC. Cornerstone Financial and CoreCap are separate and unaffiliated entities.