Compared to last week’s excitement, these past 5 trading sessions have almost felt like sleepwalking. It has been decidedly slower in terms of meaningful earnings announcements, economic reports and news from the Federal Reserve. So much so, at times, it has felt like the only things happening in the world were/are campus protests, the conflicts in Gaza and Ukraine and Donald Trump’s trial in New York.
While that seems like a gracious plenty, and I suppose it is, they don’t move the markets. At least not any longer.
On our daily conference call this morning, our chief equity strategist, David McGrath summed up the recent activity in the stock markets thusly, and I paraphrase mightily: “There was no reason for stocks to rally this week. However, there was no reason for them to fall apart either. As such, stocks did what they like to do, and went up.”
At least that is how I processed his comments, and I think he is right.
All other things being equal, the markets often tend to move higher when the information isn’t bad.
But where does that leave us now?
I have made no secret of my belief that the markets will be rocky this summer. Despite the relatively sanguine start to May, I am not sure what fuels the rally throughout the summer. Ordinarily, one would like to see lower interest rates and lower energy prices, but those things likely won’t be in the offing. That is, unless bombs start exploding in the United States or on oil platforms around the world.
That’s a refreshing thought. You can just call me Mr. Sunshine.
Now, it might seem I am contradicting myself. That last full paragraph doesn’t really jibe with my previous contention about the markets tending to go up, does it? Admittedly, no. However, that doesn’t mean I am talking “out of both sides of my mouth.”
Let me explain.
Imagine it is a perfect summer day. Light puffy clouds against a painted blue sky, all of it. They are altocumulus clouds, in case you are wondering. You sit back in a comfy chair to bask in the sun, and someone hands you a perfectly brewed glass of iced tea. Sounds pretty good, huh?
So, do you decline it? Unless you are from Utah, the chances are probably not. Now, do you take just one small sip and pass it back to your benefactor? Again, probably not, because a cold glass of iced tea on a summer day is awesome and you aren’t an anarchist.
My guess is you will take a nice pull from the glass, let the sun hit your face and repeat as necessary. That is until the tea is gone and you are chewing on the remaining ice. Am I right, even if you might be wondering where I am going with this?
Think about it. All other things being equal, you will continue to drink the tea until it is finished. It doesn’t matter if only the first half of the glass quenched your immediate thirst. That is how it is with stocks. They will continue to climb pass the point of, shall I call it equilibrium, for no other reason than momentum.
Remember Newton’s first law? “An object at rest remains at rest, and an object in motion remains in motion at constant speed and in a straight line unless acted on by an unbalanced force.”
So, just as you will continue to drink the iced tea until you have finished it, stocks will continue to increase in price until investors feel the potential for risk is greater than the potential for gain. Ordinarily, this happens when the markets finally realize they are running out of reasons to rally.
All it takes in an overextended market is for a couple of large investment firms, like Capital Group or Fidelity, to decide to ‘rebalance’ their equity allocations back to ‘target.’
I am not kidding about that. Although passive investment products might dominate many areas, a 5% decrease in desired stock exposure at those two firms above is a lot of money. These sales set off the quant traders and then the technicians, and so on and so forth. After several trading seasons of red ink, John Everyman decides he has seen enough and sells the index fund he has in his 401k.
Or course, this will lead the passive firms, like Vanguard and BlackRock, to sell shares to cover Mr. Everyman’s outflow, and, again, so on and so forth. This will happen until investors determine the potential for gain is greater than the potential for risk, and increase their equity exposure.
If it seems like a never-ending cycle, it is. The question then remains: “when will the big money decide it is time to take money off the table, especially if things don’t seem like they are falling apart?”
The low-hanging fruit is that it will do so when any consumer weakness becomes apparent. Frankly, everyone has been waiting for this for quite a while. The consumer doesn’t necessarily have to fall apart. It just has to cool to a point where hiring slows. After all, the labor market’s continued, surprising strength has propped up the U.S. economy for longer than most felt possible this deep into a Fed-tightening cycle.
There are signs this might happen sooner than later.
- To be sure, the official jobs numbers remain impressive.
- However, ask recent college graduates how plentiful jobs really are.
- Take a look at recent sentiment gauges to see how consumers feel about the future.
- The recent ‘reports on business’ from ISM suggest hiring is flat.
- And finally, the so-called “Quits Rate” clearly show U.S. workers aren’t hopping jobs the way they were not long ago.
All of these things, and others, portend weaker payroll numbers moving through the summer months. Of course, this might not happen. The safe bet is that it will. Unfortunately, this will be a gradual trend which will keep the Fed on the sideline until later. However, a trend it will be nonetheless.
So much so, by the time the Fed finally gets around to cutting the overnight rate, the markets will be figuratively screaming: “what took you so long? Did you not see the data we saw?”
Of course, the last 150 words or so might seem alarming, but I don’t mean for them to be. Please don’t take anything I have written here today to mean, or otherwise suggest, I believe the sky is going to fall or economic Armageddon is around the corner. Neither is likely. Even so, the potential for cheaper money is the fuel stocks have been using to continue climbing. Without it, expect some rebalancing back to target allocations and rockiness during the summer.
All that other stuff? Kids protesting on college campuses? Defacing statues? Continued strife in the Levant and Ukraine? Donald Trump’s trial de jure? You can pack all those things up in a package, put a pretty bow on them and hold them until Christmas, or longer.
They might make headlines. However, the cost of money and consumer spending drive the markets in the U.S.
Have a great weekend.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this any and every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
John Norris
Chief Economist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as well as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.