The U.S. stock markets opened sharply in negative territory this morning, August 5, 2024. This after two consecutive down days to end last week. After such a strong July, some sort of pullback wasn’t surprising. However, the magnitude of it has been.
But why?
The headlines on media websites suggest it is due to fears of a sharp downturn in U.S. economic activity. There is an old expression in the financial industry: “when the U.S. catches a cold, the rest of the world catches the flu.” This seems to be the case, as global investors have been dumping stocks in fear of a U.S. slowdown.
At least that is the story, and everyone is sticking to it.
But is the U.S. economy falling apart? After all, it wasn’t so long ago the Bureau of Economic Analysis (BEA) announced the US economy grew at a 2.8% rate during the 2nd Quarter. Further, despite the jobs reports coming in weaker than they had been, employers are still adding to payrolls. As for the rest of the official data, nothing looks dramatically different than it did last month.
So, it would seem folks are panicking over a potential worst case scenario. This being a sharp U.S. recession which spreads around an already-tepid global economy. On the flipside, the best case scenario is the U.S. continues to post 2.8% Gross Domestic Product (GDP) numbers every quarter for the foreseeable future.
As we all well know, the probable-case scenario is in between the worst- and best-case ones.
In all likelihood, economic activity is cooling in the United States. Maybe you have sensed as much with your eyeballs. Parking lots aren’t quite as full. Reservations are easier to get. The local XYZ fast food restaurant closed down, as did the “stuck in the middle” retail shop in town. The number of BOGOs at the grocery seem to be going up. Workers, particularly young and inexperienced, are having a harder time finding a job.
However, there is a difference between an economic slowdown and an economic collapse. Further, there is also a difference between a pullback in the stock market and financial Armageddon.
Absent a financial system collapse in the United States or another pandemic, it is difficult for me to imagine an economic slowdown which would validate the type of panic we have seen in the markets the last several days.
Fortunately, as I type, neither of those things seems terribly likely. Further, as I have already suggested, the economic data continues to be, shall we say, mediocre, and there is huge difference between that and awful.
The Black Ink
As for the markets? The money was way too easy during the first seven months of 2024. With economic activity and corporate earnings performing the way they have been, investors would have ordinarily been happy with a 6-7% year-to-date return in the S&P 500 through July. They got in-excess of 15% instead. To say this surprising rally wasn’t going to continue at its then-current pace was an easy bet.
The Red Ink
But all the red ink? Well, all it takes is for a fistful of large institutional investors to “take some risk off the table” in order to cause problems in an already “frothy” market. After July’s amazingly strong returns, I suspect the desire to realize gains was incredibly strong at a number of large shops. So much so, I wouldn’t be surprised to eventually learn the “seasonal rebalancing,” which ordinarily happens in September, started a month early in 2024.
In fact, I would actually be surprised if that isn’t the case. What’s more, I would also be surprised if the rates of return don’t vary significantly across economic sectors and asset classes.
The Selloff
That is a clever way of saying large cap growth and other tech stocks will bear an outsized brunt of this selloff. The reason for it is simple:
Recent growth rates are likely unsustainable, making current valuations, shall we say, expensive. This doesn’t mean investors have permanently soured on tech stocks. Far from it. It simply means the quicker the pullback to more normal valuations, the quicker the large, institutional investors will hop back into them.
Essentially, this isn’t, or shouldn’t be, permanent.
- The economy is a little slower, but it isn’t collapsing.
- Stock valuations are higher than normal, but, and this is important, heavily weighted to a few economic sectors.
- The Federal Reserve is on pace to cut the overnight lending rate in September, which should prop up the economy and the markets.
I could go on, but the message would be the same: “the probable-case scenario is the U.S. economy is probably growing at or around 1.5% and the markets are adjusting to this reality.”
If that is the probable-case scenario, you could argue the unpleasantness of the last several trading sessions is exaggerated. Therefore, the more exaggerated it is, the shorter the unpleasantness will be. We might not be completely out of the woods yet. However, the woods are not as deep, dark and scary as they may seem today.
Oh yeah, one last thing, try not to watch the television or spend too much time on your favorite media websites. They will be sure to feed you as much negative news as they can, because it sells much better than good news. (Better yet, watch the Olympics, instead.)
Thank you for the continued support.
John Norris
Chief Economist
Please note, nothing in this note 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.