While several variables drove markets down then up during August, the seminal event was the more dovish than expected interest rate guidance provided by Fed Chair Powell at Jackson Hole (JH) on August 23rd. Making it clear the Fed intends to initiate rate cuts on September 18th, Powell enunciated the FOMC is now focused on the employment side of their dual mandate. His language implied the Fed will now be proactive in its attempt to prevent further weakness in the labour market. This was an important pivot in the Fed’s messaging and directionally supportive of a soft-landing economic environment.
Interest rates have fallen off a cliff since hitting their recent peak on July 1st, with the yields on U.S. 2s and 10s falling 90 and 70 basis points respectively through last Friday’s close. Weaker growth, softer pricing data and rate-cutting supportive Fed-speak kickstarted the bond rally from which stocks took their cue. Then June’s U.S. CPI print hit on July 11th, triggering a greater than five standard deviation move in the relative strength of the Russell 2000 (small cap index) versus the NASDAQ 100, the largest de-rating since the bursting of the tech bubble in 2000. Hence, the S&P 500 gave back most of its month-to-date gains, finishing with a total return of 1.2%, while the Russell returned +10.2% and Canada’s S&P TSX split the difference, tabling a total return of 5.9%. Likewise, each of our two funds once again generated positive net returns.
Post the strong bounce back of equities during May, the combination of deteriorating market breadth and weakening economic statistics in June suggest stocks may enter a choppier period during the summer. Regardless as to whether that implies sideways or negative price performance, strong messaging that the Fed put remains in place, plus the expectation of one last barnburner quarter of earnings from mega cap tech should prevent stocks from experiencing a significant downdraft in the near term.
The worries of April were the source of investor happiness during the month of May as thanks to factors that served to stop the rise in U.S. government yields, the S&P 500 recaptured the majority of its April decline. First, the Federal Reserve tapered QT by more than expected, effectively boosting forward 12-month liquidity by US$420B. On this point, we continue to contest Powell’s notion that monetary policy is tight; phooey it is! Sure, rates have gone up but a) the U.S. economy is far less sensitive to interest rates than it was in the past, and b) the ten-year graph below confirms the U.S. continues to swim in a sea of liquidity (70% above pre-COVID levels). We believe this latter fact has played a significant role in boosting the price of assets and U.S. economic growth. Second, the U.S. Treasury’s ‘Quarterly Refinancing Announcement’ (QRA) was in-line with expectations including nominal auction sizes expected to be stable for “at least” several quarters. Finally, U.S. April economic data released in May was softer on growth and inflation, a combination seen as being good for forward rate cuts yet within the context of an economy still growing enough to generate the profits requisite of a S&P 493 (ex-M7) trading at more than 19X forward EPS.