Stock Talk - 2024 Summer Stock Markets: Where Things Get "Real"ly "Interest"ing

Starting point is 00:00:00 Investors, we're almost halfway through 2024, and I have to admit this has been one of the more interesting years I've seen during my career. While volatility at the S&P 500 index level remains near historic low bounds, X that 2007 year, single stock volatility is much higher than I can recall. You have large-capped stocks like Adobe trading up 15% in one day, or in the case of Dell, trading up or down plus or minus 15% within two to five months of each other. The S&P 500 continues to follow the presidential election cycle almost to a T. But below the index level, lies a chasm in the dispersion between the two sectors outperforming the S&P 500 year-to-date. That's technology and communication services, and the other nine sectors lagging behind the S&P 500 for 2024. J.C. Parrots of All-Star charts puts this into perspective. As of last Friday, June 14th, the S&P 500 and the NASDAQ 100 both hit new all-time highs.

Starting point is 00:00:55 However, fresh five-week lows in the advanced decline line of the broader NYC index hit new six-week lows. Oddly enough, the advanced decline line of the NASDAQ 100 also hit new six-week lows. That's what the market technicians call bad or deteriorating breadth. And investors, while bad breath is not a great timing tool, it is a condition that warrants monitoring as it means below the service, there are creeks and fissures in the markets. Investors, remember, the S&P 500 is a market cap weighted index. So the larger market cap stocks like Apple, Microsoft, and Nvidia carry a much higher weight and influence than the stocks 50 through 500. Take a look at the dispersion chart of the equal weighted S&P 500 by sector for the last 15 weeks

Starting point is 00:01:40 in about four months. Look closely for a second, you'll probably be shocked at the data you see. This chart shows the best overall performing sector over the last 15 weeks on a breadth basis which doesn't adjust for market cap weight. It's not technology, it's not telecommunication services, but rather it's the usual, boring, utility sector. I think few investors see this, and even fewer can explain why it might be happening. This is why I titled this episode, "'2024 stock markets, really interesting.

Starting point is 00:02:12 And this is where I pivot to an explanation back to the bond and interest rate markets. Investors, we've discussed nominal interest rates, those you usually see on TV, the inflation component of interest rates, and the real interest rate component. or premium an investor requires overinflation to hold treasuries. Remember, real interest rates has a large significance in many investors' calculation of equity risk premium and helps determine PEs or evaluations for stocks. The Fed has a great deal of control and influence over short-term real interest rates in the market when it sets shorter-term borrowing rates.

Starting point is 00:02:46 Here's the basic math equation again. Nominal interest rates equals inflation expectations plus real interest rate premium. Here's a quick table of each of those components broken out by treasury maturity. I'm just pulling the data from Bloomberg, but it's the real-time market data that's tradable as of the weekend of June 16th. I've got a few quick observations from the table. First, nominal interest rate yield curve. That is, the yield difference between long-term and short-term treasuries, such as one-year

Starting point is 00:03:14 or even T-bills, is inverted. This means it costs more to borrow money on the short-term than the longer term. The situation can exist for a very long time, but it's a very long time. It's restrictive on bank lending and is one method by which the Fed tries to control the economy to slow inflation. Historically, yield curve inversions set the clock ticking for a soft landing, or more often than not, an economic recession. This inversion plays havoc with more highly leveraged companies and smaller bank stocks, which occupy huge weights in the smaller cap indexes such as the Russell 2000. The longer this situation exists, the tougher it is on

Starting point is 00:03:51 on their business prospects. Investors feel content getting paid higher rates over the short term, and they're just sitting there, watching, not taking on what would be longer-term uncertainty, owning short-term treasuries. The second column highlights real-time market inflation expectations. These aren't the numbers calculated by surveys

Starting point is 00:04:10 or government employees. These are the current market-based expectations in real time. As you can see by this series, the market's expectations of future inflation in five to 10 years are lower than they currently are. This tells investors that the Fed is accomplishing its lower inflation goal. In fact, looking at the two-year breaking of inflation number, it's 1.957.

Starting point is 00:04:31 The Fed is already back below its 2% goal. Here's a chart of the two-year inflation dating back 20 years. As one can see, it's back in its historical range. If you're still with me, I'm sure you're asking yourself, I thought Chris was going to teach me something about why breadth is so narrow looking year-to-date in large-cap tech and why so few sectors are outperforming. I believe the answer lies in the last column. That's the column of real interest rates,

Starting point is 00:04:56 and more specifically, how the real interest rate yield curve is shaped now versus earlier in the year. Remember, investors, this is really one of the main tools that the Fed has to cool inflation. However, in doing so, it also runs a risk of not just cooling inflation, but cooling the overall economy too much in either causing a recession or breaking something before we see what's going on in the real economy.

Starting point is 00:05:20 So from this table, one-year real interest rates are over 3.57% while 10-year real interest rates are just over 2%. Six months ago, at the beginning of the year, the one-year real rate was around 2 and 3-quarters percent and declined to just under 1% in April, but it's risen over 2.5% since then. At the beginning of the year, the 10-year real rate was about 1.7%. It rose to 2.5% in April and has now declined back to 2%. So overall, the last six months, the 10-year real rates have risen mildly, say a quarter of a percent, while short-term real rates have risen 250 basis points off their low. That's investors in the market wrestling with and adjusting to the Fed's hawkish talk and they're higher for longer maximum. The Fed has real interest rate curve inverted in a big way right now.

Starting point is 00:06:11 And while this is brought down longer-term nominal interest rates by cooling inflation fears, which has helped higher growth, low debt leverage, large-cap megatech sectors that have Microsoft, and VDivdian Apple in them, it has historically bad for stocks with high debt loads and low growth rates. It hasn't done a thing to help most other sectors. Why? Because sectors like industrials, consumer discretionary, and energy are generally shorter cycle economic areas that move higher with an overall economic swing, both bad and good. And indexes like small-cap Russell carry more value-tilted names, names with higher debt loads, and more overall cyclical activity in their businesses. Investors, even the price-weighted Dow Jones Index, has smaller weightings and technology

Starting point is 00:06:57 and other sectors that benefit from a tilt lower and longer-term nominal yields and their components, inflation and real rates. Indexes like the Russell 2000 have investors waiting to pull the trigger to buy more of them, waiting until the Fed messages a rate cut or until they actually cut rates preemptively. So the economy doesn't slow too much and tip us into a recession like 2007, 2008, or the second half of 2000 into 2001. Investors, there's a fine line between a soft landing and a downturn that morphs into a more serious economic decline in recession that hurts every stock in the market. The Fed's large inversion of real interest rate curves, while slowing inflation is also finally starting to put the breaks on economic growth that most

Starting point is 00:07:42 non-secular growth areas need for stocks to work. And outside of the normal summer rally, this is where things in the market are starting to get really interesting. So if you're a retiree or a near retiree still watching this video, with the volatility in markets subdued at low levels and stock returns high for the last 10 years, if over the years you've found yourself reacting emotionally

Starting point is 00:08:03 in your portfolio when the markets are down or when volatility is high, like Christmas Eve of December 2018, or maybe COVID, March, 2000, or worse yet when markets are down for years post.com bubble or the great financial crisis, talk to your advisor well in advance of other investors' concerns of what would likely be a normal third quarter 24 soft landing pullback that refreshes, we think, or it could be the beginning of a much more painful economic and market downturn. Discuss how much risk is in your portfolio allocation under downside market scenarios, just in case. Investors, historically,

Starting point is 00:08:40 there's a third quarter sell-off in the markets during election years, just like there is, most every other year. And while most of these sell-offs are just cyclical corrections and short-term pullbacks and otherwise long-term bull markets and economic expansions, it's virtually impossible to tell if that sell-off is a mild correction in an economic soft landing, or if it's the beginning of something more dire like 2000 or 2008. Investors, if you're going to make decisions on reallocating your portfolio to shift money out of stocks and equities into less volatile assets, it's best to do it when the index is up and volatility is low, not the other way around. For investors and retirees who have fears that the markets might experience a 1970s lost decade or a repeat of the last decade after the dot-com buildout or who may feel

Starting point is 00:09:28 anxious over the coming election, now is a great time to give O'Carvus a call, set up a meeting, talk to one of our advisors. If you're uncomfortable with a wider range of possible equity outcomes, the Oak Harvest team has launched a new strategy that retains the ability to go long stocks, short stocks, as well as buy partial hedges and shock absorbers for your stock portfolio. Information on this exciting new strategy can be found at oak harvest funds.com. For myself, from Eric behind the camera and the whole team are here at Oak Carvis, thank you and have a blessed weekend. All content contained with an Oak Harvest podcast expresses the views of the speaker

Starting point is 00:10:05 and is for informational purposes only. It is based on information believed to be reliable when created, but any cited data, indicators, statistics, or other sources are not guaranteed. The views and opinions expressed herein may change without notice. Strategies and ideas discussed may not be right for you, and nothing in this podcast should be considered as personalized investment, tax or legal advice, or an offer or solicitation to buy or sell securities. Indexes such as the S&P 500 are not available for direct investment and your investment results may differ when compared to an index.

Starting point is 00:10:43 Specific portfolio actions or strategies discussed will not apply to all client portfolios. Investing involves the risk of loss and past performance is not indicative of future results.

Stock Talk - 2024 Summer Stock Markets: Where Things Get "Real"ly "Interest"ing

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