Stock Talk - Russell 2000 - Rotation Nation or just Squeeze me Seymour, more Little Shop of Horrors'?

Starting point is 00:00:00 On the morning of Thursday, July 11th, the government released its much-anticipated monthly CPI inflation report. It was lighter than economists expected, thus giving hope to first, earlier Federal Reserve rate cuts, and second, more rate cuts in 2024 and 2025. Recall that in his last few speeches, Federal Reserve Chairman Jerome Powell indicated that the Central Bank was aware that holding rates high for too long could hurt the economy. He got positive CPI data on the back of a slightly devish Paul and, come boom, stocks opened higher. The S&P gapped higher, but later sold off throughout the day and closed on its lows. While this happened, the long-maline Russell 2000 gapped higher and strengthened, even more on Friday. The variance between the two indexes was historically wide for the last

Starting point is 00:00:48 45 years. Yes, investors, the last 45 years. Even more extreme was the NASDAQ composite whose blistering year-to-date 2024 performance led by large-cap tech. stocks underperformed the Russell 2000 by more than five percentage points on the day in what appears to be the biggest daily gap on record. Take a look at the daily chart of the Russell 2000. You can see two huge up days a week ago. Friday, July 12th is circled. Investors, the ETF that best represents the Russell 2000 is the IWM-I shares Russell 2000. In case you were curious, over 30% of this ETF is sold short as a bet it declines or underperforms the S&P 500. That's outrageously high for an ETF with over $65 billion

Starting point is 00:01:37 in assets under management. Unless you were short with all those folks, almost everyone, and I mean everyone, got excited about this move up and was out commenting on it. It was historic, yes, and it was a great move up for those who've been waiting for small cap stocks to catch up. But was it the beginning of a major secular shift? Or was it just the start of a possibly two to three to four-month bounce in small caps. No one can tell you for sure. Before I continue with today's content, I'm going to give a shout-out to the entire Oak Carvest team.

Starting point is 00:02:08 USA Today ranked us as one of the best financial advisory firms in 2024. They give the award to the top RIA firms in the United States based on two criteria, recommendations from individuals from among 25,000 financial advisors, clients, and industry experts, and growth in assets under management over the last year, and over the last five years respectively. I personally am looking forward to helping us move up this list over the coming year by taking care of our current clients and future clients as well.

Starting point is 00:02:39 Now take a look at the longer term chart of the Russell 2000 Index. Investors, it has finally made both new 52 week and two-year highs, so the chart is broken out of a two-year training range. However, as one can see, it still sits almost 10% lower than the high seen in late 2021, near 2450 on the index. Moreover, if one looks closely at the continuous blue line in the background of these charts,

Starting point is 00:03:06 that's the relative strength of the Russell 2000 versus the S&P 500. You can barely see a blip up in this metric. Since the Russell's relative strength peaked in March of 2021, it's been three and a half years of woeful underperformance, relatively, versus the S&P 500. An optimist might say the chart looks a lot

Starting point is 00:03:28 like the Russell 2000 having a weekly close above 2125, say 2135. The setup looks a lot like late 2020, which I've circled on the longer term weekly chart. Back then, the Russell broke out to a new one-and-two-year high and went on to race another 600 points or another 35% over the next nine months. A similar move now would equate to close to 2850 on the Russell 2000. Well, I'm sorry to say, I think it goes higher, I can't get a move that high over the next year. Why? Because the cause of the move up was, one, short-covering by poorly positioned hedge funds and quants, and two, lower inflation lifting expectations that the Fed cuts sooner or deeper, which

Starting point is 00:04:13 could extend the economic cycle and re-accelerate growth in 2025. But investors behind the scenes, what I really see going on is more of the same in the economy. What's that? That's slowing. And while slowing inflation and slowing growth is good at first, as investors think Goldilocks and a soft landing, the data behind the scenes is creaking and warning that the Fed waiting until September to cut rates

Starting point is 00:04:37 might be too little, too late. Remember, that a slow growth or recessionary environment would be tough for small-cap stocks because they tend to carry more debt and they tend to be more economically sensitive and oriented to U.S. consumers more than their larger companies out there focusing on international. Remember, back to our previous discussions

Starting point is 00:04:57 on real growth and real interest rates? Real interest rates being the component of interest rates that is the premium to inflation. This is the one that controls equity risk premium and asset valuation. The one the Federal Reserve refers to when they're discussing being too tight or too loose with money. Well, the real-time, real rate has been great at signaling worsening economic growth that goes beyond just slowing that is reported by economists in groups like the Atlanta Fed GDP Now tracker. Take a look at the daily chart of the five-year real interest rate for the last five years. Followers of Oak Harvest Financial Group will recall how in October of 2022 and then again in October of 2023, based on this factor and a few others, our investment team signaled what we thought

Starting point is 00:05:42 would be a bottom in stocks and a strong forthcoming rally. What's interesting is on Thursday, July 12th, when the CPI data came out, this metric broke below two and most of its moving averages. That's why the Russell 2000 ripped. That's why the computer algorithms bought and sold different baskets of stocks. Remember, slowing and slower is good, until it isn't.

Starting point is 00:06:07 Let's take a look at the monthly chart of this indicator back 25 years of the same five-year real interest rate. The current pattern looks a lot like a big head and shoulders top to me. Many investors would think that this is a good thing. Lower interest rates are good on the good-bad scale. right? Shouldn't all boats rise in the market with lower rates? Unfortunately, prior to the advent of the

Starting point is 00:06:29 great financial crisis in 2007 and 8 and the implementation of quantitative easing and other post-GFC programs, this is actually a warning flag in my book. As one can see prior to these programs, when the markets were less influenced by the Fed, when real rates broke moving averages and started downtrends like late summer of 2000 and late summer of 2007 historically, it started the clock ticking for a more major slowdown and eventually a recession in the next 12 months. Yes, investors, that wasn't the case in the second half of 2009 or 2018 because the Fed jumped in with special programs. They jumped in with the Fed backstop and the Fed put in an extraordinary way. But investors, do you believe they'll immediately break out the same playbook if they see a

Starting point is 00:07:16 significant slowdown today? After trying for two years to regain their reputation as independent, I don't know if they will, but I wouldn't bet my portfolio and all my gains over the last two to three years being greedy, thinking that the Fed backstop will be in full force in late 2024 or 2025. As our team has previously discussed, if you're a retiree or near retiree who has had a tendency to get emotional about your investments when the markets are down and volatility is high, does it take every ounce of your willpower not to sell the lows? the dot-com bust, great financial crisis recession, COVID pandemic? If over the years you found yourself reacting emotionally in your portfolio to presidential elections and their uncertainty, now is the time to talk to your advisor to walk through your plan well in advance of other investors' concern of what will likely be a third quarter of 2004, is it a soft landing pullback that refreshes, or the beginning of a much more painful economic and market downturn?

Starting point is 00:08:16 Meet with your advisor, Oak Harvest or not. Discuss how much risk is in your allocation plan under a downside market scenario just in case the economy rolls over in late 2024 and 2025, regardless of who's elected this November. While most third quarter sell-offs are just cyclical corrections and short-term pullbacks and otherwise long-term bowl 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, say like 2000 or 2008.

Starting point is 00:08:51 I will argue with all takers that it didn't matter who was elected those years. Bush or Gore in 2000 or Obama or McCain in 2008, the ultimate winner was already dealt a bad hand by the Federal Reserve in the economy by the time they were elected. If you're going to make a reallocation decision to shift money out of stocks and equities into less volatile assets, it's best to do it when indexes are up and volatility. is low, not the other way around. If you're uncomfortable with a wider range of possible equity

Starting point is 00:09:20 outcomes, the O'Carvis 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 new strategy of ours can be found at oak harvestfunds.com. For myself, from Troy, Jessica, from Eric behind the camera, from the whole investment team, from Houston here, who's still recovering from Barrow, but going strong. Have a blessed weekend. All content contained with an Oak Harvest podcast expresses the views of the speaker 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.

Starting point is 00:10:04 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. 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 - Russell 2000 - Rotation Nation or just Squeeze me Seymour, more Little Shop of Horrors'?

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