Major Indices Up in August Despite Volatility
Despite pullbacks and elevated volatility in the earlier days of the month, major equity indices were up in August amid easing inflation, a dovish change in monetary policy, and increased probabilities of a soft landing. The S&P 500 gained 2.4% for the month while the Dow Jones Industrial Average was up 2.0%, posting a new all-time high, and the Nasdaq Composite followed with an increase of 0.7%. US value stocks (+3.0%) were among the best performers, followed by international developed equities (+2.9%) and US large-caps (+2.3%). Bonds fared well as investment grade corporates rose 1.8%, high yield credits gained 1.6%, and the US Aggregate Bond Index increased 1.5%. Aside from gold (+2.1%), commodities struggled as crude oil was down 4.4%, broad-based commodities declined 0.2%, and silver fell 0.2%.
Powell Signals Dovish Change in Fed Policy
At this year’s annual Jackson Hole symposium, Federal Reserve Chairman Jerome Powell expressed a dovish stance. “The time has come for policy to adjust,” he stated, all but confirming the Fed is ready to start cutting interest rates. As recent Consumer Price Index (CPI) and Personal Consumption Expenditure (PCE) reports continue to show disinflationary progress, Powell signaled he is more convinced that inflation is on a sustainable path back to the Fed’s 2% target. “The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks,” he said. The Chairman also drew attention to recent signs of weakening in employment indicators and communicated that the Fed will do everything it can to support a strong labor market. His speech also revealed officials aren’t anticipating a large loss in jobs or a high probability of recession. As of September 2nd, a 100% chance for the first rate cut to occur in September is priced in per the CME FedWatch Tool, with the odds of a 25 bps cut and 50 bps cut standing at approximately 68% and 32%, respectively.
US Growth Remains Healthy
Per the second preliminary estimate, US GDP for Q2 grew at annual rate of 3.0%, up from the first preliminary reading of 2.8%, and well above 1.4% in Q1. The upward revision was largely attributed to increases in consumer spending, as well as gains in private inventory investment and nonresidential fixed investment. For Q3, the GDP outlook also remains healthy as the Atlanta Fed GDPNow model forecasts 2.5% growth as of August 30th.
How do Equities Perform in Cutting Cycles?
When analyzing the S&P 500’s performance across all Fed rate cutting cycles going back to 1965, history suggests that on average, equities tend to perform well in the months after the initial cut given growth remains intact. However, if recessionary conditions follow, equity returns have historically struggled.
Opportunities Outside of the Magnificent
Among the 900 constituents in the S&P 900 Index, which contains large and mid-cap stocks, 251 companies have seen earnings growth greater than 25% over the last twelve months. More notably, only four of the “Magnificent Seven” stocks make that list, with 15 constituents growing their earnings faster than NVDA, 35 outpacing that of AMZN, 60 expanding net profits more than META, and 151 increasing earnings beyond that of GOOGL. This suggests that there may be more attractive opportunities across other cheaply valued stocks with appealing growth potential.
Do Not Lose Sight of the Big Picture. Fed Rate Cutting Cycles Have Historically Led to New Market Leadership. Rotate Portfolios Away From the Magnificent Seven
Data has been volatile from Q1 through today, which is historically common in this part of the cycle. However, several indicators have weakened or fell short of expectations more recently as lags from tight monetary policy have started to materialize:
Declining inflation via CPI, PPI, PCE
Slight loosening in the labor market evidenced by Initial/Continuing Claims, JOLTS Job Openings, ADP Payrolls, Nonfarm Payrolls
Contractionary ISM Manufacturing and Markit Manufacturing PMIs
We acknowledge this initial weakening but also note that the economy has not yet meaningfully deteriorated. Not all indicators have declined to severely low levels, and others still exhibit strength:
Expansionary ISM Services and Markit Services PMIs
Strong aggregate Q2 S&P earnings
Healthy Q2 GDP, as well as Q3 GDP forecasts
A consumer that remains strong via Retail Sales
However, we feel it is crucial to monitor for the rate of decline among future data at this point in the cycle.
Moreover, don’t get myopic and lose sight of the big picture. We had a 10-year period where investor portfolios were dominated by mega-cap, US growth stocks. This tilt produced attractive risk-adjusted returns, but investing is about buying low and selling high. Maintaining an overweight towards a cohort that is expensive, over-owned, and where the upside is limited feels counterintuitive from an investing standpoint.
Capital is ultimately allocated in search of the best return per unit of risk. We think the mid-cap/smaller-cap space offers an attractive return per unit of risk on a forward-looking basis as the interest rate cycle begins to take effect. We are not saying that this factor will specifically work today, tomorrow, or next week. We simply argue that investor portfolios need to evolve in the next 1, 3, and 5 years, and this market segment looks attractively priced.
Warranties & Disclaimers
As of the time of this publication, Astoria Portfolio Advisors held positions in SPYG, SPY, SPYV, SPDW, SPMD, SPSM, SPEM, SPBO, SPAB, MUB, IEF, SPIP, GLD, SLV, USO, BCI, NVDA, AMZN, META, and GOOGL on behalf of its clients. There are no warranties implied. Past performance is not indicative of future results. Information presented herein is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. The returns in this report are based on data from frequently used indices and ETFs. This information contained herein has been prepared by Astoria Portfolio Advisors LLC on the basis of publicly available information, internally developed data, and other third-party sources believed to be reliable. Astoria Portfolio Advisors LLC has not sought to independently verify information obtained from public and third-party sources and makes no representations or warranties as to the accuracy, completeness, or reliability of such information. Astoria Portfolio Advisors LLC is a registered investment adviser located in New York. Astoria Portfolio Advisors LLC may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements.