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Included in this report:
- Weekly summary.
- Update on market positioning.
- Stock market forecast.
- Overnight effect and pairs trades update.
1. Weekly Summary (August 19–August 23, 2024)
- After the Chairman of the Federal Reserve confirmed expectations of a rate-cutting cycle, the rally in stocks continued.
- Large-cap stocks (SPY) gained 1.4%. Since the low of August 5, 2024, the SPY has gained 10%. In the last three weeks, the ETF has risen 5.4%.
- Long-duration bonds (TLT) gained 1% on the week as bond market traders were cautious about the economy’s strength and inflation. The TLT ETF is down 36.6% from the all-time highs of March 2020.
- Commodities (DBC) ended the week with small gains, and any upside was limited due to a 2.9% fall in crude oil’s spot price.
- The US dollar index (UUP) plunged 1.6% on the expectation of lower rates.
- Gold (GLD) ended the week unchanged.
- For the week, the equally weighted magnificent seven stocks gained 1.1%. The stock of Nvidia Corp. (NVDA) gained 3.8%.
- The real estate sector (XLRE) gained 3.6% this week on the expectation of falling rates. Only the energy sector was down by 0.1%.
Comments: “The time has come” for interest rate cuts, but possibly also for other second-order non-linear effects triggered by those cuts. But we really do not know what will happen.
Some analysts published charts on financial social media that presumably show that bear markets have followed after the start of rate-cutting cycles. There is no way to establish cause and effect due to the small sample size and many confounders.
Severe bear markets accompanied the 2000 and 2007 rate-cutting cycles, but it may not be rational to assume that they caused them. We know what caused the dot-com bear market and the GFC, but it was not a rate-cutting cycle. Before that, as shown on the above chart, the late 1970s and late 1980s rate cut cycles did not prevent bear markets, but there were energy crises back then with sustained inflation. However, we still do not know what will happen if the aggressive rate-cutting cycle the market expects materializes. The economy is a highly non-linear stochastic process and trying to guess what will happen is a futile exercise. Investors may be better off following simple indicators rather than resorting to a process that is indistinguishable from astrology.
Stocks, bonds, and commodities gained, and the dollar fell.
This week, stocks, bonds, and commodities gained more than 1% each, while the US dollar plunged 1.7%. Since 1995, there have been 14 occurrences of this pattern: The initial instance occurred during the week ending on January 9, 2004.
The green arrows on the weekly S&P 500 chart indicate occurrences of the above pattern.
This pattern has resulted in mixed performance for the index. Corrections followed five of the events (gray circles), but the rest followed strong uptrends or were at correction bottoms. This tells us that the sample size is small. We suspect that given a large enough sample and a large variety of confounders, the market direction will be a fair coin toss.
In this particular case, further debasement of the US dollar could fuel the equity market rally in the short term, but in the medium term, this may cause problems, including an uptick in inflation. We also believe that the depreciation of the US dollar and the repricing of paper assets fuelled a significant portion of the rally in the last two weeks.
Historically, wealthy stock investors have benefited more from share appreciation than they have lost from purchasing power. The issue lies in the significant impact a loss of purchasing power has on the working class. This policy is part of financial repression and pro-capital. In the long term, it is unsustainable because it increases inequality, but no one knows when it will reach an upper limit. In the meantime, it works well for making the wealthy richer. In our opinion, this is the most important aspect of the current macroeconomic policy, and the rest is more or less noise.
2. Update on market positioning
We use two cross-sectional momentum long-only strategies that generate signals for capital markets and factor ETFs. Year-to-date, both strategies outperform the S&P 500 total return by a wide margin. The equally-weighted performance year-to-date is 21.9%.
Last update: Friday, August 23, 2024, after the market close.
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Specific disclaimer: This report includes charts that may reference price levels. If market conditions change the price levels or any analysis based on them, we may not update the charts. All charts in this report are for informational purposes only. See the disclaimer for more information.
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Charting and backtesting program: Amibroker. Data provider: Norgate Data
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