Last week saw the biggest surge in volatility in months (and really for 2024) as investors were confronted by a triple header of potential negatives from 1) Economic growth concerns, 2) An unwind of the yen carry trade, and 3) Reversal of extreme overweight’s in tech/AI names. But for all the volatility, the S&P 500 ended the week just fractionally lower and is still only off 5.7% from the recent highs.
Given the strong finish for stocks and the ability to bounce back from early-week declines, much of what I read over the weekend characterized this recent volatility as just a typical pullback in an upward-trending market. Put differently, it was almost dismissive of the recent volatility.
While I do not think fundamentals have deteriorated enough to warrant de-risking and reducing equity or risk exposure, I do want to reinforce this point: There are serious changes potentially happening to the U.S. economy and markets, and if they go bad, they will end this 2024 bull market and as such I want to caution against dismissing this uptick in volatility, even if stocks are still resilient.
Here’s why I say that. 1. The number of economic indicators pointing towards slowing growth or outright contraction is growing at a faster pace, and a slowdown that ends this bull market, while not the likely scenario, is becoming a bigger risk. So, I am not dismissive of soft economic data as it’s a potential major problem.
2. The surge in the yen has revealed dangerous overcrowding in the yen carry trade that has, in the past, led to prolonged bouts of market volatility and liquidity stresses. Put simply, the yen should not be able to strengthen more than 10% vs. the dollar in less than a month.That is not a sign of a healthy or orderly market, and the currency markets are very big. Perhaps this bout of volatility in the yen has “wrung out” the weak hands in the yen carry trade, and it’s more stable now. But these unwinds seem to occur in waves, and despite the late-week stability, it’s not at all clear this is over, and it’d be a mistake to assume so.
3. Overweights in tech and AI names have absolutely been reduced and there’sbetter balance in the markets, but much of this 2024 rally has still been driven by the Mag 7 gains ( gains in the key AI stocks). If more AI/tech firms offer mixed guidance (specifically NVDA on Aug. 28) we will see tech decline further and it’ll drag this market down with it.
4. The recent pullback has improved the valuation picture for this market, as the S&P 500 is trading around 19.4X 2025 S&P 500 EPS (5,344 divided by $275). While that’s down from the 21X-22X valuation peaks, it’s still historically high, and if we are in a slowing economy, the “right” multiple is more like 17X-18X (which is 4,675-4,950). Stocks are impressively resilient, but the risks facing this market are substantial (like,end-of-the-bull market substantial).And while they are not likely, they are becoming more likely with each passing week.
Elections sometimes matter in the overall picture of the market. In 2016, I predicted a 20% drop in the market if Hilary won the presidency based on the continuation of the policies of President Obama and President Bush. Both down played the importance of deregulation and oil independence and lower taxes.
I predicted that if Trump won that the policies would dramatically change and stimulate a change from a secular bear market to the beginning of a secular bull market. After he was elected we had 14 months in a row of positive stock markets and the greatest growth in the market after a presidential election in history!
Again politics is going to help or hinder the growth of the market. Not to be political, I look only at policy and what will help or hinder the market. If a Democrat wins this year, the markets could end the rally and possibly move to a secular bear market. If Trump wins, we will see the same positives that affected the 2016upturn. It may not be as strong as the 2017 move due to current valuations, but it will definitely reflect a pro-business, deregulation environment.
Last year the markets were volatile to down in the months of August and September. I suspect that we will see the same volatility this year. As we get closer to the election and see the third-quarter earnings reports, we will know if this upturn is sustainable. For now it does not pay to try to time these moves. I will keep you informed with any news that could affect your portfolios. I have 25% in value for now but may change that if the markets look to reverse this volatility and continue the bull move.
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