Broker Check

Why the Outlook For Stocks Got Worse Last Week (Not Better)

May 08, 2024

Investors cheered both Fed Chair Powell saying rate hikes were unlikely and almost universally disappointing U.S. economic data last week, but while that provided a boost for stocks and bonds, investors need to be careful what they wish for because despite the late week rally, the outlook for stocks got more dangerous last week. I say that for two main reasons. First, while Powell pushed back on the idea of rate hikes, the Fed openly embraced higher-for longer and that means there are not going to be any near-term rate cuts, unless growth suddenly and abruptly collapses.

 

Point being, imminent rate cuts were an important part of the October-March rally and the reality is that we likely are not getting rate cuts anytime soon. Second, for the first time in several years, numerous economic indicators are pointing to slowing momentum.

 

Consumer companies’ earnings reports are flashing some warning signs on the consumer, and while still low historically, the unemployment rate looks like it wants to drift higher. To be clear, none of these signals mean the economy is slowing right now. It is not. Growth is still positive; it just appears it is getting less positive than we’re used to.

 

The problem is that at 5,100 in the S&P 500, there is virtually zero allowance for any slowing of economic growth, and that’s why the events of the past few weeks have made the next several months in this market more uncertain and more dangerous than before. We and others have been saying this for weeks: One of the few candidates that can truly kill this rally is a stall or contraction in the economy. There is virtually zero chance of that happening priced into markets, so even if data deteriorates and it becomes a 70/30 proposition, it will likely weigh on markets.

 

Here’s the bottom line: Don’t get lost in the inflation debate. Yes, price pressures are sticky but they will continue to drift lower (albeit slowly) over time, especially given it appears the economy is losing momentum. Instead, stay focused on growth. That’s what matters not for the next few weeks, but for whether the S&P 500 sees 5,700 first or 4,700. If growth maintains, stocks can move higher. If it rolls over, the S&P 500 will not be able to hold 5,000.

 

From a positioning standpoint, this past week’s events reinforce my preference for overweighting “quality” as a factor and more broadly, value. I am staying away from small cap companies and mid cap companies as they are having a difficult time weathering this environment. I am in large cap and dividend paying stocks because they are weathering this volatility and are set up to bounce back if the Fed decides to lower interest rates.

 

If economic data begins to meaningfully slow over the next two-three months, then this market has a major problem (it just doesn’t know it yet). Going forward, we’ll continue to watch economic data very closely and again, at this point in the economic cycle, it’s not about inflation (that won’t rise especially if growth is slowing) or the Fed (they’re only cutting in the near term if growth slows).

 

It’s about growth and it needs to remain resilient for the S&P 500 to hold current levels and, eventually, move higher.


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