August 26, 2024 | Pain Trade During a Period of Illiquidity

MARKETS

S&P 500: Down -30 points to 5604, VIX: 16.50

Asia: Japan -0.66%, China +0.04%, Hong Kong +1.06%

Europe: Euro Stoxx 50 -0.22%, FTSE +0.48%, DAX -0.03%

FX: USD (DXY) up 0.13%, EUR down 0.22%, GBP down 0.18%, JPY down 0.07%, CNY down 0.01%

Energy: WTI Crude up 3.22% to $77.24, Brent up 2.78% to $81.21

Cross markets: Terminal rate unch at 5.33, Implied rate cuts 2-years from terminal unch at 228bp, 5/10 yield spread +16bp

Treasuries: 2-year yields unch at 3.917%, 10-year yields up ~1bp at 3.805%, 30-year yields up ~1bp at 4.100%

WHAT WE'RE THINKING

Snapshot: US equities are mixed and off best levels after the S&P 500 (SPX) finished last week just ~60bp below the all-time high.  Market breadth improves this morning with the equal-weight S&P 500 outperforming the cap weighted SPX. Tech is weakest ahead of a busy week of earnings that includes ADSK, CRM, CRWD, DELL, HPQ, MRVL, NTAP and NVDA. The underperformance in Tech is partly a function of Powell’s address on Friday (promotes rotation into cyclical sectors and small cap stocks) and a disappointing PDD earnings report. Utilities and Energy are the top performing sectors with Financials, Transports and pockets of Consumer Discretionary also outperforming.  Treasury yields are little changed with a bit of curve steepening.  The Dollar Index is a touch higher in a countertrend move following a three-week decline. Gold is little changed while WTI crude rallies nearly +3% on the latest flare-up in Middle East tensions and Libya production headlines.

• It’s a quiet start to a busy week of earnings with NVDA as the most important report on Wednesday, while July PCE on Friday will be the macro highlight. Consensus is looking for core PCE to be up +0.2% MoM, which would push the YoY rate up 0.1% to 2.7%. 
• In addition to NVDA on Wednesday afternoon, DELL and AGVO earnings/guidance due Thursday afternoon will also have implications for the AI outlook. 
• The August Jobs Report on Friday 9/6 will be the most critical input for monetary policy after Powell on Friday said the committee doesn’t ‘seek or welcome further cooling in labor market conditions.’  
• Today’s macro data is focused on July headline durable goods orders that came in well ahead of estimates.  The August Dallas Fed manufacturing Index also came in stronger but remained in contraction territory.  
• Over the weekend, Philadelphia Fed President Harker said he’s penciling in 50-75bp of rate cuts this year. This morning, Richmond Fed President Barkin told reporters the committee may take a ‘test and learn’ approach to rate cuts.  SF Fed President Daly speaks later today.  
• As noted above, PDD is the only earnings report this morning with shares under pressure after sales missed and the company warned of competition/external challenges.

Pain trade: The Fed’s concern is focused on labor market conditions and is nearly one-sided. The debate over a 25bp or 50bp September rate cut could make markets choppy, but we see the pain trade skewed to the upside for the next three weeks. The record compression in realized equity volatility (VIX) from 8/6-8/13 makes Vol Targeting strategies incremental buyers while the corporate buyback window remains wide open through 9/13. Buyback demand was the largest of the year last week according to two sell-side trading desks, while Powell’s comments on Friday could be a green light for systematic funds to add leverage during a period of illiquidity (summer holiday). Note that mid-September usually kicks off a period of seasonal weakness for US equity markets.

Cyclical recovery? Last week’s stronger-than-expected consumer facing earnings reports, services PMI and weekly jobless claims support the resilient growth narrative, while Powell’s presentation at Jackson Hole confirmed that September will begin the easing cycle.  The combination caused a mini short squeeze in cyclical baskets and the Russell 2000 (RTY).  The RTY catch up trade remains the most compelling alpha generating opportunity in US equity markets with as much as 40 percentage points on the table.  In late July, we warned readers that upside in the RTY without confirmation from cyclical cross markets like copper prices was unsustainable.  Copper prices and the gold/copper ratio remain key to the outlook for RTY outperformance.     

Fed: The focus should be on real yields (nominal yields – inflation expectations), which remain at elevated levels that are roughly in-line with levels from last summer.  A current 2-year real yield of ~225bp is extreme monetary tightening and the Fed funds rate of 5.30 is at least 200bp above the Taylor Rule implied neutral rate.  Note the NY Fed used two other measures to imply a neutral rate (unidentifiable in real time) of ~2.5%. With this in mind, many economists are now beginning to adjust their forecast to include 125bp of rate cuts this year and a cadence of 25bp cuts at each meeting into next summer.   

Chartist: Technical resistance for the SPX sits in the 5650-5745 range. A break below 5455 would signal a change in trend and make us short-term ‘tactically bearish’ for the third time this year.  Next level support sits at ~5325 and then ~5130.  Longer-term support sits at the ~4800 level that marked the top from late 2021. 

FACT OF THE DAY

On most maps, the Mercator projection – first developed in 1569 to display accurate compass bearings for sea travel – is still used. This method is wildly inaccurate and makes Alaska appear as large as Brazil and Greenland 14 times larger than it is. 

JSC IN THE MEDIA

Fed more likely to cut 25bps: Andrew joins ‘Fast Money’ to talk signs of economic slowing, what to expect from the FOMC moving forward, and more. Watch on CNBC

Small caps could be in for a revival: Small and mid-cap stocks usually outperform during a cyclical recovery, that may come into view once the Fed begins its easing cycle.  However, not all factors point to an imminent cyclical recovery.  Andrew discusses what is missing and what to look for. Read More on CNBC

Fox Business News: Andrew joins Charles Payne on Making Money to discuss risks to the soft landing scenario and factors necessary to sustain the current bull market. Watch Video

See more of JSC in the Media.

THIS DAY IN HISTORY

August 26, 1895: The first electric generator at Niagara Falls began producing power in 1895. The plant, built by Nikola Tesla and George Westinghouse, was the first large-scale hydroelectric power plant in the world. The generators were 5,000 horsepower, two-phase, four-wire, and ran at 25 Hz. The plant generated direct current electricity and provided it to a range of two miles from the plant.

CATALYST CALENDAR

Tomorrow: 1) Conference Board confidence survey for August; 2) Richmond Fed manufacturing index for August; 3) Dallas Fed services index for August; 4) Australia’s services CPI for July; 5) Earnings before the open: HAIN, SCSC; 6) Earnings after the close: AMWD, BOX, JWN, PVH, S, SMTC

Wednesday: 1) Eurozone M3 money supply for July; 2) Earnings before the open: ANF, BBWI, CHWY, DCI, FL, KSS, SJM; 3) Earnings after the close: AFRM, APLD, COO, CRM, CRWD, FIVE, GEF, GES, HPQ, NTAP, NTNX, NVDA, OKTA, PAHC, PSTG, VEEV, VSCO

Thursday: 1) Eurozone auto registrations for July; 2) Germany’s regional CPIs for August; 3) US Q2 GDP/PCE revisions; 4) US weekly jobless claims; 5) US pending home sales for July; 6) South Korea’s industrial production for July; 7) Japan’s Tokyo CPI for August; 8) Japan’s retail sales/industrial production for July; 9) Earnings before the open: AEO, BBY, BF’b, BURL, CPB, DG, GMS, OLLI, PLAB; 10) Earnings after the close: ADSK, DELL, GPS, LULU, MDB, MRVL, ULTA

Friday: 1) US personal income/spending for July; 2) US PCE for July; 3) Germany’s unemployment for August; 4) Eurozone CPI for August; 5) India’s Q2 GDP; 6) Chicago PMI for August; 7) Michigan confidence survey for August; 8) China’s NBS PMIs for August

Jackson Square Capital produces Inside Markets. We also offer financial planning and investment management services. Learn more here and catch up on our recent media appearances.

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This material is intended for informational purposes only. It should not be construed as legal or tax advice and is not intended to replace the advice of a qualified attorney or tax advisor.