Pullbacks are the stubbed toe of the stock market. I was reminded of this over the last week as I contemplated the recent surge in volatility while picking up toys after our two-year-old finally fell asleep. As I carried a Tonka truck back to its usual parking spot next to the toy farm, I slammed my toe into the foot of the couch. The pain was acute, but not worthy of a full-blown panic. After a few deep breaths, the sting began to wear off and I assessed the damage to find a little redness, but nothing broken. Somewhere in this painful process, the parallels between my toe’s unfortunate encounter with the couch and the recent equity market sell-off became clear. For the market over the last week, the foot of the couch was embodied by overbought conditions — especially in big tech, waning confidence for a soft landing due to weak employment data and a contractionary Institute of Supply Management (ISM) manufacturing reading, and the rapid unwinding of the crowded yen carry trade.
Before the jobs report was released on Friday, we wrote a commentary on the U.S. dollar. In light of the events over the weekend and Monday, we start with some comments on the global stock market selloff.
The broad stock market benchmarks are down about 3% this morning as several factors have lined up to create conditions for a sharp global selloff. A batch of weak economic data, notably Friday’s jobs report, sparked concerns that the Federal Reserve (Fed) may have taken its higher-for-longer rate policy too far.
After such a strong rally since last fall, valuations, sentiment, and investor positioning had become stretched. What markets are experiencing today is an unwinding of that bullish positioning, which is particularly evident in the yen and the so-called carry trade. Japan’s Nikkei suffered its worst one-day decline since 1987.
Where do we go from here? We anticipated more volatility, as we discussed in the LPL Research Midyear Outlook 2024, based on the size of this year’s move, evidence of stretched positioning and elevated valuations. A capitulating Fed, timely evidence of a growing economy, and a test of the 200-day moving average on the S&P 500 are some factors to consider as we wait for the market’s bottoming process to play out.
For more of our thoughts on this global bout of volatility, please follow the LPL Research blog.
Investors had a healthy appetite for risk so far this year as a so-called potential soft landing has been factored in. We have an economy with rising wages, decelerating inflation, and a Federal Reserve (Fed) on the cusp of cutting rates. What more could you ask for? Of course, political uncertainty and headwinds from geopolitical risks could rain on that parade, and that’s why investors should exhibit discernment in a market like this.
The first half of the year was a challenging environment for a lot of fixed income markets, especially higher-quality markets. With the Federal Reserve (Fed) seemingly unlikely to lower interest rates until after the summer months (at the earliest), the “higher for longer” narrative has kept a lid on any sort of bond market rally. While falling interest rates help provide price appreciation in this higher-for-longer environment, fixed income investors are likely better served by focusing on income opportunities, which has been the traditional goal of fixed income investors. Investors can best navigate the late-cycle economic environment by adding high-quality bonds, offering attractive risk-adjusted returns, and lowering overall portfolio volatility. Consider moving away from cash, with the Fed likely to cut rates in the second half.
Outlook 2024: A Turning Point, released in December 2023, featured our perspective on how stocks might respond to turning points in inflation and monetary policy. That response was quite positive, as we now know, as easing inflation, anticipation of Federal Reserve (Fed) rate cuts, increasing chances of a soft landing for the U.S. economy, and artificial intelligence (AI) excitement combined to send stocks up double-digits over the first six months of 2024. Now past the halfway mark, a lot of good news is priced in, valuations are elevated, and monetary policy may not offer much opportunity for upside. If stocks are going to add to first-half gains in the second half, earnings must play a key role.
With stock valuations elevated after such a strong first half, earnings growth will be key to holding, or potentially building on these gains. LPL Research believes stocks have gotten a bit over their skis, but earnings season may not be the catalyst for a pullback in the near term given all signs point to another solid earnings season and stocks have mostly performed well during the peak weeks of reporting season in recent years. We may not get an increase in second-half estimates over the next couple of months — that's a lot to ask — but we should get a few points of upside and double-digit earnings growth for the second quarter on the back of technology strength.
With a Federal Reserve (Fed) meeting, a Bank of Japan (BOJ) meeting, two very important inflation reports, and nearly $120 billion of new Treasury securities auctioned — last week was quite the week for markets. And while the Fed meeting was supposed to get top billing, it turned out the inflation data stole the show. In fact, at least for the Treasury market, it’s been the economic data that has had the largest impact on changing bond prices/yields. But with economic data released daily, that has meant the volatility in the Treasury market has been dizzying lately. So, what should bond investors do during this period of heightened volatility? Keep calm and clip bond coupons.
Indian Prime Minister Narendra Modi’s recent victory in the national elections was muted at best. While he secured a rare third term in the nation’s highest office, his decisive legislative supermajority failed to materialize. Modi has made revitalizing the Indian economy and increasing foreign direct investment (FDI) a cornerstone of his pro-business platform. With markets adjusting to the unexpected outcome and new legislative circumstances, he and his party now pursue cementing the economic gains generated in his earlier terms, to ensure India continues making strides towards a modern capitalist economy that includes the wider populations and supports all Indians. Global markets will be monitoring the composition of the new cabinet and the introduction of the budget in July to ascertain that the Modi doctrine remains relevant, pro-business, and above all else, pro-India.
Indian Prime Minister Narendra Modi’s recent victory in the national elections was muted at best. While he secured a rare third term in the nation’s highest office, his decisive legislative supermajority failed to materialize. Modi has made revitalizing the Indian economy and increasing foreign direct investment (FDI) a cornerstone of his pro-business platform. With markets adjusting to the unexpected outcome and new legislative circumstances, he and his party now pursue cementing the economic gains generated in his earlier terms, to ensure India continues making strides towards a modern capitalist economy that includes the wider populations and supports all Indians. Global markets will be monitoring the composition of the new cabinet and the introduction of the budget in July to ascertain that the Modi doctrine remains relevant, pro-business, and above all else, pro-India.
The first quarter earnings season is largely in the books, and it was excellent. In fact, S&P 500 earnings per share (EPS) would have been up double digits in the quarter if not for a big loss Bristol Myers Squibb (BMY) absorbed in an acquisition. Even with that nearly three-point drag from the drugmaker, a nearly 7% increase in earnings — the biggest since the first quarter of 2022 — is impressive. Big tech strength was again the primary driver, and estimates impressively rose.
The post-pandemic economy is treating people very differently, creating a headache for central bankers. The extreme differences can often get traced back to living situations, as renters have a very different experience than homeowners. Since millions of homeowners refinanced mortgages to extremely low rates a few years ago, the economy is less sensitive to interest rate policy. In fact, the Jackson Hole Economic Policy Symposium sponsored by the Kansas City Federal Reserve in August will debate the effectiveness and transmission of monetary policy because of these post-COVID-19 dynamics, likely revealing important investment implications.
It continues to be a challenging environment for a lot of fixed income markets, especially higher quality markets. With the Federal Reserve (Fed) seemingly unlikely to lower interest rates until after the summer months (at the earliest), the “higher for longer” narrative has kept a lid on any sort of bond market rally. And while falling interest rates help provide price appreciation in this higher-for-longer environment, fixed income investors are likely better served by focusing on income opportunities. That’s where preferreds come in. With yields still elevated relative to history, we think preferred securities are an attractive option for income-oriented investors.
