HIGHLIGHTS

• The Growth Scare Is Here (What It Means for Markets)
• Weekly Market Preview: How Far Can This Pullback Go?
• Weekly Economic Cheat Sheet: Important Growth Report Today
• What the Fed Decision Means

The week of August 5, 2024, begins with a major global market sell-off following the Bank of Japan’s decision to tighten monetary policy for the first time in three decades. As investors brace for the volatility tsunami impacting a cross-section of risky assets (stocks, credit, commodities), greater uneasiness and a slowing U.S. economy could be enough to prompt the Federal Reserve to adopt a more aggressive schedule for cutting interest rates and loosening monetary policy. As such, we as investors may be given a narrow window to add on market risk if financial contagion does not spread or does the global economy fall into recession.

The interconnectedness of global financial markets means that Japan’s financial turmoil could have ripple effects worldwide and exacerbate tightening financial conditions that would impact the funding sources of risk-on position-taking. The sell-off is not only impacting global equities, particularly markets with high-yielding currencies funded in the so-called carry trade. A carry trade is a trading strategy that involves borrowing at a low interest rate and investing in an asset that provides a higher rate of return. A carry trade is typically based on borrowing in a low-interest rate currency and converting the borrowed amount into another currency such as Australia, New Zealand, and Latin America, but also corporate credit risk and commodities.

Despite the recent pullback and selling pressures, the analyst community remains sanguine over earnings prospects, not just for U.S. companies, but for global markets as well. Earnings are expected to grow over the next two years for the major markets (U.S., Japan, Europe, and Emerging Markets) even if that growth trajectory starts to slow down. Near-term liquidity-driven selling could eventually give way to long-term earnings growth reality.

STOCKS

SOURCE: Factset and Vann Equity Management Research Team

“The S&P 500 fell sharply last week thanks to disappointing economic data as the economic growth scare finally arrived and pushed the S&P 500 to multi-week lows.”

• What is Outperforming: Defensive sector, minimum volatility, and sectors linked to higher rates have relatively outperformed recently as markets have become more volatile.
• What is Underperforming: Tech/growth and high valuation stocks have lagged as yields have risen.

Market Recap

Domestic stocks attempted to stabilize into the middle of last week as tech earnings suggested AI-driven growth prospects were still intact; however, bad economic data Thursday and Friday led to a resurgence in recession concerns that saw the S&P 500 roll over to end the week down 2.06%. The index is now up 12.09% YTD.

The Growth Scare is Here

The growth scare that our investment team has been worried about finally appeared last week courtesy of the soft ISM Manufacturing PMI and jobs report and the result was a sharp drop in the S&P 500 and a collapse in Treasury yields (to nearly six-month lows). Additionally, on Friday we heard countless mentions across the financial media of recession risks and possibilities.

However, it is important to push back on the emotional anxiety that naturally occurs when stocks drop and the financial media screams trouble. Here is the reality from last week’s data: First, for anyone paying attention (as we all have been) last week’s data was not a surprise. There have been signs of a loss of economic momentum in various data points for months via economic reports and corporate commentary.

Second, last week’s data really was not that bad in aggregate. Yes, the ISM Manufacturing PMI was ugly, but it has been weak for months and was not that much worse than before. Jobless claims and the jobs report, meanwhile, were worse than expected but on an absolute basis, 249k jobless claims is still very low and while July only added 114k jobs, the three-and six-month averages are still very healthy in the high-100k range.

Third, and most importantly, last week’s declines are more about the complacency we and others have warned about, not about a sudden, serious deterioration in the data. Two weeks ago, the S&P 500 was trading near 5,600 on a 2024 EPS of $245ish and 2025 EPS of $270ish. That is a 22.8X multiple and a 20.8X multiple, respectively. Those are multiples for perfect environments, i.e., solid (and not slowing growth), explosive earnings growth, and no existential risks (geopolitics, etc.). That is not the environment the market has been in for months and last week the data was bad enough to make the market finally admit it and that is why stocks dropped hard, not because the actual fundamentals turned materially worse (they just were not as good as hoped for and investors finally had to admit it Friday).

Our investment team can confidently say this: If the data were as worrisome as the market implied on Friday, nothing would have been up last week; but plenty in the market was in energy and utilities. If the data were screaming recession, those sectors would not be positive, they would just be down a lot less than everything else.

Bottom line: The growth scare is here. We are reducing volatility in our equity portfolios via defensive sectors and lower volatile names because we doubt it is over yet. Last week’s data just told us, unequivocally, that growth is slowing, and the market finally had to listen. That does not mean a contraction or recession is imminent and as such we do not think de-risking via raising cash is appropriate unless you are sure you can get back in appropriately, because the outlook for this market has not significantly changed as much as the price action implies.

Economic Data (What You Need to Know in Plain English)

Economic data was almost universally disappointing last week, and two of the three major monthly economic reports pointed to an economy now losing momentum and those weak readings spiked economic growth concerns and sent stocks lower and Treasuries higher. The big report last week was on July jobs, and it was the weakest report in a long time. Job adds were 114k, far below the 170k estimate and the lowest number in several years. The unemployment rate, meanwhile, rose to 4.3%, above the 4.1% expectation and the highest reading since October 2021. Perhaps most disconcertingly, the U-6 under-employment rate rose to 7.8% from 7.4%, the highest level in several years.

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