S&P 500: +3.93% DOW: +2.94% NASDAQ: +5.29% 10-YR Yield: 3.88%
What Happened?
U.S. stock indexes posted significant gains on Friday, marking their best week of 2024 after a severe decline earlier this month. For the week, the S&P 500 surged 3.9%, the Nasdaq gained 5.3%, and the Dow advanced 2.9%, marking the S&P 500’s strongest weekly performance since November 2023. Positive economic data, including stronger-than-expected retail sales and a drop in jobless claims, helped alleviate recession fears and drove the market rally. The S&P 500 is now just 2% below its mid-July record high.
Despite the overall positive trend, some areas showed weakness. The U.S. housing market struggled, with July housing starts falling to a four-year low. Globally, stock markets generally rose, with Hong Kong’s Hang Seng Index and Japan’s Nikkei 225 both seeing notable gains, while Mainland Chinese indexes remained under pressure. Corporate earnings reports continued to impress, with over 78% of S&P 500 companies beating expectations. Notably, technology stocks, including Nvidia, Apple, and Microsoft, saw significant weekly gains. Consumer sentiment improved more than anticipated, reflecting a stabilizing economic outlook. Underneath the surface, all sectors were in the green, with cyclical sectors like Technology (+7.7%), Consumer Discretionary (+5.0%) and Financials (+3.2%) leading the charge.
CPI slows to 2.9% in July, Lowest Since 2021
- The consumer price index, a broad-based measure of prices for goods and services, increased 0.2% for the month, putting the 12-month inflation rate at 2.9%, its lowest since March 2021.
- Excluding food and energy, core CPI came in at a 0.2% monthly rise and a 3.2% annual rate, meeting expectations.
The key takeaway – In July, U.S. inflation increased as anticipated, with the Consumer Price Index (CPI) rising 0.2% month-over-month and 2.9% year-over-year. Core CPI, excluding volatile food and energy prices, also rose 0.2% monthly and 3.2% annually. Housing costs were a major driver, contributing 90% of the inflation increase, while other areas like auto insurance saw significant gains. The data supports the likelihood of a Federal Reserve interest rate cut in September, although some inflationary pressures, especially in housing, remain persistent, complicating the economic outlook.
The inflation data signals a mixed economic landscape, with core inflation easing but still present in key areas like housing. The persistent inflation in certain categories, such as shelter, suggests the Fed may proceed cautiously with rate cuts. The likelihood of a September rate cut has increased, potentially easing borrowing costs and providing a boost to markets. However, the ongoing inflationary pressures may limit the extent of rate cuts, maintaining a level of uncertainty in financial markets. This balance between easing inflation and sticky price increases could lead to continued volatility in both equity and bond markets as investors navigate the Fed’s potential actions.
Recession Risks Fall As Retail Sales Rise And Jobless Claims Decline
- Initial jobless claims totaled a seasonally adjusted 233,000 for the week, a decline of 17,000 and lower than the Dow Jones estimate for 240,000.
- Stock market futures, which had been negative earlier, turned sharply positive after the release
The key takeaway – U.S. retail sales rose by 1%, signaling strong consumer spending and easing recession fears. This increase was driven primarily by a 3.6% surge in motor vehicle and parts sales, while retail sales excluding autos increased by 0.4%. Additionally, initial jobless claims decreased to 227,000, further highlighting the resilience of the labor market. These positive economic indicators reduce the urgency for a significant Federal Reserve rate cut in September, with a 0.25% cut now more likely than the previously speculated 0.5%. The solid growth data supports the possibility of a soft economic landing, despite lingering inflation concerns that remain above the Fed’s 2% target.
The combination of robust retail sales and a strong labor market diminishes the likelihood of an imminent recession, suggesting that the U.S. economy is holding steady despite challenges. This may influence the Fed to adopt a more measured approach to rate cuts, focusing on data-driven decisions rather than making aggressive policy changes. As a result, the market’s expectations for rate cuts have been tempered, with investors now anticipating more modest adjustments in response to ongoing economic strength.
Markets Are Way Out of Line With Reality, According to These Measures
- Key valuation measures like the CAPE ratio, forward PE ratio, and Fed Model indicate that U.S. large-cap stocks are significantly overpriced compared to historical averages and other asset classes. This suggests that recent market gains might not be sustainable.
- Historically, periods of high stock valuations, as indicated by these measures, tend to lead to weaker future returns, suggesting that investing heavily in major stocks now could result in lower long-term performance.
The key takeaway – The debate over investment strategies often contrasts long-term holding versus adjusting portfolios based on current valuations. While a buy-and-hold approach is common, especially given the underperformance of many fund managers, it’s crucial to consider valuation measures like the CAPE ratio (Cyclically Adjusted Price Earnings Measure), forward P/E ratio (Price-to-Earnings), and Fed Model. These indicators suggest that U.S. large-cap stocks are currently overpriced compared to historical norms and other asset classes. This raises concerns that the recent market rebound might be a false signal, making it wise to reconsider investing heavily in major stocks.
Historically, high valuations predicted weaker future returns. Although no single measure is perfect, the CAPE ratio and other tools indicate that current stock prices offer little margin of safety. The CAPE ratio, for example, shows the S&P 500 is highly expensive, while forward PE and the Fed Model also suggest overvaluation. These signals imply that current high prices could lead to lower future returns, advising caution for investors.
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