The S&P 500 and Dow Jones ran to new all-time highs in September, while the NASDAQ failed to regain its high. This was propelled by the news that the US Federal Reserve cut rates by 50 bps. Even though the market is at or near all-time highs, our leaders of the Mega Caps and Semis have faltered. Both have previously been bad signs for the future performance of the market.

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Topics

Leaders not Leading

Review of 2021/2022

Federal Reserve 50 bps cut

US Elections

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Leaders not Leading

The S&P 500 did push higher but this was mostly led by more defensive sectors such as Utilities, Gold, Financials, Real Estate, and Fixed Income. For the past 2 years, the sectors that have led this run were the Magnificent 7 and Semiconductors, and now are showing relative weakness vs. the markets. This change is typical of “late-cycle” investing as investors try to become more defensive and pivot away from growth areas. This comes from fears of slower economic growth or a potential upcoming recession.

This rotation is usually not a good indication of things to come as investors get protective but generally does happen in an interest-cutting cycle where these companies will benefit. Given the current market positioning, it is easy to see the relative attractiveness of lower rates and the effects of a defensive company's earnings going forward. This should not mean the Magnificent 7 will fall apart, but they have past peak earnings growth and will benefit less when interest rates decline. The chart displays this paradigm well, where the combination of the Top 5 companies will see less rapid earnings growth going forward that will be more in line with the S&P 500.

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This does not mean they are not great companies and great holdings, but only they may not deserve a far superior valuation vs. the market. The S&P 500 currently is around 20x Forward PE, considering the Magnificent 7 (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) are trading at 33x-34x Forward PE, it is likely that there is some mean reversion in these names.

Review of 2021/2022

With the leaders underperforming the setup is looking a lot similar to 2021/2022. At the end of 2021, the NASDAQ (purple) Composite peaked on November 19th, 2021, whereas the S&P 500 (green) peaked later that year on December 31st, 2024. While the NASDAQ did move up it failed to regain its all-time high. Showing growth leadership was lost towards the end of 2021.

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What followed in 2022, was a long run downwards for 2022 when growth fears plagued the market, with a sharp rise in inflation and interest rates. While this happened, the US did not experience an economic recession but did have economic weakness with GDP coming in at 1.9%. This was a “soft landing” with positive growth but weak, the S&P 500 returned -18% in 2022.

Fast forward to today, and the setup is eerily similar. The NASDAQ (purple) reached an all-time high on July 10th, 2024, but the S&P 500 (green) is at new all-time highs leaving the NASDAQ behind. This may show that growth leadership has once again been lost. 

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2021/2022 has shown us you do not need an economic recession to bring the markets down almost 20%. If there is an expectation of slower growth and higher unemployment, that might be all that is required.

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Federal Reserve 50 bps cut

The stock market reacted very positively after the 50 bps cut in September, to aid the slowing US economy. In the past, this has not been a good sign of the future. This has been a race to get ahead of something rather than a green light to invest. 

50 bps cuts are not the norm and have only happened 3 times in recent history which were 2001, 2007, and 2020. Each time, the market has initially rallied higher, but each has preceded a recession, this has just been a signal that the Federal Reserve is trying to get ahead of a problem. This differs from the years the Federal Reserve started with 25 bps 1990, 1995, 1998, and 2019. In each of those years, the market declined for a short period before rising to new highs and there was no recession. 

This time could be different, but history is not on the market’s side. Most times what people do is more important than what they say. While they are telling us everything is ok, they are not acting like everything is ok. 

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US Elections

In November, the US will head into appointing its next president. The months leading into elections are normally the worst performing months of the year in election year due to the uncertainty around the recession and this usually comes after a rally in the summer months. We would never try and predict a winner, and you could make marginal arguments on either side of who would be good for each sector or company. In the past, the best-case scenarios for markets have been either a full Republican Sweep or a Democratic President with a split or Republican Congress.

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Our vote is for markets to go higher; therefore we would back a Democrat for President and Republican Senators.

In election years the worst performing month of the year is October with a rally in November and December after the election. This is due to the uncertainty going into the election and certainty and optimism after the election. This is the general playbook for election year investing, with the only exception being the years when the US is headed into a recession.

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In 2000 and 2008, the certainty of the new US President did not stabilize markets. While there is no certainty that the US will enter a recession there is a higher possibility of it than in the past election years.

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Summary

The loss in growth company leadership and 50 bps cut has historically led to short-term rallies in the S&P 500 but ultimately has led to larger declines in the S&P 500. Also, the rotation to more defensive areas is typical of “late-cycle” investing. October of an election year is typically the worst month for markets because of the uncertainty of who the US President will be. In the last 40 years, the market has rallied after the election with two exceptions, 2008 and 2000, both recession years.

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Justin, Konrad, and Merriel