September 5, 2024
Good morning,
It seems counterintuitive for long-term (quarters/years) investors to concern themselves with micro (hours/days) moves in the market. I believe long-term investor success is dependent on portfolios being aligned with long-term market trends. Long-term trends (the simplest examples being bull and bear markets) are all born as short-term trends. The art of investing is identifying the short-term trends that will last. That requires constant vigilance of the market micro moves and filtering out all the daily “noise” for long-term trend shifts. Typically, changes in long-term trends occur around periods of heightened volatility. For the second time in as many months, the VIX (volatility index) closed above 20 yesterday – a threshold level used to define a period of high volatility.
As mentioned on Tuesday, the next few months may be critical to markets. Let’s zoom-out to the long-term market picture for perspective. Recession fears have been at the forefront of investors’ minds for nearly three years. The debate started when Jerome Powell declared that the Fed was willing to push the U.S. economy into recession to keep inflation expectations anchored. Concerns ebbed and flowed, but the most aggressive tightening cycle in four decades, the longest yield curve inversion on record, two years of contraction in the Leading Economic Indicators, and more recently, a bearish signal from the Sahm Rule have kept recession fears front and center.
For equities, the questions of if and when a recession is coming are paramount. The “if” matters since the worst bear markets have been associated with recessions, with an average decline of 35%. The challenge, of course, is the “when.” Economists do not have a great track record of identifying recessions beforehand. An unofficial arbiter, the National Bureau of Economic Research, famously waits for months or even years before announcing that a recession has started or ended. Since the stock market leads the economy, waiting for an official declaration is far too late.
Forward-looking economic indicators that may provide clues of a recession earlier than traditional sources are still signaling a low risk of a recession in the next 2-3 months. And while the S&P 500 Index usually peaks 6-months before the start of a recession, the worst damage to SPX has not started until two months beforehand (Bloomberg). Note: the most recent S&P 500 Index high was in July.
Let’s go back to market Tops and how they develop. Volatility rises, and the recovery moves following a series of pullbacks with increasing frequency fail to make new highs and instead make lower lows on each pullback. This process may take months to complete.
At the beginning of this year, calling for a recession at year-end or early 2025 seemed blasphemous. Today, evidence is mounting, and that call is a lot less unbelievable. The current micro market debate is soft vs hard landing – history suggests that the Fed has often failed to stick the landing.
The equity market is still within 3% of its July high. It does not seem to be valued for even a soft year-end landing, let alone a hard one. We will begin to get defensive as/if the indicators change (you can tell that I expect them too). And I am wary of adding money to equities at this time.
Be well,
Mike
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