Every year, I wonder why the stock market doesn’t close in August since so many traders go on vacation and the algorithmic program traders whipsaw the market up and down on light volume. Due to creating these air pockets, I expect this “down, up, down again” market action will persist until the trading volume is exhausted – or until more traders return after Labor Day.
The collapse in Treasury yields should force the Fed to cut a full 1% since the Fed funds rate is now 1.5% above the 10-year Treasury rate. If the Fed waits until September 18th, it will be too little, too late, since the Bank of Canada, the Bank of England and the European Central Bank (ECB) will have likely cut rates twice by then. With layoffs continuing to be announced, unemployment could be 5% or higher by October. Based on rising unemployment, declining PCE inflation and plunging Treasury yields, it is far beyond time for the Fed to act by cutting rates now, before their Jackson Hole meeting in late August.
Many pundits have blamed recent market volatility on domestic politics or economic statistics, but I think most of it traces to the Japanese carry trade, as magnified by program trading. That’s a situation where investors sell the Japanese yen to benefit from the U.S. dollar’s appreciation versus the yen, as the U.S. dollar yields far more than the near-zero interest rates in the yen. However, as U.S. recession fears mount, U.S. Treasury yields began to collapse and the Japanese carry trade became temporarily unwound, so the Nikkei 225 Tokyo stock index plunged 12.4% last Monday, only to resurge by 10.23% Tuesday.
Here are the most important market news items and what this news means:
- With over 90% of the stocks in the S&P 500 announcing their second-quarter earnings so far, earnings growth is averaging an impressive 10.9% and Nvidia will be the grand finale on August 28th.
- Despite a manufacturing sector that has struggled for the past 21 months, the service sector and booming energy exports continue to fuel U.S. GDP growth. The Atlanta Fed is now estimating 2.9% annual GDP growth for the third quarter.
- The Presidential election cycle is now in full force since Kamala Harris followed Donald Trump and promised “no taxes on tips.” Kamala Harris has not yet also promised no taxes on social security benefits like Donald Trump, but do not be surprised if she come up with more promises. As a result, the September 10th debate is shaping up to be a big deal, and consumer confidence is expected to rise as the Presidential candidates promise us everything and anything.
- There is mounting evidence that China’s economic woes are mounting. This is hurting Germany since China is its biggest export market for vehicles. Not surprisingly, the ZEW Indicator of Economic Sentiment, which tracks analysts’ economic expectations for the next six months, plunged to 19.2 in August, which is substantially below economists’ consensus estimate of 29. The current economic situation component in the ZEW index plunged and may have been influenced by severe flooding in recent months that has hindered many manufacturers of aluminum and specialty components for the automotive industry.
- At the Kansas City Fed’s annual conference in Jackson Hole next week, central bankers from around the world will meet and may signal that further key interest rates cuts will be forthcoming. Export nations like Germany are expected to benefit as key interest rates are cut, since it should stimulate demand. The most favorable outcome from the Jackson Hole meeting will be if central banks signal more key interest rate cuts to stimulate their respective economies. Naturally, it would also help if these central banks also signaled that inflation has been defeated.
- This week the big news will be inflation. The Labor Department announced on Tuesday that the Producer Price Index (PPI) rose 0.1% in July, which was below economists’ consensus estimate of 0.2%. Wholesale service costs declined 0.2% in July, which was a positive development since service costs had risen in previous months. However, wholesale goods prices rose 0.6% in July, due largely to an increase in gasoline prices. The PPI report was very positive and indicative that inflation continues to cool.
- The CPI is also expected to be favorable, but all eyes will be on shelter costs, namely owners’ equivalent rent. Fortunately, home prices are now being cut at the fastest pace in the past two years, especially in popular regions like the Sunbelt, so owners’ equivalent rent may continue to soften.
- There is one major inflation glitch, namely energy prices. The fear in energy markets is that Russia’s crude oil exports will continue to decline and that Ukraine may hit Russia’s Arctic pipeline, which would be devastating and potentially send crude oil prices to $100 per barrel. Ukraine is making advances against Russia and actually crossed into Russian territory in Kursk as well as several other villages and severely disrupted Russian supply lines. Additionally, Ukraine blew up a Russian natural gas rig in the Black Sea, west of Crimea that was reported to hold 40 Russian military personnel. Reportedly, this natural gas rig was packed with “reconnaissance equipment.” Russia also set Ukraine’s Zaporizhzhia nuclear power plant on fire with black smoke pouring out of one of the two cooling towers, but so far there have not been reported elevated radiation levels.
Overall, we remain in the dog days of summer, where trading volume is expected to remain weak. I have noticed that small capitalization stocks continue to meander higher, which is a positive development as the stock market’s breadth and power improve. The fact that Eli Lilly (LLY) has emerged as the new market leader as it blew by Novo Nordisk (NVO) to become the new leader in weight loss drugs, helps to reduce the stock market’s obsession with the Magnificent 7.
