For those of you who would prefer to listen:
The Fed cut interest rates for the first time this year. No surprise, it was a virtual certainty heading into the meeting. This was the first rate cut in 9 months, after an extended period of pause to gauge the impacts of tariffs and overall inflation. Fed Chair Powell called it a “risk-management cut”. It’s not a catchy phrase. But it speaks to the indecisiveness at the central bank. Debate is natural. It’s healthy, when used with respect.
There is no recession in sight. That’s a really good thing. Ever since the yield curve inverted years ago, economists universally called for a pending recession. It never came. Sure, there have been areas that have slowed. Some of those areas are still sluggish. But there’s also some serious strength in America’s Economy. Tech is the obvious area, as the AI trade dominates activity. The Stock Market is that reflection.
The American Consumer keeps proving its resiliency. Retail sales grew faster than expected in August. The spending was pretty broad, as restaurants, car dealers and clothing stores saw a meaningful bump. Consumer spending accounts for roughly 70% of America’s economic activity. It’s showing few signs of slowing. The Atlanta Fed raised its estimate for Q3 GDP to 3.4% growth. That’s an annualized rate. It was previously predicting 3.1% growth. That would also be an increase from the 3.3% growth in Q2. You can see that’s going in the right direction.
The Economy keeps growing. That’s a really good thing. But the areas of weakness keep getting worse. The Job Market has cooled. Layoffs have picked up, keeping the unemployment rate elevated from the previous multi-decade lows. The bigger issue is the fact that companies have stopped hiring. There seems to be a general freeze on new job creations as Corporate America navigates through the potholes of inflation, tariffs and of course the anticipated yet unknown impact of AI. With so much uncertainty ahead, it’s only natural for companies to pause.
Housing is the other weak spot. Homebuilder Lennar reported its fourth consecutive quarter of earnings declines. The company keeps offering incentives with hopes to stimulate buyers. The big problem is housing affordability. Mortgage rates have come down a bit from that 7% level. But 6.5% interest rates on a 30-year loan is far from cheap. On top of that cost is materials and labor that keep new housing prices elevated. New housing starts fell 8.5% in August, hitting the lowest level since early on in Covid. Both Jobs and Housing are critical to America’s Economy. A home is by far the largest asset that most Americans own, if they own. And Housing is getting worse, not better.
Another way to view the strength in retail sales: High-end consumer. The Top 10% of American consumers account for half of total spending. That’s not a typo. The Average American has been struggling with high prices. A recent Bank of America analysis, based on its 70 Million customers, indicated that high income consumers keep spending at similar rates from previous months while those with a lower income have slowed. The Stock Market is often an influence on high-end spending while jobs and wages drive lower income earners.
The Fed has an important job to do. Even they don’t all agree on what to do within. The mandate is maximum employment and stable prices. Employment has cooled but prices have not. The Fed’s tools can’t do two things at once. Monetary policy is not on a preset path. The Market is pricing in 2 more cuts before January. The Fed isn’t guiding to that yet. This from one of our Wall Street sources:
“While the median dot shifted up to show three cuts in 2025, there is still a pretty wide split. Indeed, nine officials saw two cuts or less (one saw a hike) for the rest of the year. Powell made a very revealing admission: “We have two-sided risks which means there is no risk-free path.” I think this means that the next two meetings should be priced closer to a coin flip for rate cuts. Put differently, three cuts this year are far from guaranteed. This isn’t like last year when we were sort of locked in for 100bps. It’s probably one reason why yields backed up during the press conference. Lastly, looking at the economic projections, the median doesn’t look especially worried about the labor Market or inflation. If today’s move was primarily about risk management, I think there is a risk the Fed can fall behind on their employment mandate later.”
The yield curve has definitely steepened of late. The front end of the curve has fallen. That is influenced by the Fed. But the back-end has remained relatively firm. Interestingly and perhaps telling, both the 2-Year and the 10-year Treasury yields rose on the day the Fed cut. That is an indication that the Fed cut was already priced in, and inflationary pressures are still present. Importantly, the Bond Market is in good shape; Credit spreads remain tight. There is very little evidence of stress in the system. That’s beyond key. The Bond Market is usually the first to sniff out trouble. What’s more, lower rates and a steeper yield curve are generally fuel for the Stock Market. That’s what we’ve got and the rally to all-time highs reflects it. The rally will keep on keeping on… until it doesn’t. We’re all over it.
Friday was option expiration day for September contracts. Being a Quad Witch, it was one of the largest of the year. That happens when all 4 types of options contracts expire simultaneously. An estimated $3.5 Trillion tied to the S&P 500 alone either got rolled or expired. That helps explain the rapid price action in the final hour of trading. Interestingly, the week that follows often carries more significance. With the monthly options done, the following week tends to give birth to new trends. In fact, during the first half of the year, nearly every major change in trend came within days of an option expiration. We certainly saw it around the first Quad Witch in March which came right before Obliteration Day in April.
Volatility could be on the rise. We would not be surprised to see more aggressive price action next week. We remain quite Bullish for the months ahead. We do see further gains ahead. The broadening out of participation has certainly been a welcome sign. But the next couple of weeks could be challenging. The relentless rally is showing some signs of fatigue. The Market is due for a breather. Investor complacency has been creeping back in as every dip gets bought. Bullish sentiment just cleared 40% again this week. It’s back at the highs on the year which has previously preceded some selling pressure. Investor Sentiment has proven to be an effective contrarian indicator, although it’s far more timely around lows than highs. The reason? In investing, fear is a stronger sensation than greed. It’s emotional. It’s human. It’s natural.
The Market is like a natural organism. It represents the wisdom of crowds. It’s the truest representation of fair price. Matching buyers and sellers based on supply and demand determines fair value. Something good and scarce will bring a higher price. Some average and abundant will bring the opposite. The Market reflects those human emotions. It’s been the case since the beginning. The Market triggers competition. There are winners and losers. Humans get fearful. Humans get greedy. Some humans even try to cheat. For better and for worse, that’s as natural as natural gets.
The world lost a generational talent this week. Robert Redford died at 89. Known for so many things, Redford attracted eyes on the big screen. Woodward, Gatsby, Sundance and Hobbs. He was an electric horseman. He was in the Sting. Robert Redford created a film festival. A river ran through it. Redford looked good. He acted good. He directed good. He done good.
As a baseball fan, my favorite Redford movie was the Natural. A kid from the Midwest who carved a bat with his dad from a tree that was struck by lightning. He called it “Wonder Boy”. He was an instant star, but his career got sidetracked, only to start over at an advanced age and prove to everyone that talent is talent, but patience and persistence matter too. It’s a good story. That dude could hit. Of course it’s fiction. But fiction can help fuel reality, both for bad and for good. I like the good. We need to tell more stories about the good. That helps spread more good. It’s authentically natural.
I’m going to watch the Natural again over the weekend. I bet one of you might too. Comeback stories are awesome. I dig the underdog.
I look forward to hearing the line: “There goes Roy Hobbs. The best there ever was”. He was a Natural.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
