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Wall Street has so far emerged from its summer hiatus with a confirmed commitment to stocks.
The S&P 500 has done enough to maintain its upward trajectory, with last week’s brief and modest pullback nearing the top of the May-July range but never breaking through, giving the index some excuse to pull back more fully while keeping the correction under the surface.
The stability in index levels reflects the full backing of stocks by professional investors, who appear undeterred by the ubiquitous warnings of weak seasonal patterns beyond the summer. Or perhaps we’re simply encouraged that incidents that occurred in September and October tend to clear up in the second half of the fourth quarter.
Measures of equity exposure and risk appetite from Goldman Sachs, State Street, the National Association of Active Investment Managers, and Bank of America agree that asset allocators are “stocking up” for the fall.
The Leuthold Group maintains its Courage/Fear Ratio, which has risen to its highest level in approximately 18 years. It tracks a portfolio of courage (small-cap stocks, emerging markets, commodities, cyclical S&P 500 sectors) and a fear basket (US dollar, gold, S&P low-volatility stocks, and 10-year Treasury bonds).
Venu Krishna, an equity strategist at Barclays, noted last week that the aggressiveness of retail investors has subsided somewhat. “Retail participation has weakened in recent weeks, suggesting that the recent wave of FOMO is being driven primarily by institutional investors rather than individual traders.”
This is consistent with the professional discipline of pursuing profit growth, and this is the single most powerful bullish factor, even though there is a very real risk that large companies will become “over-profits” as profits are brought forward by AI capital spending. The Cboe S&P 500 Volatility Index (VIX) below 15 (adequate, if not sustainably low) is telling some big money quantitative models to keep the risk tachometer locked in the red.
It is also true that some of the most important concerns have not materialized. Concerns that U.S. macro conditions are unstable and that a Fed rate hike could be a mistake were allayed by last week’s strong data, culminating in a strong jobs report.
And growing reasonable concerns about the pace and sustainability of the AI investment supercycle saw little concrete support throughout earnings season, as “spenders” revised capex forecasts upward and “vendors” raised guidance throughout last week’s Dell and Broadcom period.
Aren’t high yields all bad things?
Of course, both of these dynamics – solid economic growth and continued AI capital investment intentions – continue to drive key concerns and interest among investors. It’s an increase in bond yields.
The rise in the 10-year Treasury yield toward 4.8% is perhaps best viewed as a “normalizing shock,” with interest rates returning to their pre-GFC range and returning to their pre-2000 relationship with stocks (increasing yields are negatively correlated with stock prices).
As I noted here last week, absolute yield levels are perfectly consistent with a strong equity market. But this time, the 10-year Treasury yield has reached 4.7%, up from less than 1% six years ago, a departure from a similar level 25 years ago, when it reached a point on its way down from 8% in 1994.
The current yield of 4.7% means that most bonds issued in recent years have been trading below their issue price, making investors wary of bonds — just as bonds are once again beginning to provide adequate cushion through yield income.
“It’s becoming increasingly difficult for government bond returns to be completely negative over the medium term, so the news flow will continue to be negative, but at least bonds are moving back into bonds,” acknowledged Jim Reid, head of global macro thematic research at Deutsche Bank.
Bonds were still bonds in the 1990s, but last time yields and stocks moved almost in opposition over short periods of time.
Far from undermining the rationale for today’s stock/bond 60/40 portfolio, the 60/40 Vanguard Balanced Index Fund from March 1990 to March 2000 (the peak of the tech bubble) posted an annualized total return of 14.8%. That’s more than 69% of the annualized return achieved by the S&P 500 alone over that span.
Over the past decade, when bond prices were generally expected to offset stock declines, Vanguard Balanced Funds imposed higher opportunity costs and captured only 61% of the S&P’s return, largely because starting yields were much lower than they are now.
The situation for bonds on a transaction basis may deteriorate further in the future. With 10 days left until the next Fed meeting, the market’s odds of raising or keeping rates unchanged are uncomfortably close to 50-50, making this week’s inflation numbers a bit off the charts. Oil prices are rising again, Japan may be selling US Treasuries to protect the yen, and global fiscal imbalances are eroding, psychologically at least.
But starting with a higher yield can cushion sudden unexpected moves if things get a little rougher than a professional investor would expect from a fully invested stance.
market thermometer
around the street
– Although the terrorist attacks of September 11, 2001 struck the heart of America’s financial capital, their impact on markets was dwarfed by their human, geopolitical, and cultural toll. But they were just as important.
Following the longest New York Stock Exchange shutdown since the Great Depression, the S&P 500 index reflexively fell 11% during the week of September 17, shocking a market that had already fallen 28% over the past 18 months since the peak of the tech bubble.
After the first tough trading week, I wrote the cover story for Barron’s magazine’s September 24, 2001 issue, arguing that “Now is the time to buy stocks.” This piece was a matter of good timing, both luck and basic contrarian impulses. From there, the S&P rose 24% over the next 10 weeks, one of the most ferocious bear market gains in history.
The bottom line is that this rebound will likely extend the 2000-2003 bear market somewhat, avoiding a full accounting of the technology overinvestment, declining profitability, accounting scandals, etc. that would devastate stocks into late 2002, with stocks down 18% from their post-attack lows of September 21, 2001. I would like to argue that the market has bottomed out at a level below that of the Japanese market.
-For common sense information from the front lines of ETF adoption and smart portfolio construction, check out the research articles by Jeffrey Ptak of X Accounts and Morningstar Research.
There’s a spoilsport quality to his observations that I appreciate, and I’m skeptical of over-engineered fund structures and over-promises.
Here, Ptak quantifies the cumulative loss experienced by investors in the Defiance Daily Target 2x Long OKLO ETF (average invested dollars down 98.5% annually).
He is also credited with flagging the newly registered Defiance ETF, which is built to capture the value of private startups through a baroque derivative-of-derivatives mechanism. “The Adviser intends to allocate approximately 80% of the Fund’s portfolio to the Pre-IPO Leaders’ Sleeve primarily through swap agreements that reference perpetual futures contracts.”
market is closed
As mentioned above, no one is backing down from the onslaught of AI and capital investment, at least not from the companies involved. It is this way of representing AI trading that is evolving in ways that are difficult to predict.
Nvidia has outperformed the broader semiconductor group by 35 percentage points since June 30, after lagging pathetically for the previous 11 months. Software has recovered 70% of the “Thirspocalypse” sales that lasted from October to April.
Last week, with Nvidia acquiring AI model distribution and development platform Hugging Face and Meta Platforms gaining traction with its latest open source AI release, the tide briefly shifted toward AI consumption over AI construction proxies.
Indeed, memory stocks are showing early signs of breaking out of a months-long downtrend. And perhaps AI-powered industries that rely on multi-year backlogs are starting to look like they’re on the wane.
But the real reason the major indexes are so close to all-time highs is a resurgence in the prices of some of the biggest tech platforms.
The iShares Nasdaq Top 30 Stock ETF captures this well, outperforming the more limited Magnificent 7 Cluster.
“QTOP” includes Mag7, as well as the most relevant semiconductor companies and other leading non-tech AI companies. It reached a relative peak in May and June in the run-up to SpaceX’s IPO, but declined dramatically as momentum collapsed, advancing into earnings season.
It remains nearly 5% below its peak three months ago. Unless it starts making new highs relatively soon, this AI bull market locomotive could prove to be running out of steam.
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