The Week in Charts (8/5/24)
View the video of this post here.
Over the last 30 years, the purchasing power of the US consumer dollar has been cut in half due to inflation. At the same time, the S&P 500 has gained 960% (8% per year) after adjusting for inflation.
With US National Debt hitting another record high of $35 trillion and expected to continue to rise, the odds favor more inflation to come which will mean further declines in purchasing power.
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Why you need to invest, in one chart…
The most important charts and themes in markets and investing…
1) Is This Time Different?
The US Unemployment Rate moved up to 4.3% in July, its highest level since October 2021.
While that’s still well below the historical average of 5.7%, it’s now 0.9% above the cycle low from April 2023 (3.4%). Historically, a recession has started on average 3 months before that 0.9% move higher in the Unemployment Rate.
Which brings us to the key question for investors and the Fed: are we entering a recession today or is this time different?
2) The Biggest Correction of the Year
US stocks were certainly not pricing in any recessionary scenario in mid-July with valuations soaring to their highest levels since 2000 and the S&P 500 Index up 20% on the year.
But a lot has changed in a few short weeks. From peak to trough, the S&P 500 declined 9.7% from its July all-time high to its low today, marking the biggest correction of the year.
Such a decline, of course, is entirely normal. Volatility is a feature of equity markets, not a bug, and without it they would offer no higher reward than sitting in cash.
The price of admission for receiving the S&P 500’s long-term total return of 10% is suffering through many drawdowns along the way. The current 8.5% drawdown on a closing basis is just the latest in a never-ending series of tests, and it’s actually a mild one at that. The median intra-year drawdown since 1928 is -13%.
3) Embracing Panic
Speaking of tests, Japanese investors received a huge one today with the Nikkei 225 falling 12.4%. That was the 2nd largest decline in history, trailing only the 14.9% fall during the October 1987 crash. What happened in the year after the 1987 crash? The Nikkei 225 rose 26.5%. Those who embraced panic were rewarded. The same was true a year following the GFC declines in October 2008 and earthquake/tsunami decline in March 2011.
The Nikkei’s 2-day decline of -17.5% was the biggest in its history, surpassing even the 1987 crash.
That was enough to push the index into negative territory on the year, erasing the 26% gain it had just a few weeks ago. There was a lot of bullishness surrounding Japanese equities back then and a lot of bearishness today. Crashes have a way of changing the narrative in an instant.
4) Volatility Returns With a Vengeance
The narrative for most of this year was about the incredibly smooth ride higher in US equities with volatility nowhere in sight.
But that narrative is officially over with the $VIX spiking 65% today to close at 38.57. That was the 2nd largest one-day increase in the Volatility Index ever, and the highest $VIX close since October 2020.
The $VIX went as high as 65.73 in the morning panic, a level we haven’t seen since March 2020.
5) An Emergency Rate Cut?
As we saw back in March 2020, expectations for Fed policy moves can change in a hurry when markets are in turmoil.
After the FOMC meeting last Wednesday, the markets were comfortably pricing in a 25 bps rate cut in September. After the weak employment report last Friday, the odds shifted to a higher probability of a 50 bps cut. And when the $VIX went vertical this morning, the market was not only fully pricing in a 50 bps rate cut but also a slight chance of a 75 bps cut.
An animated Jeremy Siegel went on CNBC to argue the Fed shouldn’t wait that long, calling for an emergency rate cut of 75 bps right now. After that, he believes they should do another 75 bps cut at the September meeting.
There will be many strong opinions in the coming weeks over what the Fed should or shouldn’t do, but those hoping for aggressive easing here should be careful what they wish for. If that easing comes because the Fed is fearing an oncoming recession (as was the case in September 2007 and January 2001), it may not prove to be the panacea they believe it to be (see video discussion here).
6) Bonds Are Acting Like a Hedge Again
Stocks have been falling, and so have interest rates.
Which makes this correction very different than the ones we’ve been experiencing over the past three years when the biggest fears were over inflation and rising interest rates.
In the past week, those fears have clearly shifted to the economy and the possibility of an upcoming recession.
And with the Fed expected to cut interest rates over 100 bps by year-end, yields have fallen sharply across the curve. The 10-Year Treasury yield ended last week at 3.80%, down from 4.71% in April and below where it entered the year (3.88%). The 2-Year Treasury yield moved down to 3.88%, its lowest level since May 2023.
This move lower in rates has helped push US bonds up 2% since July 16 while the S&P 500 is down over 8% and the Nasdaq 100 is down over 12%.
The Aggregate Bond ETF ($AGG) is now up 7.7% in the past year, outperforming Treasury Bills ($BIL +5.4%).
7) Another Ignominious Debt Milestone
It’s official.
The US National Debt has crossed above $35 trillion for the first time, $13 trillion higher than where it stood just 5 years ago (a 59% increase).
Where will it go from here?
Likely much, much higher. There seems to be no political will to put a meaningful dent in the massive deficits we’ve been running, year after year. And this has been occurring with an economy still in expansion. One can only imagine what will happen to the National Debt during the next recession.
8) Q2 Earnings Update
With 58% of companies reported, S&P 500 Operating EPS are up 3% year-over-year, the slowest growth rate since Q4 2022.
A summary of last week’s Magnificent Seven results:
- Microsoft’s ($MSFT) revenues increased 15% over the last year to a new record high of $64.7 billion. Net income grew 10% YoY to $22 billion (2nd highest quarter ever).
- Meta’s ($META) revenues increased 22% over the last year to a new 2nd quarter high of $39 billion. Net income increased 73% YoY to a new 2nd quarter high of $13.5 billion. Operating margins increased to 38% from 29% a year ago.
- Amazon’s ($AMZN) revenues increased 10% over the last year to a new 2nd quarter record of $148 billion. Net Income increased 101% YoY to $13.5 billion, the 2nd highest quarterly profit to date. Operating margins increased to 9.9% from 5.7% a year ago.
- Apple’s ($AAPL) revenues increased 5% over the last year to $85.8 billion, a record high for the 2nd quarter and highest growth rate since Q3 2022. Net income grew 8% year-over-year to $21.4 billion. Operating margins increased to 30% from 28% a year ago.
9) More Affordable Rents
US Asking Rents were down 0.8% over the last year, the 14th consecutive month showing a YoY decline.
Why have rents been going down? Rising vacancies due higher supply after the multi-family construction boom in recent years.
Asking Rents are now 2% below levels from 2 years ago while Average Hourly Earnings have increased over 8%. That’s making rents more affordable to the average American.
10) A Few Interesting Stats…
a) How much is a Gold medal worth? That depends on what country you’re representing…
b) 17% of 25-35 year-olds in the US now live with their parents, the highest share since the period following the Great Depression in 1940.
c) The longest yield curve inversion in history (758 days) is close to ending with the 10-year Treasury yield now only 0.08% lower than the 2-Year Treasury yield. Historically, the flip back to a positive sloping curve after a long inversion has occurred near the start of a recession.
d) The ISM Manufacturing PMI has been below 50 (in contraction) for 20 out of the last 21 months. With data going back to 1948, that’s only happened one other time: 1989-91 (Recession in 1990-91).
e) Meta’s Reality Labs unit lost another $4.5 billion in Q2, bringing its cumulative losses since 2020 up to $50 billion.
And that’s all for this edition. Have a great week everyone!
-Charlie
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