The Week in Charts (7/15/24)
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The most important charts and themes in markets and investing…
1) Down Goes Inflation
This is the inflation report we’ve all been waiting for – not just a slower rate of increase but an outright decline.
The Consumer Price Index fell 0.1% in June, the largest drop since May 2020.
Headline CPI moved below 3%, its lowest level since March 2021 and better than expectations for a 3.1% increase.
At 3.3%, Core CPI (ex-food/energy) fell to its lowest level since April 2021 and handily beat estimates for a 3.5% increase.
The biggest driver of the declines in headline/core CPI was the continued move lower in housing inflation. Shelter CPI has now moved down on a YoY basis for 15 straight months, from a peak of 8.2% in March 2023 (highest since 1982) to 5.2% today.
While it is still lagging real-time data which shows rents falling 0.7% over the past year, the gap is narrowing. And if it continues to narrow as expected in the coming months, it will continue to push down the rate of inflation.
It’s now been two years since CPI peaked at 9.1%. Since then, every major component with the exception of Transportation is showing a lower rate of inflation today.
2) Here Come the Rate Cuts
We saw a huge shift in market expectations for the Fed Funds Rate after the inflation report.
The market is now pricing in a 94% probability of a Fed rate cut in September.
Why is that important?
In every single FOMC meeting since 2009 the Fed has done exactly what the market was pricing in entering the meeting.
So unless the odds change in the next two months, a cut is coming.
What happens after that September cut is uncertain, but the market is currently expecting another 1-2 cuts this year followed by 4 more cuts in 2025.
Who would a rate-cutting cycle help?
First and foremost – borrowers – who have been feeling the pain of higher rates.
Credit card interest rates of 21.5% remain near record highs and over 7 percentage points higher than the historical average.
This has pushed credit card delinquency rates up to 3.23%, their highest level since 2011.
Higher rates have also had a big impact on the auto industry, as most vehicles are not paid for in cash but are financed.
The current financing rate of 8.65% (4-year loan) is the highest we’ve seen since May 2001 and delinquency rates continue to rise.
Speaking of rising, the Interest Expense on US Public Debt hit $1.095 trillion over the last 12 months, another record high. US Government Debt is fast approaching $35 trillion and no one stands to benefit more from rate cuts than the Federal Government. The Fed will never admit to it, but you can be sure there’s immense pressure on them to cut rates in order to slow down this interest expense spiral.
3) The Rotation Heard Round the World
July 11, 2024 will go down as one of the wildest days in market history.
Following the CPI report we saw an epic rotation where all of the previous losers (small caps, value, international, regional banks, etc.) became winners and all of the previous winners (large caps, US, growth, tech, magnificent 7, etc.) became losers…
The 180 degree shift in market cap leadership was stunning to witness.
Just days earlier I noted the enormous spread in returns within the S&P 500. The 50 largest stocks were up over 13% on the year while the 50 smallest were down 12%.
But on July 11, we saw the complete opposite, with Small Caps ($IWM ETF) rocketing higher with a gain of 3.6%. At the same time, large caps ($SPY ETF) fell 0.9%.
The 4.5% spread was a 6 standard deviation event and the 2nd biggest outperformance by small caps on record, trailing only the 10 sigma differential on October 10, 2008.
How unlikely is a 6 sigma event? If markets followed a normal distribution, such an event would be expected to occur only once every billion years. But clearly they don’t, and it won’t take another billion years for it to happen again.
4) An All-Time High a Day
The S&P 500 hit its 37th all-time high of the year last Wednesday, which was the 6th trading day in a row with a record close.
In crossing above 5,600 for the first time the S&P 500 has already hit eight 100-point milestones this year.
This was the 12th best start to a year through 131 days and the 2nd best in the last 25 years, trailing only 2019.
While the stock market has been booming for most of the year, the bond market has been languishing in the red.
That changed last week with the better-than-expected inflation report and the resultant decline in interest rates. The Total Bond Market ETF ($BND) is now at its highest level of the year, up 1% year-to-date.
If the Fed starts cutting rates in September, what would be the impact on the bond market?
Based on the last 9 rate-cutting cycles, bonds would likely get a boost, with the Bloomberg US Aggregate showing above average annualized returns in the past.
5) Shades of March 2000
The ratio of Growth stocks to Value stocks in the US hit its highest level March 2000 last week, the peak of the dot-com bubble (see video discussion here).
What happened in the 7 years after that? A complete reversal, with Value outperforming Growth by an enormous margin (+85% vs. -29%).
6) Fundamental Gains vs. Share Price Gains
The past 10 years have been great for the stock market with the S&P 500 index increasing 188%.
Have the underlying fundamentals shown similar gains?
Not exactly. S&P 500 Sales have increased 58% over that time while Earnings are 95% higher.
Which means that stocks are higher not just because of fundamental growth but also because of multiple expansion.
We can clearly see that in the following two charts…
#1 – The S&P 500 is now trading at nearly 3x sales, double the historical median and approaching its peak valuation from Q4 2021.
#2 – The S&P 500’s P/E ratio moved up to 25.8 last week, 40% above the median P/E ratio since 1988 (18.5).
7) Costco’s Highest Valuation Ever
Speaking of valuation, Costco’s Price to Sales Ratio has moved up to 1.55, the highest level in company history and 3x above its historical average.
Costco’s P/E Ratio has moved up to 55, the highest level since 1999 and 2x above its historical average.
8) Nike’s Biggest Drawdown since 2000
Does valuation matter?
In the short run, not all. Investor exuberance over the prospects for a richly valued stock can always became more exuberant.
But over the long run, valuation tends to matter very much, especially after extremes.
The latest example: Nike ($NKE), which traded at a record 6x sales just a few years ago. Fast forward to today and it trades at 2x sales, right around the historical average.
Its 58% drawdown is the biggest for the company since 2000.
What changed?
Growth rates and sentiment. Sales have declined over the past year, demand from China has plummeted, and Nike is forecasting further weakness in the quarters to come.
When all the news was positive, Nike’s elevated valuation didn’t seem to matter at all. But when the cycle turned, it mattered very much.
9) A Few Interesting Stats…
a) US Home Insurance rates have increased by an average of 20% since the start of 2023 and are expected to continue to rise. In California, State Farm is currently asking regulators for a 30% increase on top of the 21% increase that was recently approved.
b) US Banks still have over $500 billion in unrealized losses due to the decline in their bond holdings from rising interest rates.
c) US wages outpaced inflation by 0.8% in the past year, the 14th straight month of positive YoY real wage growth.
d) The best and worst performing stocks in the S&P 500 this year…
e) The percentage of 401(k) plans with a default 6% employee savings rate has doubled over the last decade and is approaching 30% (see video discussion here).
And that’s all for this edition. Have a great week everyone!
-Charlie
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