Waiting For The Rally To Widen Out

Stocks opened higher this morning but quickly faded, mirroring Nvidia (NVDA). With a roughly 15% total return through the first half of 2024, the S&P 500 is now in a holding pattern looking for direction. BMO’s Brian Belski believes the market is due for a correction in the near-term, but will probably be higher by the end of the year. That’s certainly my assessment of investors’ consensus opinion.

Looking back over the last six months, I characterize the stock market as idiosyncratic. A market driven by such narrow leadership (5-10 mega-cap technology & internet companies) is abnormal. On one hand, investors piled into these names because they are generating strong earnings growth fueled by the AI boom. Tech has been a go-to for reliable growth. On the other hand, this boom is beginning to take on an almost speculative hype, pushing up expectations and stock valuations to precariously high levels. One can readily see the extreme divergence in sectors returns. The S&P’s technology and communications sectors are up something like 28% this year, whereas the next highest-performing sector (financials) is up only 9%. And some areas—small-caps, transports, real estate—are actually down.

Investors are wondering when this rally will widen out. I think it will happen when interest rates begin to fall. Some of the cyclical sectors like industrials, financials and materials do better when interest rates are trending gently lower. Their profit margins tend to improve, and I’m guessing investor sentiment will too.

According to a Bureau of Economic Analysis (BEA) report, consumer incomes accelerated last month and helped push spending a bit higher as well. On a year-over-year basis incomes rose 4.6% and spending climbed 5.1%. At the same time, inflation softened in May, potentially clearing the way for the Federal Reserve to begin lowering interest rates. The Fed’s preferred inflation gauge—Core PCE—slowed to an annual rate of 2.6% in May. That’s the lowest rate since the Spring of 2021, and clearly suggests we are back on the path toward normal inflation. This combination of lower prices and resilient consumer spending is great news.

It seems to fly in the face of other recent data pointing to slower economic growth, as well as anecdotal hints that consumers are slowing purchases due to financial strain. After all, General Mills just lowered prices by 4%. McDonalds rolled out $5 Meal Deals after reporting weak sales. Both Walgreens and Target announced price cuts earlier this month. Best Buy cut prices on appliances. Some in the media interpret these moves as a desperate response to a faltering consumer. I disagree.

Consumers are simply responding in a pragmatic way to a lack of value. Prices across the economy are roughly 20% higher than pre-pandemic levels. Companies arguably took too much pricing and tried to make it permanent—or at least hang onto it as long as possible. So we see that a meal at McDonald’s is more expensive than a comparable meal at In-N-Out. This clearly makes no sense, but it will be sorted out by competitive forces. My point is, consumers are discerning, not desperate.