I have been giving the latest move by the US Federal Reserve some thought, and I think a couple of comments and charts are helpful in framing where we are.
Firstly, for those watching carefully, the 50 basis points (bps) move was flagged through ‘official’ channels like the Wall Street Journal a few days ahead of the meeting. As it was so close to the event, economists remained stuck at 25 bps and so we had one of the most uncertain countdowns for several years. This led to raised volatility around the announcement and a very strong reactionary day, which pushed the S&P and Dow Jones to new highs. The Nasdaq remains slightly below highs because of the cooling off in the AI trade over the summer.
I think we can draw one clear conclusion from the Fed move: there is concern about the pace of slowdown and about the potential impact on employment, but the move is made with little data-backed certainty which is why Powell’s comments often seemed contradictory. He repeatedly stressed that the economy was strong, yet the 50 bps cut would suggest otherwise (the only other 50 bps cuts at the start of a cutting cycle were in 2001 and 2007!).
Powell talked about a ‘recalibration’, perhaps unsurprisingly so given the dislocation between the Fed rate and the two-year yield – rarely has the gap been so big. This can only mean the Fed is behind the curve. I felt Powell was floundering; caught offside and trying to find a way to put his hands up without causing undue alarm. Given what the market is telling us, 50bps was the right call and it certainly sets the hare running in a scramble to re-evaluate positioning into the year end.
At the end of last week, I was drawn to two charts that are guiding my thinking about how to set up positioning for the next three to six months.
The first – from Bernstein – shows the relationship between US interest rate changes and the relative performance of the S&P equal-weighted index versus the (market cap weighted) S&P 500.
Figure 1: Leadership within equities changes with the Fed rate cuts, typically in favour of S&P 500 equal-weighted over S&P 500
Source: Bernstein
This supports the view I put out there in July’s Quarterly Newsletter, that whatever markets do into year end, the trend is now likely away from concentrated names and trades and the market should broaden out. Here, that is represented by the S&P equal weighted opportunity but elsewhere I have seen it pitched as Russell 2000 v 1000 and the like. It supports an active approach and the representation of themes through a broader selection of names.
The second chart, from Goldman Sachs, explains the uncertainty that still prevails and shows why it is so hard to be bullish on the momentum trade. This illustrates the performance of the S&P 500 following the first rate cut in a cycle; it’s typically up 10-15% over the following 12 months if there is no recession and down 10-15% if there is a recession.
Equities typically rally following the first Fed cut if no recession, as of September 12 2024; price return
Source: Goldman Sachs Global Investment Research
The Fed commentary made clear that the economy is strong, yet the rate cut would suggest otherwise, so we must believe that the market is going to remain volatile around data points until the path of the economy is clear.
All of this is supportive of a broadening out in the market which should translate into a fertile time for stock/sector/theme pickers. Looking at the winning equities ‘baskets’ this month (according to Goldman Sach’s designations), the US is led by housing, non-profitable tech, ‘power up America’ and infrastructure – all lower rate beneficiaries.
Our base case remains that set out in July: alpha will be generated from a focus on a broadening out of market leadership and less so from betting on the absolute direction of markets. It’s time to think beyond the consensus trades of the last 12 months.
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