Don’t Fight The Tape, But Not The Place To Get Overconfident
U.S. equities staged an impressive rally last week, with the S&P 500 ripping +3.45% while closing the week at a new all-time high. The Nasdaq Composite levitated +4.25%, the small-cap Russell 2000 rallied +3.01%, and foreign equities as measured by the All-Cap World Index ex. U.S. gained +3.05%. It's been a monumental +24% run following the -19% correction in the S&P 500 from the February peaks to the April 8th post-liberation day lows. Through Friday's close, we're talking about +$10 trillion in market cap gains in less than three months. It's an epic move, to be sure. Sharp bounces off of deep non-recessionary corrections aren't unique, but rarely do they occur as swiftly as this one has transpired. Moreover, more times than not, rallies of this magnitude coincide with meaningful fundamental catalysts: sweeping legislative change, a dramatic shift in monetary policy, massive liquidity injections…but this one seems to be built on the back of sidestepping worse-case outcomes.
Sure, it can be argued that there have been positive catalysts, and I recognize such a perspective, but admittedly, I don't see it the same way. Take the Big, Beautiful Bill as an example – it doesn't move the needle in terms of adding to GDP growth. The bulk of the benefit comes from extending tax cuts already in place. What about monetary policy? Nope, Chair Powell and the majority at the Fed remain resolute in their 'wait and watch' approach to their next policy move – although with a loosening bias. As for tariff deals, well we've gone from 90 nations lining up to do deals to 18 in deep negotiations to 10 nearing the finish line. Sounds great on the surface, but if they are anything like the nothing-burger that was the deal signed with the U.K., then we're not talking about anything that amounts to more than a hill of beans from a fundamental standpoint.
The recycled China trade deal that resurfaced last week is yet another example of investors' willingness to see everything as a positive and nothing as a negative at this juncture of this epic rally. For those who might have missed it, I'm talking about the "agreement" between President Trump and Xi Jinping that involves China loosening exports of rare earths and the U.S. lifting some restrictions on exports to China. This was already announced back on June 12th, so it should not have come as a surprise to anyone, but the S&P 500 was already on a roll heading into Friday's ratification. However, this just shows that no one should ever underestimate the power of the stock market to respond to the same piece of news, over and over again. This isn't the first time.
I know, I know, I can already sense the pushback coming from Trump supporters about how this administration is shaking things up, putting the world on notice, protecting our national interests, bringing peace to the Middle East, cutting through the red tape of over-regulation while unburdening industry, standing up for the forgotten man/woman…it all sounds great, and I don't disagree, but I also look at each of these as easier said than done. Saying them and following through with effective policy to achieve the desired outcomes are two different things. I've heard the former and am rooting for the latter to come to fruition, but I find myself well short of claiming a victory is at hand.
Over the last several weeks, investors have recognized that we have eliminated "tail risks," to be sure – the odds of a global trade war have plummeted, defusing the potential of World War III coming out of the Middle East, and falling off the fiscal cliff in 2026 all appear to have been resolved. As a result, markets have looked through almost every piece of bad news while unabashedly embracing any and all pieces of good news. To which, let me remind investors who adorn a skeptical bias, like myself, to keep an open mind. The technical backdrop for equities and bonds is very constructive at the moment, with programmed flows from vol-control and other trend-following strategies putting a consistent bid under asset prices for the foreseeable future. Last week, the Nasdaq put in a golden cross, and as you can see from the chart below, previous crosses over the past six years have been followed by big melt-up phases.
While this cannot exactly be described as a rally based on the fundamentals (see more below), the technical picture has improved considerably with the cumulative daily advance-decline lines for both the NYSE all-issue composite and the S&P 500 making fresh all-time highs – supporting the notion of a spring-summer rally remaining intact. Beyond quantitatively driven strategies and fund flows, corporate buybacks remain a monster buyer for stocks lurking in the background. However, the fact remains that earnings fundamentals are eroding at the margin, and valuations have become super stretched once again, so the market is more suitable for traders than for investors.
All the while, there are a few caveats to this feel-good market rally. If we look at indexes not influenced so much by the mega-cap stocks, we can see that they are still well below their cycle highs: S&P 500 equal weight -3.3%, S&P 400 (Mid Cap Index) -8.5%, and Russell 2000 -11.0%. It's become common knowledge that U.S. equities live and die with the Mag7 and a small set of other large-cap growth companies. Outside of fleeting momentum shifts, the following relationships – large caps>small caps and growth>value – have experienced what appears to be a permanent shift in large part as a result of passive flows and other supporting structural dynamics. However, seeing just two of eleven sectors that make up the S&P 500 make all-time highs (Tech and Industrials) along with the index is a bit of non-confirmation on the overall health of this new high. Another indicator showing the lack of participation in this rally is the depressed level of S&P 500 constituents hitting new 52-week highs at a time when the S&P 500 is making a new all-time high (see below chart). This could be argued both ways – lots of room for the catch-up trade or a non-confirmation signal; we'll find out the answer in the fullness of time.
As great as everything seems on the surface, with equities at all-time highs and most of the worst-case outcomes off the table (which allows the economy and equities to revert to their natural expansionary form), there are some risks to remain mindful of. For starters, it is not clear that the tariff file will be insignificant when it comes to the impact on global growth: Yale Labs’ latest estimate is that the U.S. average tariff rate sits at 15.6%, up six-fold from where it was at the start of the year, and the highest since 1937 (which was the big "double-dip" recession during the Great Depression). This amounts to an average de facto tax hike (real income squeeze) of $2,000 to American households. That is nearly a full -1.0% drag on GDP growth right there. Then tack on the immigration file and all the curbs and deportations, and right there, we have an additional 1.0% hit to economic activity. The deregulation thrust adds +0.2%, and the Budget Bill is actually, at best, neutral since most of the "tax cuts" are merely extending the status quo.
As for the Big, Beautiful Budget Bill, it will be making its way back to the House after the Senate managed to pass its version in a 51-49 vote over the weekend (the Republicans used an accounting move to exclude the $3.8-trillion tax extension when calculating budget deficits). The fiscal hawks are caving, which is giving equity market investors something else to rally around, despite the fact that what truly hangs in the balance is the unstable future of unsustainable deficits and debts, and the question of where the money will come from to finance unprecedented government borrowing requirements. But that remains a worry for another day. Unfortunately, that day is eventually coming; no one knows when, but it likely won't be the Boomer Generation that has to atone for the fiscal irresponsibility dumped onto younger generations. I'm not pointing a finger, because we are all at fault for what our elected officials legislate, but for the here and now, investors only sense another "win" in Donald Trump's pocket.
At the same time, investors are expecting a lot of trade deals to come our way, and now they are breathing a sigh of relief knowing that the President wasn't serious about the July 9th deadline for the reciprocal tariffs. It's all about "wins" as we witness the goalposts being moved once again with the President backing away from his July 4th deadline, and this is why investors are so quick to dismiss any aggressive talk coming out of the White House – because what you see is not what you get. I see flexibility and one's ability to change their mind when facts change as an admirable quality, but the looseness with which President Trump changes direction can sometimes be likened to chaos in as much as it can be considered flexibility. Admittedly, there have been times lately when I feel like my head is spinning, but it does seem as though either the investor base has become immune to all of this policy on the fly, or sees a light at the end of every policy tunnel, no matter how often the President changes his mind.
This brings me to the Fed and the unenviable position that Chair Powell finds himself in. The number of insults the President is hurling at Jay Powell has spun out of control with the sort of comments that one would expect from a child – I mean, "a low IQ for what he does" and "I think he's a very stupid person, actually." I am no Jay Powell apologist, but it's fair to say the next Chairperson is going to have to be a 'yes' person. President Trump has hinted strongly that he aims to appoint the next Chairperson as early as September-October, but Jay Powell's term does not end until next May. That would leave around six months of everyone knowing who the next Fed leader will be when it is far more typical for that lag to be closer to three months. Why, pray tell? To generate more pressure on the Fed to cut rates and create a "shadow" Fed Chairperson of sorts, since everyone will be more concerned with what the new pick is going to be saying — thereby diluting the effectiveness of the current Chief (beyond calling Jay Powell an idiot, what better way to undermine him?).
On the short list of candidates being floated around are Christopher Waller, Kevin Warsh, Kevin Hassett, David Malpass, and Scott Bessant. The only one who hasn't yet served in the Trump administration in some capacity during the first or current term is Kevin Warsh, and Warsh could also be viewed as potentially the only non-"yes man" given he is a noted monetary hawk. That makes him unlikely to be appointed, while all the others are likely to fall in line with the administration's objectives and, therefore, risk tainting the Fed's independence insofar as it exists. Perhaps not a big deal if you are some frontier Banana Republic dictatorship, but this will drive another nail into the coffin of the perception of the U.S. dollar as an unrivaled reserve currency. The implications are clear – own some gold, commodities, high-quality U.S. equities, overseas stocks, and even crypto; for foreign investors exposed to the U.S. stock market, make sure to maintain your hedges against the dollar bear market, which has already wiped out half of the foreign investors' capital gains. And the case for curve steepening trades in the Treasury market is as strong as it has ever been.
Speaking of the U.S. dollar, the -10% downdraft since the start of the year is a big deal, given the underlying circumstances. With the Fed standing pat while other central banks around the world cut rates (64 rate cuts YTD according to BofA, which puts global easing in '25 on track to be the biggest year of global rate cuts since 2009), and with the United States being the one imposing the tariffs, the dollar should be firming, not falling. And the fact that it is in rapid descent (off a further -1.3% last week to a three-year low) when it should be heading in the other direction is a story that receives very little attention. The average equity market investor only looks at this myopically in what this means for currency-adjusted and export-related profits for the industrial sector – what they ignore is that the dollar is among the most important of prices in the global economy, and it is sending everyone a vital message.
Back to gold for a moment, which has paused over the past three months but is still up a resounding +45% over the past year. A pause hardly means the bull market is over, and the reason for that assessment is that the major powerful force over these past years and decades has come from the actions of the deep-pocketed central banks. A rising share of the world's monetary authorities are diversifying out of dollars and into bullion. The World Gold Council just completed its survey of 73 central banks, and 43% intend to add to their gold reserves in the coming year, up from a 29% share at this time in 2024 (and the highest in the eight years since the survey began). In these past three years, the pace of central bank gold buying activity has doubled (more than 1,000 tons annually) – mirroring what the price has done over this period. Gold investors will have something to worry about when these deep pockets stop buying. Until then, this is a buy-the-dip market that all investors should have exposure to.
As for some general market thoughts as I close up this week's missive…I see the charts and data showing July as the strongest month of the year are making the rounds. There's no reason to argue with history, but understand that if everyone is talking about it, it's likely that the majority are already positioned for it. Another supportive data point making the rounds is the amount of equity buying vol-control funds need to do over the summer months, given the decline in equity volatility. Combine this bid with corporate buybacks, and you do have yourself a heavy tailwind, but once again, given that it's bombarded my financial feed makes me think a fair amount of this flow is already being front-run, and any additional buying will be met with willing sellers. As for corporate earnings estimates, as we get set to kick off Q2 earnings in a couple of weeks – EPS revisions are no longer being cut. Some argue that they are on the rise, but you need to squint to see it. Nevertheless, it's another negative removed from the equation, but it doesn't change the reality that the forward P/E multiple on the S&P 500 has increased 4 points since early April to a lofty 22x.
That's a bit rich for this value-minded analyst, especially with real interest rates (10-year) at 2.1%, more than 150 basis points above their historical average, but as we've come to learn, valuations have been trending up over time as the overall market has become dominated by high margin tech companies with monopolistic business models. Additionally, valuations only matter when they matter. So always be mindful of them, but don't continue to look for a market to be frequently trading at a discount when it has done just the opposite over the past twenty-five years. Your opportunities to buy quality at steep discounts have been few and far between since the turn of the century, but those prudently positioned to take advantage of those brief moments of opportunity have been handsomely rewarded. Nevertheless, complacency has started to set in to the equity market, with the VIX slipping to a 16-handle and positioning on its way to being fully loaded up in the bull camp. Mind you, it's not the wrong place to be, but keep your head on a swivel and fight the urge to get too far out over your skis at the moment.
As for the economic data, we'll get a slew of it this week, which I am eagerly awaiting to see if the weakness we saw in the May data was just a blip or something we all need to be a little more concerned about. Last week, we got consumer spending data that was relatively weak and a Chicago Fed National Activity Index (CFNAI) reading that came in at -0.28 for the month of May. This followed an April reading that was revised to -0.36 from -0.25 with the diffusion index falling to -0.24 in May from -0.3 in April. Let me remind you that the CFNAI is one of the most complete assessments of the economy we have on a monthly basis, replete with 85 separate variables. When it dips down to these levels for more than a couple months, it should get investors’ attention that economic weakness is not only deepening but also spreading. Should we get further economic data this week showing a continued softening, then I'm inclined to say the repricing we're seeing in the Fed Funds futures market (from four rate cuts to five from now to the end of 2026) has more to do with economic weakness than it does with Trump appointing a dove as the next Fed chair.
This is a holiday-shortened week, and I'll sign off by wishing all who celebrate a safe and Happy 4th of July. I won't be penning a missive next week as I'll be traveling over the holiday and on the road seeing clients—then a little vacation time with the family to recharge the battery. If something significant occurs, I'll interrupt my respite to share some thoughts. Otherwise, enjoy, and I'll be back to bore you in two weeks.
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