Macro Drivers Impacting the Markets: Election, Inflation/Interest Rates, Earnings

“Anyone who is of sound mind and body can sit down and think of twenty things in their life that could have gone differently. Where maybe they didn’t get a fair shake and where they took the path of least resistance. If you’re one of the few who acknowledge that, want to callous those wounds, and strengthen your character, it’s up to you to go back through your past and make peace with yourself by facing those incidents and all of your negative influences, and accepting them as weak spots in your own character. Only when you identify and accept your weaknesses will you finally stop running from your past. Then those incidents can be used more efficiently as fuel to become better and grow stronger.”

- David Goggins, Can’t Hurt Me

• Hold onto your seats, things just got a lot more interesting. We’ve transitioned from a market where the direction of equities had been predominantly determined by developments in interest rates, inflation and earnings, to a market that has recently added the U.S. election as a dominating macro factor, as if forecasting needed to be more complicated.
• It’s much too early to tell how Biden dropping-out and Harris stepping-in will impact this dynamic other than to say, it will add uncertainty, and with uncertainty comes We expect the volatility will be especially intense in the sectors of the markets that had already began to price in a Trump victory.
• As of Sunday night:
• Betting Market Probabilities (PredictIt, Prediction Market)
• Trump 60%
• Harris 39%
• Real Clear Politics Polling Average
• Trump 7%
• Harris 7%
• Fund Raising: In the six hours following Biden announcing his exit ActBlue (the Democrat small donation platform) raised $36m
• Thankfully there is still more to market dynamics than the S. Presidential Election. With inflation still falling and earnings season getting off to a solid start, the Fed appears to be headed towards a path of recalibration of rates lower. However, in the last week we’ve seen an uptrend in positive economic surprises, which if it were to continue, could throw a monkey wrench into the plan for rate cuts because a stronger than expected economy would theoretically jeopardize hard fought victories in inflation data.

• What you need to get right in the last two years to make money in the equity markets boiled down to two things:
• Understand the varying path of inflation and knock-on effect to market expectations for interest rates
• Correctly call earnings that consistently beat on the upside, especially as it relates to the Magnificent 7
• Although these two macro drivers remain dominant themes, over the last couple weeks the S. Election has emerged as a third macro driver, creating an additional cross current as an input into market forecasting.
• The fingerprints of the S. Election macro driver were left all over sectors last week, as market participant began positioning for a Trump victory, after Biden’s poor performance at the debate setoff concerns about is ability to win another term and Trump’s strong showing at the RNC, powered by a new message of unity after a failed assignation attempt.

• Sunday morning’s news of Biden’s withdrawal from the S. Presidential Election and endorsement of Harris will likely bring additional volatility to the sectors impacted by speculation of a Trump victory last week after his strong showing at the RNC.
• One of the most common phrases of economists and market forecasters to describe the post-pandemic world is “there is no playbook for this”. They’ll get a new way to apply this phrase between now and November 5th, because the last time an incumbent decided not to run was 1968, when Johnson backed away under entirely different circumstances.
• At a minimum Harris stepping in will call into question the rotation into sectors that would benefit from a Trump victory until market participants can better assess the potential for Harris to pull off a victory.

• Retail Sales for June blew away expectations, with the prior month revised higher.
• Expectations were for a decline in gasoline prices and the impact of a cyberattack virtually shutting down auto sales for part of the month to drive Retail Sales lower, so the upside economist were caught flatfooted with a gangbuster release.
• Hard numbers from the Retail Sales report contradict soft data reported in For example, the University of Michigan Survey of Consumer Sentiment Survey indicates that 41% of respondents think that now is a “good time” to buy a large appliance, below the long-term trend of 65%. Similarly, the same survey indicates that only 26% of respondents think now is a “good time” to buy a vehicle, below the long-term average of 57%.
• Consumers continue to be able to tap real wage growth and unusually strong Balance Sheet strength to support spending.

• The Fed might be running into a What if the labor market deteriorates, but the economy grows above potential? If that’s the case, it calls into question if Fed Fund is restrictive.
• Additionally, if the economy does show signs of growing above potential, there’s less of a chance that inflation will cool significantly, which means the Fed will need to continue to keep rates higher for longer.
• The 2-year Treasury rose 45 to 4.51 last week, indicating that bond investors are sniffing out that growth may be surprising on the upside.
• Below is a short list of economic indicators that came in above and below estimates last week.
• Above: Retail Sales, Housing Starts, Building Permits, Industrial Production, Capacity Utilization, Leading Economic Index, Philadelphia Fed Business Outlooks
• Below: Initial and Continuing Jobless Claims

• The Cleveland Fed developed an index designed to track the rate of rental increases for new tenants by dissecting microdata in the Bureau of Labor Statistics (BLS) data on CPI, which they have determined leads BLS rent increases by four Housing is the largest component of CPI, accounting for about 36% of the Index.
• The Cleveland Fed New Tenant Repeat Rent Index is released on a quarterly As of the most recent measurement new tenant increases are -1.1%, the first time this number has turned negative since the Great Financial Crisis.
• This syncs the latest data from the Apartment List National Rental Report, which indicates that beginning the second half of 2022 “seasonal declines in rent prices have been steeper than usual and seasonal increases have been more mild. As a result, apartments are on average slightly cheaper today than they were one year ago. Year-over-year rent growth nationally currently stands at -0.7 percent and has now been in negative territory since last summer.”

• We analyzed quarterly data going back to 1978, looking at the dispersion of returns between the Russell 1000 and Russell 2000, and what that meant for S&P500 performance for that quarter and the following quarter (3-month and 6-month performance), and found the hit rates and average return to both be higher as the dispersion grew.
• Including the 19 days in this quarter, 184 quarters were used for the analysis.
• 69% of the time the S&P500 was up for the quarter and 72% of the S&P500 was up measuring two quarters out.
• If the quarter ended on Friday, the Russell 2000 outperformance over the Russell 1000 (disparity) would be the 23rd out of 184 largest outperforming quarter.
• The average one quarter return of the S&P500 for the periods where the disparity was lower was 21% and the average two quarter return where the disparity was higher was 4.71%.
• The average one quarter return of the S&P500 for periods where the disparity was lower was 95% and the average two quarter return where the disparity was higher was 8.97%.
• 81% of the time when the disparity was higher the S&P500 was positive one quarter out, versus 67% of the time when it was lower.

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