China Syndrome

Weekly Newsletter: October 7, 2024

“China syndrome” is a description of a fictional result of a nuclear meltdown as well as a 1979 movie. How does all of this relate to the markets? First, Microsoft is making a deal to restart a part of Three Mile Island, the site of the most significant nuclear accident in US history. Microsoft is looking to buy ALL the energy generated by the facility. Second, China is looking to inject $142 billion into its banks to support its economy. Extra money, no matter what the currency, has a way of making it around the world. Finally, the employment report on Friday caused many commentaries to go nuclear as it was much stronger than expected and called into question the Fed’s decision to cut rates last month. Combined with higher commodity prices over the past month, the Fed may be painted into a corner at their next meeting, just after the November elections. Will the markets “melt up” because of the easy money policies or sink on a recalculation of Fed policies that may indeed remain higher for longer? Lots to watch over the coming thirty days to the elections.

The focus was squarely on the employment report, as it was the first significant economic release following the Fed’s decision to cut rates last month. The decision to cut rates was a concern regarding the weakening of the job market. That was laid to waste as the report exceeded the highest forecast and the prior month revisions were also raised. A clue to the strength of the jobs report might be gleaned from the weekly jobless data, which remains in line with the pattern established from 2016-2019, ahead of the Covid shutdown. The economic data during that period demonstrated solid economic growth with modest inflation. Thus far, the economy has not yet shown signs of buckling under the “weight” of 5% interest rates since the Fed stopped increasing rates in July 2023. If the optimistic view of future interest rate cuts winds up being revised much lower, it may have a bigger impact on the financial markets than the economy.

Thus far, the bond model remains in “lower rate” mode, however, that could change in the weeks ahead as commodity prices are now up 5% on a year-over-year basis, and higher by over 6% in just the past month. Interest rates have been increasing, even as the Fed “cut” their funds rate last month. Higher rates are also impacting on some interest rate-sensitive sectors like Real Estate Investment Trusts (REIT). Utilities usually react negatively to higher rates, but they have been bolstered by the realization that AI and data centers will be creating huge energy needs. Higher yields may be an early warning that the Fed may have acted too aggressively/quickly.

It has been an uneven trail in the market sectors since early July. That marked the (current) peak in the technology run that began early in 2023. The discussion about the “Magnificent 7” and the domination of those seven stocks on the overall performance of the market-weighted indices was all the rage. However, since that time, Mag 7 and technology in general, have struggled vs. small stocks, value, and even international. Granted, much of that outperformance by “the rest” of the market came over a 3–4-week period following that performance peak. Since mid-August, there has been more of a push/pull between each of the asset classes. What has not changed is the valuation dynamic, where the largest stocks remain richly valued, while the smaller stocks have more modest valuation levels. Over the coming years (not weeks), small/value stocks should be better performers. We will see if that plays out, as large stocks have been reluctant to give up their dominance.

The bond market will continue to be in focus as the best way to determine market “positioning” for the next Fed meeting. If rates continue to rise, especially for short-term maturities, it is an expectation that maybe the Fed will be on hold in November.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.