Large to Small Rotation Continues as Momentum Unwinds

Photo Credit: Cedric Dhaenens, Unsplash

Weekly Market Recap for July 19th

This week's performance was similar to last week. The Nasdaq 100, Momentum, Growth, and Technology sector underperformed, while the Russell 2000, Value, and Equal Weight factors outperformed. We attribute the ongoing factor rotation to the slow momentum trade as interest rate cuts come into view. Bonds were flat as Treasury yields stabilized, the USD weakened further, and the price of oil continued to move higher.

S&P 500 Index (Last 12 Months)

S&P 500 Technical Composite (Last 24 Months)

Bullish and Bearish Narratives

June PPI Takeaways

Actual: +0.2%
Consensus: +0.1%
Prior: +0.0%

Commentary: Producer prices increased in June after no change in May and a +0.5% increase in April. The increase in headline PPI contradicts last week’s soft CPI report, but the underlying details were more favorable than the headline indicated. A significant portion of the June increase was attributed to a +1.9% jump in trade services margins, which represents the cost difference between a wholesaler’s inventory cost and sales price. Higher margins for machinery and vehicle wholesaling primarily drove the increase in trade services. As the chart below shows, the trade services PPI tends to be highly volatile and can distort the headline PPI reading. Looking at core PPI (excluding Food, Energy, & Trade Services), PPI was unchanged for the first time since May 2023. The likelihood of a September rate cut continues to increase.

Producer Prices Rise in June

Producer Volatile Final Demand Trade Services

The Prospect of Rate Cuts Unlocks New Opportunities

The timing of the first interest rate cut is becoming more apparent. However, the credit market already has prices at the start of the cutting cycle, particularly in the long duration. The yield curve has been inverted for over two years as investors price in slower economic growth, lower inflation, and rate cuts. As a result, the long end of the yield curve is reasonably priced for the current backdrop. Our view is that it will take a black swan event, recession, or larger-than-expected rate cuts for Long Duration to outperform significantly. While bonds price in the first rate cut, the gap in the equity market remains wide. The discussed large-cap stocks' outperformance in 1H 2024, while smaller companies underperformed due to concerns about the impact of higher rates. Our base case is that falling inflation and interest rate cuts will 'unlock' the rest of the market, narrowing the gap between large-cap and small-cap stocks.

Market attractive areas include:

• Interest-rate sensitive industries

• High dividend stocks

• The equal-weight factor

• Small caps

Hard Data Shows the Economy Continues to Expand

The increased number of negative economic surprises in Q2. While the negative surprises raised concerns about an economic slowdown, the Fed's Weekly Economic Index (WEI) of high-frequency data did not confirm the weakness. This week's economic data releases (summarized below) provided another look at the state of the economy, showing that it continues to grow despite higher rates. In addition, the WEI continues to trend higher. The economy appears to be reaccelerating in the third quarter in the lead up to the first interest rate cut.

Look Ahead to Next Week

The two notable economic data points next week are Q2 GDP growth and durable goods orders. Analysts are currently projecting +1.9% Q2 GDP growth, an increase from Q1's +1.4%. The following week is the Fed's FOMC meeting, where the central bank is unlikely to cut interest rates. This week's economic data releases included:

This week's economic releases included:

Retail Sales
Actual: 0.0%
Consensus: -0.2%
Prior: 0.3%
Commentary: Unchanged in June compared to expectations for a decline; May revised higher from +0.1% to +0.3%; control group retail sales, which excludes volatile categories & factors into Q2 GDP, rose by +0.9%; strong control group sales should ease concerns about the U.S. consumer's health.

Industrial Production
Actual: +0.6%
Consensus: +0.3%
Prior: +0.9%
Commentary: Most major groups posted gains, with the index posting its best two months since 2021; output of consumer goods rose by +1%, the most since July 2023; manufacturing output rose by +0.4% after a +1.0% increase the prior month; the report suggests the goods economy is reaccelerating.

Housing Starts & Building Permits
Housing
Actual: 1,353k
Consensus: 1,300k
Prior: 1,314k

Building Permits
Actual: 1,446k
Consensus: 1,395k
Prior: 1,399k

Commentary: Housing activity reaccelerated in June, with starts and permits both surpassing expectations; the volatile multi-family segment entirely drove housing starts, while single-family declined; homebuilder sentiment earlier in the week fell by -1 point to 42, the lowest since December 2023. Housing market summary: more houses are being completed while fewer houses are being started.

Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.

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