Stock market’s long-awaited Great Rotation needs to overcome this nagging worry
Stock-market investors got more than a whiff this week of what bulls hope to be the start of a long-awaited rotation away from an increasingly narrow band of megacap technology winners to left-behind parts of the market.
But a big question remains: Will the consumer play along?
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Stocks and segments of the market most sensitive to interest rates surged Thursday after the June consumer-price index came in cooler than expected, further cementing expectations the Federal Reserve will deliver the first cut of a new easing cycle in September.
The June producer-price index released Friday came in hotter than expected, but didn’t do much to alter an improving inflation picture. The Fed’s favored inflation gauge, the core personal-consumption expenditures index, is expected to fall further. Fed-funds futures traders have priced in a 90% probability of a quarter point cut by the central bank’s September policy meeting.
But if the economy is already beginning to stumble, stocks and sectors sensitive to the economic cycle will be less likely to enjoy a sustained rotation. And nervous types argue there are certainly things to worry about on that front.
“Consumer spending has been a key driver of economic growth in the current expansion. However, recent data suggests that the consumers’ resilience is fading — particularly among the lower-income earners,” said Larry Adam, chief investment officer at Raymond James, in a Friday note.
Management calls after some early earnings-season results from the likes of Nike Inc. NKE, Walgreens Boots Alliance Inc. WBA, and General Mills Inc. GIS back up those concerns, reporting that consumers are staring to pull back, Adam said.
Or take a look at shares of Helen of Troy Ltd. HELE, which shed more than a quarter of their value this week (see chart above) after the consumer products company reported a big and rare earnings miss and slashed its full-year outlook, citing particular weakness in its beauty and wellness business.
More important, listen to how Helen of Troy CEO Noel Geoffroy talked about the outlook on the company’s post-earnings conference call:
Geoffroy noted the company had “heard broadly from mass retail that traffic overall is slower throughout the country and promotional pressure is increasing,” leading retailers to manage inventories more closely to account for the slowdown, with some implementing systems to allow for just-in-time inventory management.
The tone alarmed Peter Boockvar, chief investment officer at Bleakley Advisory Group.
“I’m sorry but this is nothing but consumer recessionary type language,” he said, in a Wednesday note.
Meanwhile, Thursday’s CPI reading sparked a historic day in the stock market.
The long-suffering small-cap Russell 2000 RUT surged 3.6%, while the previously Nasdaq Composite COMP slumped 2%, marking the biggest one-day outperformance for the Russell over the Nasdaq based on records going back to 1986, according to Dow Jones Market Data.
The S&P 500 SPX, which has seen its nearly 18% year-to-date gain fueled by that ever narrower cohort of megacap tech stocks expected to benefit most from a surge in artificial-intelligence spending, went topsy-turvy. The S&P 500 lost ground as tech heavyweights took a drubbing, but much of the rest of the index’s components rallied. The equalweight version of the S&P 500 outperformed the market-cap-weighted S&P 500 by 1.8 percentage points.
The whole episode appeared to be enhanced by a painful unwinding of previously profitable trades by hedge funds centered on going long big tech stocks and short small-cap stocks and other parts of the market.
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It all comes as investors have appeared over the summer to grow more confident that inflation dangers are fading, turning the focus toward whether the economy will achieve the coveted soft landing or face something more pernicious as the lagged effects of the Fed’s aggressive rate-hiking cycle become more increasingly felt.
For the rotation to be sustained beyond a few weeks, “economic growth must remain resilient and we cannot have a growth scare,” said Tom Essaye, founder of Sevens Report Research, in a Friday note. “If we do get a growth scare, then cyclical sectors like energy, industrials, materials and financials will likely not do well.”
Investors can act accordingly.
Those that think growth will slow should overweight super-cap tech TDIV and defensive sectors like utilities XLU, healthcare XLV and consumer staples XLP, Essaye wrote. Those that think growth will be resilient should overweight value stocks VTV and the equal-weight S&P 500 RSP.
For his part, Essaye said he’s more concerned about growth than the
consensus, so he won’t be chasing value and cyclical stocks, instead sticking to his preference for defensive sectors and longer term Treasurys that will benefit from a sustained fall in yields alongside moderating growth.