The market wants a Federal Reserve interest-rate cut soon, but it doesn’t want to need one. Wall Street economists are fixated on identifying tariff effects, yet stocks either celebrated or shrugged off three warm and sticky inflation readings this week, laboring to hold near record highs. The S & P 500 immediately processed a moderately elevated consumer price index report Tuesday as solidifying the chances for a September cut by the Fed into a still-steady economy, logging on that day slightly more than what would become a 0.9% gain for the week. Notably, over the next three days — through a hot but noisy producer price index reading and a messy University of Michigan consumer-sentiment survey — the benchmark treated Tuesday’s closing level just under 6,450 as a floor, testing it repeatedly and finishing the week right on it. The index has now logged a total return of 10% year to date, having more than recovered the near-20% tariff-panic collapse in April. .SPX 3M bar SPX 3-month chart The divide between optimists and pessimists on the market entering the second half of August is whether this action seems judicious or oblivious. The starting point for determining such things should be in assuming the market has it roughly right and isn’t overlooking much of the important stuff. Whether the Fed “should” look through potential tariff-driven inflation, the market is trying its best to do so. As Bespoke Investment Group summed things up at week’s end: “Price has trended steadily higher in a tight range over the last few months, representing rather sanguine action even though much of the news flow has been negative. While politics plays a big role in the going narrative about the market and the economy, price ultimately tells the real story. Whatever negativity there is out there hasn’t been nearly enough to interrupt the uptrend that’s been in place since we made new highs in early summer.” The latest push higher has not been terribly emphatic, or broadly inclusive, allowing skeptics to withhold style points from the rally. Both the Dow Jones Industrial Average and the equal-weight S & P 500 tagged new highs this week before faltering a bit, a sign either of fatigue or late-summer indifference. Big rotations This week also saw some forced-seeming rotations, with the weakest laggards in the S & P 500 performing best and the Russell 2000 small-cap index making yet another lunge for its late-2021highs on all the anticipated-rate-cut energy. Neglected groups such as health care showed some life, the likes of Johnson & Johnson breaking higher from a long slumber, even before news of Berkshire Hathaway’s second-quarter purchase of UnitedHealth shares jolted that name higher on Friday. These reinforcements allowed the overtaxed mega-cap AI glamour names to take a rest. Such rotations tend to support and refresh a rally while suppressing volatility, though eventually they can imply an exhaustion of leadership that may make the tape less stable than when the largest index weights are in firm control. From a certain angle, it could appear odd that the bond market is simultaneously assigning more than an 80% chance of a Fed rate cut in six weeks when equities are at records, valuations are full, crypto is melting higher, credit spreads are drum-tight and buzzy IPOs are rocketing out of the gate. Registering nominal appreciation for these flush conditions while still asking for monetary-policy help, Wall Street, in the words of the old Elvis Costello song, has “a mouthful of ‘Much obliged’ and a handful of ‘Gimme.’” This is less a contradiction than it is nuance. The jarring monthly payrolls miss of two weeks ago came after the Fed had last called the risks “balanced” between labor weakness and revived inflation, and the latest inflation upticks weren’t enough to offset the job-market softness. Not to mention the relentless White House campaign to browbeat Fed Chair Jerome Powell to lower rates while auditioning dovish successors. And confidence on multiple rate cuts, after one in late September, is not as evident in market pricing. Perhaps the market is conveying comfort with its own ability to hang tough even in the absence of a Fed move next month, casting a 25 basis-point reduction in short-term rates as a “Nice to have” rather than a “Need to get.” More tangibly, earnings forecasts for the remainder of the year are on the rise again, albeit with the AI-propelled tech players the largest contributors. When profits are growing, credit markets are calm and the next Fed move is a cut, stocks tend to have little trouble holding their valuations. Historically, when the Fed resumes an easing campaign after a pause of at least six months (December was the last cut), stocks have responded well over subsequent months, based on this study by Ned Davis Research. There’s no doubt the market sometimes takes credit in advance for a hoped-for future that might never arrive. It could turn out this is one of those moments. Economists at Morgan Stanley argued Friday that Powell in the upcoming week’s Jackson Hole symposium address is his last best chance to push against market pricing of a September cut, believing that “the Fed would prefer to retain optionality and, if anything, we look for Powell’s remarks at Jackson Hole to be similar to the message from July.” In other words, noncommittal and data dependent. One possible “tell” would come from the bond market’s reaction to any data or rhetoric that makes a cut less likely. If the 10-year Treasury yield were to rush lower in the face of reduced perceived chances of a rate cut next week, it could be taken as bonds declaring a high risk of a policy mistake, with the Fed behind the curve. If not, equity markets should take heart. One answer to those confused by the strength of the equity indexes in the face of still-elevated policy flux and potential stagflationary forces: Maybe markets are still burning off the last of the relief that burst forth after a worst-case scenario was priced in during the spring sell-off. Similarities to 1998 and 2018? Around the time that downturn was underway, I repeatedly noted the rich history of sharp, severe corrections that result from a sudden shock, stop just short of a 20% decline and are not associated with a recession. Precedents include the 1998 hedge-fund blowup, the 2011 U.S. debt-downgrade scare and the late-2018 tariff/Fed-mistake tumble. Fidelity’s head of global macro Jurrien Timmer tracks such patterns, and the current recovery is in synch with those of 1998 and 2018 so far. Clearly this is a small sample and these are close to best-case paths from here, but the echoes are pretty distinct. It’s no longer possible to argue that most investors are still outright bearish or are fighting the market’s four-month advance. Systematic and quantitative funds are back to very full equity exposures. But there remains a lack of aggressive participation by the broader group of professional investors, by some measures. Deutsche Bank’s composite investor positioning gauge is up to the 71 st percentile over the past 15 years, not a very high reading when indexes are at a record. Saying that not all investors have pushed every chip they have into the market is not the same as arguing the market enjoys a wide margin of safety, of course. Seasonal factors remain challenging and the tape is probably due for a routine wobble of a few percent before long. But there’s not much reason to argue if one arrived it would be the start of the “Big One.”
Stocks power to record highs again despite warning signs. Can the market’s strong run continue?
