Market Update

This week’s macro data pushed large cap equities to their best performance streak in over a month.

The S&P 500 is up 3.7% so far this week, which if it holds would be the best weekly performance since November. It’s been a broad rally this week. Small caps (Solactive 2000 +2.7%) are up and mega caps (Magnificent 7, +6.1%) have outperformed.

Performance was driven by a week long run of favorable data across producer prices, consumer prices, retail sales and jobless claims. That’s helped quell market slowdown fears sparked from the July jobs report. Prices came in in-line or lower than Street expectations, Initial claims (those applying for unemployment insurance) came in lower and the control measure of retail sales (what is used in the gross domestic product calculation) tripled market forecasts.

Stronger data pushed yields higher on the short end of the curve this week. The 2-year is up four basis points on the week, while further out the curve the 10-year is lower (three basis points). 

In micro news, the largest private employer in the United States, Walmart (+7.7%), reported second quarter earnings. The retailer raised sales growth guidance for the year at 4.75% (versus expectations of 4%). Management also gave an upbeat description of the consumer as “each part of the business is growing – store and club sales are up, and eCommerce is compounding”. Shares of Starbucks (+26%) got a caffeine kick this week when the coffee chain announced it will replace its CEO with Brian Niccol, the current Chipotle CEO. The news caused some indigestion for shares of Chipotle, which are down 2.8%. The stir in management comes as activist investors Elliott Investment Management and Starboard Value have amassed stakes in Starbucks.

With this week’s moves behind us, we look ahead and describe the playbook for a potential rate cutting cycle.

The rate cutting playbook

This week’s inflation and labor market data free up the Federal Reserve to cut interest rates in September on their own terms. Futures markets are pricing in a 100% probability of a 25 basis point cut with about a 25% chance of 50 basis points. We think investors should dust off their rate cutting cycle playbooks to position their portfolios. Like a well-balanced playbook, there’s two sides to consider: offense and defense.

Defense: bonds may have your back.

Investors will likely start earning less on their cash in just 33 days. Now may be the time to consider moving out of excess cash and extend duration by buying bonds.

Why buy bonds? When you buy a bond, you capture elevated yields for longer. For example cash yields on T-bills are still quoted above 5% but that’s doesn’t give you the full picture. Rather, that quoted figure represents the annualized yield on a bill that matures in three months. In reality, that 5% yield means you earn 1.2% total over the next three months. Then, you have to reinvest at the prevailing rate. In other words, as the Fed cuts rates, yields on T-bills should drop quickly.

Yields have already dropped. Are you too late? We believe the answer is no, even if 10-year yields have already declined by nearly 80 basis points from this year’s peak. Historically, buying bonds one month prior to the first cut of a cycle delivers nearly 300 basis points of excess return relative to waiting until one month after the Fed has started cutting.

Starting yield doesn’t tell the whole story. Bond prices often rise when interest rates fall, whereas cash yields remain relatively stable. For example, if you invested in a product with little to no duration, like short-term Treasury bills, you would receive the current yield over the investment period. In contrast, investing in a product with duration, like core bonds, offers the potential for both yield and price appreciation if interest rates decrease.

To illustrate, if interest rates were to decrease by 100 basis points, a hypothetical investment of in core bonds which has duration would likely result in higher returns compared to cash.

Bonds can play a key role in a defensive investment strategy by providing capital preservation, income enhancement and diversification. As a potential rate-cutting cycle approaches, consider incorporating bonds and extending duration in a defensive strategy.

Offense: recovery in rate sensitive sectors

Rate cutting cycles also offer the opportunity to play some offense, particularly in those sectors that have underperformed in part due to higher rates. Below, we highlight three areas that could recover with lower rates:

1. Refinancing

Over 60% of homeowners in the U.S. own their home through a mortgage. Through the hiking cycle, mortgage rates climbed to over 8% from around 3%, and have since fallen back to approximately 7%. The higher rate environment has deterred new homebuyers from entering the market and existing homeowners from relocating. The move lower in rates could provide a welcome relief to hopeful homeowners and folks who took out a mortgage near the highs. We’re already seeing signs of that. The Mortgage Bankers Association (MBA) refinancing index had its biggest weekly jump since 2020. Even though refinancing is still dormant relative to 2021’s binge, the tick higher is a positive sign that home equity could act as a source of support for the consumer, spending and residential projects as rates fall.

2. Commercial Real Estate (CRE)

Following the fastest Fed hiking cycle since the early 1980s, aggregate CRE property prices have fallen by 12% since their peak in 2022, marking the third correction in U.S. CRE property prices in the last 30 years.

Much of the impairment has been concentrated in the office sector. As our Chairman of Asset & Wealth Management Investment Strategy Michael Cembalest noted in his latest piece, roughly 25% of workers are working from home, leading to leasers giving back 10-12% of their rented space. As such, developers have been considering taking aging office buildings and turning the properties into housing, those conversions are picking up in New York as office vacancies rose since the pandemic. Lower financing rates can encourage developers to take on these conversions, and a lower discount rate should support property values.

3. Mergers and Acquisitions (M&A)

Just this week, Mars Incorporated, the food manufacturer and packager, agreed to buy the Pringles maker Kellanova. The deal will total nearly $36 billion composed of debt and a 33% per share premium on Kellanova’s equity. Elsewhere, a Bloomberg article yesterday reported that Skydance’s Paramount deal is now being competed for by multiple parties. M&A activity has been muted this year: volumes are 20% below the 10-year average. This Mars deal, the second largest year-to-date, along with investors competing for current deals may signal green shoots for the industry into the impending rate cutting cycle. 

Whether you want to play offense, defense or a little bit of both, now is the time to prepare for a rate cutting cycle. Your J.P. Morgan advisor is here to help.

All market and economic data as of 08/16/2024 are sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

DISCLOSURES

The examples provided are for illustrative purposes only and do not represent actual performance.

Tax loss harvesting may not be appropriate for everyone.  If you do not expect to realize net capital gains this year, have net capital loss carryforwards, are concerned about deviation from your model investment portfolio, and/or are subject to low income tax rates or invest through a tax-deferred account, tax loss harvesting may not be optimal for your account. You should discuss these matters with your investment and tax advisors.

The Chicago Board Option Exchange (CBOE) Volatility Index (VIX), is a real-time index that represents the market’s expectations for the relative strength of near-term price changes of the S&P 500 Index.

The information presented is not intended to be making value judgments on the preferred outcome of any government decision or political election.

Index definitions:

The Russell 3000 Index is a capitalization-weighted stock market index that seeks to be a benchmark of the entire U.S. stock market. It measures the performance of the largest 3,000 U.S. companies representing approximately 96% of the investable U.S. equity market.

The S&P 500 Equal Weight Index is the equal-weight version of the widely-used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight of the index total at each quarterly rebalance.

The Bloomberg U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).

The S&P 500 Equal Weighted Index is the equal-weight version of the widely-used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight – or 0.2% of the index total at each quarterly rebalance.

The Magnificent Seven stocks are a group of influential companies in the U.S. stock market: Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA, and Tesla.

The Magnificent 7 Index is an equal-dollar weighted equity benchmark consisting of a fixed basket of 7 widely-traded companies (Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta, Tesla) classified in the United States and representing the Communications, Consumer Discretionary and Technology sectors as defined by Bloomberg Industry Classification System (BICS).

The S&P Midcap 400 Index is a capitalization-weighted index which measures the performance of the mid-range sector of the U.S. stock market.

The S&P 500 index is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

Bonds are subject to interest rate risk, credit, call, liquidity and default risk of the issuer. Bond prices generally fall when interest rates rise.

The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to "stock market risk" meaning that stock prices in general may decline over short or extended periods of time.

Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.

The Bloomberg Eco Surprise Index shows the degree to which economic analysts under- or over-estimate the trends in the business cycle. The surprise element is defined as the percentage difference between analyst forecasts and the published value of economic data releases. 

The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.

The NASDAQ 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the NASDAQ stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.

The Russell 2000 Index measures small company stock market performance. The index does not include fees or expenses.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

The views, opinions, estimates and strategies expressed herein constitutes the author's judgment based on current market conditions and are subject to change without notice, and may differ from those expressed by other areas of J.P. Morgan. This information in no way constitutes J.P. Morgan Research and should not be treated as such. You should carefully consider your needs and objectives before making any decisions. For additional guidance on how this information should be applied to your situation, you should consult your advisor.

All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or endorsement by J.P. Morgan in this context.

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