Daily Recap - August 21, 2024

We had a relatively stable day, marked by modest gains across the major indices. We had some news from the Federal Reserve and labor market revisions, but nothing that made big waves in the market.

Federal Reserve Minutes

The day was dominated by the release of the Federal Reserve’s July meeting minutes. Bottom line: most Fed officials expressed a clear inclination toward cutting interest rates in September, which should not be a surprise to anyone. This would mark the first rate cut in four years.

The minutes revealed that the Fed is becoming increasingly concerned about the labor market. Inflation has fallen sharply from its peak in 2022 and appears to be under control. Thus, the Fed is now turning its attention to employment and consumer spending, which will likely influence their decision to go hard on rate cuts in the next 12 months.

The average rate cut cycle by the Federal Reserve in the U.S. typically lasts between 1 to 2 years, depending on the economic conditions.

Historically, once the Fed starts cutting rates, the S&P 500 usually reacts positively. The index has averaged gains of about 10-12% during the first 12 months of a rate cut cycle. This reflects investor optimism as lower rates are expected to boost corporate earnings and economic activity. The Russell 2000 also tends to benefit from rate cuts. The index has averaged gains of around 8-10% during the first year of a rate cut cycle, as lower rates help small businesses with financing costs.

After the end of a rate cutting cycle, the S&P 500’s average performance is 5-7% in the 12 months following the final rate cut, while the small caps (Russell 2000) can see strong performance after a rate cut cycle if the economic environment improves, as small-cap stocks are highly sensitive to domestic economic conditions. Gains in the 12 months after the firanges from 10-12% for the same period.

Remember, these are AVERAGES and it doesn't guarantee this is what we will see during and after this cutting cycle, it's just a reference.

Revised Job Growth: A Stark Reality Check

In a related development, the U.S. job market received a sobering update. The government’s job growth figures were revised down significantly, marking the largest downward revision since 2009. The revised data painted a picture of a labor market that is cooling faster than previously thought, raising concerns about the strength of the economic recovery.

This revision was particularly noteworthy because it comes at a time when the Sahm Rule was just triggered.

The Sahm Rule is an economic indicator used to identify the onset of a recession in real-time. Developed by economist Claudia Sahm, the rule is straightforward: it signals a recession when the three-month moving average of the national unemployment rate rises by 0.5 percentage points or more relative to its low over the previous 12 months. Which is what we have right now in 2024.

The Sahm Rule has accurately signaled every recession in the U.S. since the 1970s, making it a reliable early warning system. On the other hand, Claudia Sahm herself expressed that while the rule is signaling a potential recession, the current economic conditions might be skewing its accuracy. She pointed out that the post-COVID economy has seen unusual patterns, particularly with the reentry of workers into the labor force, which has artificially inflated the unemployment rate. This could mean that the Sahm Rule is giving a false positive this time around.

However you spin this, a weaker labor market could justify the Fed’s consideration of a more aggressive rate cuts cycle, as slowing job growth might signal that businesses are pulling back on hiring due to economic uncertainty. This has led to renewed concerns about a potential slowdown in consumer spending, which is a key driver of the U.S. economy.

Despite the negative revision, some analysts pointed out that the overall unemployment rate remains low by historical standards, suggesting that the labor market, while cooling, is not in crisis.

Market Sentiment

Overall, the market's state going into Jackson Hole on Friday is cautious optimism. The Fed’s minutes provided some reassurance that monetary policy could become more accommodative, which is generally positive for stocks. However, the revised job growth data served as a reminder of the economic challenges that still lie ahead.