Recent data indicates the US economy has been cooling modestly and disinflationary progress has resumed, which should help hasten the start of rate cuts.<\/p>\n\n\n\n
There is a significant amount of cash that is likely to start moving to stock and bonds once the start of rate cuts appears imminent. <\/p>\n\n\n\n
We needed to see a solid earnings season in the first quarter in order to provide a foundation for stocks to move higher. By and large, we got that. <\/p>\n\n\n\n
Investors may be tempted to reduce exposure to equities right now. After all, major stock indices around the world, from the STOXX Europe 600 to the Dow Jones Industrial Average, have hit record highs in the last several weeks. And then there is the old adage \u201cSell in May and go away,\u201d which suggests that investors should dump stocks during the summer and reinvest in the fall. I\u2019m not a fan of seasonal investment strategies, and I don\u2019t believe new market highs should necessarily be feared. Here are six reasons why I\u2019m confident that stocks can move higher from here.<\/p>\n\n\n\n
In last week\u2019s blog<\/a>, I wrote that the most important data release last week would be the US Consumer Price Index<\/a> (CPI) data for April. That\u2019s because US disinflationary progress appeared to have stalled in the first quarter. The good news is that headline CPI was in line with expectations at 0.3% month-over-month and 3.4% year-over-year.1<\/a><\/sup> More importantly, core CPI was 0.3% month-over-month and 3.6% year-over-year.1<\/a><\/sup> The core CPI reading was the lowest since April 2021.1<\/a><\/sup><\/p>\n\n\n\n And while at first blush the US Producer Price Index (PPI) for April seemed hotter than expected, a closer look indicated a benign print. Further, US retail sales came in lower than expected.<\/p>\n\n\n\n Taken together, this recent data indicates the US economy has been cooling modestly and disinflationary progress has resumed. This should help increase the Federal Reserve<\/a>\u2019s confidence that it will be appropriate to begin cutting rates soon. And lower rates could push equities higher. Historically, in the 12 months following the start of the last seven Fed rate cut cycles, global stocks, as represented by the MSCI All Country World Index, have risen on average more than 6%.2<\/a><\/sup> And if we were to strip out the rate cut cycle that began in 2007 as the Global Financial Crisis was just beginning, the average return for the MSCI All Country World Index is more than 10%.2<\/a><\/sup><\/p>\n\n\n\n We needed to see a solid earnings season in the first quarter in order to provide a solid foundation for stocks to move higher. And by and large, we got that.<\/p>\n\n\n\n As I\u2019ve mentioned before, stock buybacks are on the rise in many parts of the world. For example, just a few weeks ago, Apple announced plans to buy back $110 billion in stock. And European and UK companies have significantly increased their stock buybacks, with their buyback yields now at levels seen in the United States. A 2021 study from Vanderbilt University Owings School of Business looked at 17 years of stock buyback activity and concluded that, beyond helping to increase share prices, stock buybacks also increased liquidity and lowered volatility.5<\/a><\/sup><\/p>\n\n\n\n Yes, some US stocks sport high valuations \u2014 although most of the high valuation \u201cMagnificent 7\u201d type stocks are arguably supported by high expected earnings growth \u2014 but many equities around the world have low valuations relative to their historical ranges. For example, Chinese equities are very attractively valued \u2014 they are currently at the very low end of their long-term cyclically adjusted price-to-earnings ratio (CAPE) range. And Japanese, emerging markets, European, and UK equities are all at or below their 10-year average CAPE.6<\/a><\/sup><\/p>\n\n\n\n While valuations are rarely predictive of outperformance in the short term, in general low valuation stocks have often realized upside potential with a catalyst or catalysts such as better-than-expected earnings or some form of policy support. In other words, low valuations and positive surprise can be a powerful combination. I believe it is likely that non-US stocks and smaller-cap stocks may perform better as rate cuts unfold and we near a global economic re-acceleration.<\/p>\n\n\n\n As I have said before, there is a significant overweighting to cash on the part of some investors, both retail and institutional. That excess cash sitting on the sidelines is likely to start moving to fixed income and equities once the start of rate cuts appears imminent. This could be a powerful catalyst for equities.<\/p>\n\n\n\n As a reminder, US money market assets peaked in the fourth quarter of 2008 before dropping significantly. It seems no coincidence that cash moved off the sidelines just as stocks began a strong and lengthy rally in March of 2009.7<\/a><\/sup><\/p>\n\n\n\n It seems that geopolitical risks have multiplied in the past several years. However, investors seem to be reacting to geopolitical risks not by eschewing risk assets such as equities but by including perceived geopolitical risk hedges such as gold in their portfolios. The use of geopolitical risk hedges seems to have enabled investors to be comfortable maintaining exposure to equities. In fact, gold hit a new record high on May 20, likely helped by news of a Houthi attack on an oil tanker over the weekend as well as the death of the president of Iran in a helicopter crash, either of which could add to tensions in the Middle East. But that does not seem to be dragging down stocks.<\/p>\n\n\n\n While positive on equities, I recognize that there are certainly risks to watch this year. I think we could certainly experience one or more stock market pullbacks this year as expectations around monetary policy can change very quickly. That\u2019s OK and could be healthy as it may present entry points to add to equity exposure. I do suspect that we are close to the start of a sustainable broadening of stock market participation. I hope this serves as a reminder to revisit stock portfolio weightings to ensure adequate exposure to small-cap and non-US equities.<\/p>\n\n\n\n Looking ahead, we will be getting a lot of \u201cFed speak,\u201d and I expect it to be rather hawkish as the Fed tries to keep a lid on easing financial conditions. We will be getting some other central bank speak as well, but I expect that to be more dovish as a rate cut from the European Central Bank in June seems to be a fait accompli \u2014 and there remains a good chance other central banks also begin to cut soon.<\/p>\n\n\n\n The most important data release, in my opinion, will be US Personal Consumption Expenditures Index at the end of May. This will help paint a picture for the Fed about disinflationary progress in the second quarter and could bring us meaningfully closer to the start of rate cuts. However, this week I will also be paying attention to inflation prints for the UK, Canada, and Japan as well as Purchasing Managers\u2019 Index<\/a> readings for the eurozone, UK, and US. After all, it\u2019s all about the balancing act between lowering inflation without snuffing out economic growth. Rounding out the week will be several central bank decisions, the Federal Open Market Committee minutes, and of course my beloved Michigan Survey of Consumers<\/a>, which is \u201cmust read\u201d material on Friday.<\/p>\n\n\n\n —<\/p>\n\n\n\n Originally Posted May 21, 2024 <\/p>\n\n\n\n2. Earnings season featured largely positive results<\/h2>\n\n\n\n
\n
3. Stock buybacks are on the rise globally<\/h2>\n\n\n\n
4. Valuations are attractive for many equities around the world<\/h2>\n\n\n\n
5. Cash is sitting on the sidelines<\/h2>\n\n\n\n
6. Geopolitical tensions haven\u2019t derailed stocks yet<\/h2>\n\n\n\n
Risks to watch<\/h2>\n\n\n\n
The week ahead<\/h2>\n\n\n\n
Dates to watch<\/h3>\n\n\n\n
Date<\/strong><\/th> Report<\/strong><\/th> What it tells us<\/strong><\/th><\/tr> May 20<\/td> Reserve Bank of Australia meeting minutes<\/td> Gives further insight into the central bank\u2019s decision-making process.<\/td><\/tr> May 21<\/td> European Central Bank President Lagarde speaks<\/td> Gives further insight into the central bank\u2019s decision-making process.<\/td><\/tr> <\/td> Canada Consumer Price Index<\/td> Tracks the path of inflation.<\/td><\/tr> <\/td> Bank of England Governor Bailey speaks<\/td> Gives further insight into the central bank\u2019s decision-making process.<\/td><\/tr> <\/td> Reserve Bank of New Zealand monetary policy decision<\/td> Reveals the latest decision on the path of interest rates.<\/td><\/tr> May 22<\/td> UK Consumer Price Index<\/td> Tracks the path of inflation.<\/td><\/tr> <\/td> UK Producer Price Index<\/td> Tracks the path of inflation.<\/td><\/tr> <\/td> European Central Bank President Lagarde speaks<\/td> Gives further insight into the central bank\u2019s decision-making process.<\/td><\/tr> <\/td> US Existing Home Sales<\/td> Indicates the health of the housing market.<\/td><\/tr> <\/td> Federal Open Market Committee meeting minutes<\/td> Gives further insight into the central bank\u2019s decision-making process.<\/td><\/tr> <\/td> Japan Purchasing Managers Index<\/td> Indicates the economic health of the manufacturing and services sectors.<\/td><\/tr> <\/td> Bank of Korea monetary policy decision<\/td> Reveals the latest decision on the path of interest rates.<\/td><\/tr> May 23<\/td> Germany Manufacturing and Services Purchasing Managers Index<\/td> Indicates the economic health of the manufacturing and services sectors.<\/td><\/tr> <\/td> Eurozone Manufacturing and Services Purchasing Managers Index<\/td> Indicates the economic health of the manufacturing and services sectors.<\/td><\/tr> <\/td> UK Manufacturing and Services Purchasing Managers Index<\/td> Indicates the economic health of the manufacturing and services sectors.<\/td><\/tr> <\/td> Mexico Gross Domestic Product<\/td> Measures a region\u2019s economic activity.<\/td><\/tr> <\/td> US Manufacturing and Services Purchasing Managers Index<\/td> Indicates the economic health of the manufacturing and services sectors.<\/td><\/tr> <\/td> US New Home Sales<\/td> Indicates the health of the housing market.<\/td><\/tr> <\/td> UK GfK Consumer Confidence<\/td> Tracks UK consumers’ views of their finances and the economy.<\/td><\/tr> <\/td> Japan National Consumer Price Index<\/td> Tracks the path of inflation.<\/td><\/tr> May 24<\/td> UK Retail Sales<\/td> Measures consumer demand.<\/td><\/tr> <\/td> Germany Gross Domestic Product<\/td> Measures a region\u2019s economic activity.<\/td><\/tr> <\/td> US Durable Goods Orders<\/td> Tracks new orders placed with manufacturers for long-lasting goods.<\/td><\/tr> <\/td> Canada Retail Sales<\/td> Measures consumer demand.<\/td><\/tr> <\/td> University of Michigan Survey of Consumers (final)<\/td> Assesses US consumers\u2019 expectations for the economy and their personal spending.<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n