For all the hand wringing over the Election – the personalities and the policies – investors’ attentions, mercifully, seem to have re-focused largely on the state of the U.S. economy and, oddly, the temperament – ‘hard landing or a soft landing?’ – of a pre-determined slowdown.  Getting out on the road to meet with clients is always an important barometer of investor sentiment.  While the equity market outlook among investors remains decidedly bullish (as we write, the market continues to press to all-time highs) it is notable that the number of economic bulls appears to be thinning.  An important juxtaposition from our last writing on these pages; prior to the early- August Yen carry trade[1] disruption, it would have been fair to characterize incremental “bad news” as “good news” for the market.  Since then, the opposite: “bad news” is “bad news.” The Fed felt behind the curve and cut the policy rate -50bps.  Safe to say the next leg up will require investors to scale a wall of worry…   

But what of the economy behind the tape?  To start, the shine has certainly come off the Magnificent 7[2] and adjacent erstwhile growth darlings.  Technicians will note the group’s price charts peaked in 2Q, even earlier.  While the 7 operate across a diversified set of industries, investors’ views of them have largely been attached to the emergence of Artificial Intelligence.  Price action aside, the economic implications and the fundamental considerations for longer-term investors are more involved.  “AI” remains an important theme, but for consumers and investors, it is likely a long game.  The technologies currently on offer commercially are not particularly new, or even exciting, if one considers the reach of their purported utility – we believe the real technological advances are yet to come.  There is no doubt that the seeds of innovation in development offer tremendous advancements in quantum computing, AR/VR, emotional inference, the works… but while that percolates in the background, investors have been focused on the “infrastructure phase:” chips, large language models, co-location power… billion dollar stuff that piques interest and boosts the capex data enough to give it all some air of legitimacy.  While the buzz won’t go away entirely perhaps now were entering the “quiet phase:” business use casework, application R&D, data management, FP&A…  As our colleague Tom Tzitzouris, Strategas’ Fixed Income Strategist, has posited, if AI is going to be a thing its benefits must accrue to more than just the providers of AI.  Moreover, AI will likely have to bring productivity gains to industries long succumbed to Baumol Disease[3], e.g., education, transportation, healthcare.  AI’s standing as an organic driver of growth is likely secure.  The concern is that broad economic benefits will take longer to gestate than this cycle has time for. Stay tuned. There is more to come. 

The U.S. economy has recovered from the pandemic largely on the back of four sources of strength: “Big Fiscal,” “Big Immigration,” the consumer and, Artificial Intelligence.  The former are both political constructions whose relevancy to this economic cycle hinge very much on the outcome of the Election.  As we note above, while AI is likely to stay relevant and remain an attractive outlet for capital investment, the pace of financial returns     appears to have slowed and the public-facing equities have ceded leadership to a more diversified slate of cyclicals and rate sensitive stocks.  Is the U.S. consumer strong enough to carry the load?  While cumulative, foreign, central bank actions and the bond market are notable co-conspirators, we believe the Fed’s ultimate decision to begin to unwind Chair Powell’s “higher for longer” rate policy can be traced to solid evidence that inflation remains anchored in the vicinity of acceptable levels, i.e., a “2-handle,” coupled with the emergence of widening cracks in the labor market. 

Note: The U.S. CPI[4] rose +0.2% M/M in August to 2.5% Y/Y while Core (ex-food & energy) rose +0.3% M/M to 3.2% Y/Y.  Perhaps, as Strategas’ chief economist Don Rissmiller highlights, a little high on Core for the Fed’s liking but it was largely due to the slow-moving, housing variables, i.e., old news. 

There is a package of timely data that is weakening and supports the Fed’s pivot.  U.S. light-weight vehicle sales slipped M/M in August and overall retail sales followed. Small businesses remain under pressure based on the August NFIB survey[5].  Non-farm payrolls rose a moderate +142,000 M/M last month with downward revisions to prior months of -86,000.   Private payrolls rose just +118,000 in August and the ADP data[6] again confirms this slowdown.  While there remains discrete pockets of the labor market intent on harvesting their share of recent increases in operating margins, on balance the labor market is tightening and the consumer weakening.  Once labor market weakness starts, it tends to worsen quickly, and this economy likely cannot stand on all four of its sources of strength, turning off or down at the same time. 

Thus, in the short-term, the most important spigot is Big Fiscal.  No legislation of significance will come into law before year-end, absent the exogenous.  How willing and how much can the Treasury Department prime the pump ahead of the Election and into year-end?  Quarterly tax payments from mid-September will serve as a drag on liquidity – money leaves the taxpayer’s account – but it pads the Treasury General Account available for disbursement at the direction of Secretary Yellen.

With expectations for both GDP and earnings robust in 2H’24 and long rates lower, we are hesitant to get too bearish despite the recent rise in volatility.  While further market declines in the short-term seem likely, in the intermediate-term, we believe investors should be careful about fading the combined impact of further fiscal and regulatory stimulus ahead of the Election and the Fed rate cuts.  By our lights, this remains a correction in a broader uptrend.  We remain overweight Equities in our tactical allocation portfolios, though it is prudent to reduce exposure to international markets given the epicenter of the sell-off.   

Nicholas Bohnsack