Russell Builds a Base, China Looks Inward, and What's Up With Treasuries?
Here's what I'm eyeing in the market right now as earnings take on more weight in day-to-day moves.
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Earnings are starting to play a bigger role in day-to-day market moves. Predicting earnings on a company-by-company or aggregate basis is impossible, but here is what I’m watching and think will play out in several areas of the market, including in small caps, artificial intelligence, China, and Treasuries.
Small Caps and Value Stocks
The “hurdle” for low price-to-earnings companies is quite ... low. The Russell 2000 seems to be building a base. Value stocks are doing OK. As we have seen periodically in the last year or so, there is intense interest in the markets for some new leadership to develop. We’ve seen some big shifts out of mega-cap tech and into the Russell 2000 late last year and earlier this year. We saw a similar phenomenon into Chinese stocks recently. I like the “laggards” again and will be adding if they deliver after earnings. I expect they will, but we need to see that come out. Banks are another key are in that respect.
When AI Generates a 'Story,' Check It Out
The “AI story” continues to need validation. There may be very high hurdles set up for many of these companies, and I think that, no matter how good the earnings and projections sound, it will be difficult to hold on to recent gains.
I think the most important thing I heard on last quarter’s earnings was when Walmart WMT attributed some of their success to their use of AI. If we get more moments like that, then it is off to the races for AI and the broad market.
China Stimulus and ETF Plays
Chinese stimulus was vague and continues to be at the smaller end of expectations. As discussed, I expect this to be an iterative process. They will add and tweak to try and accomplish their goals – which are primarily to drive domestic consumption of domestic brands. We had recommended lightening up last week ahead of the re-opening, and now am back to adding as I think the China Large Cap ETF FXI and the China Internet ETF KWEB will rise over the coming weeks.
One interesting note was a report that China might charge the very wealthy an unrealized capital gains tax on their foreign holdings.
Everything I see here is all about China and helping their domestic situation. That could get dangerous over time, which is why I still consider this a trade rather than an investment.
Inflation and the Neutral Rate
I’m not concerned about inflation taking off, but I think the “best days” are behind us for now. The hurricane damage may not only hurt supply chains, which will be inflationary, but the rebuilding once insurance checks start coming in will also be inflationary.
We are hearing more and more about the neutral rate, or terminal rate (I view the somewhat interchangeable) and will continue to, as the Fed’s policy discussion shifts from starting to cut, to how many cuts. 3.5%, which is my view of bottom end of the range for the neutral rate, seemed almost preposterous a couple of weeks ago, but is now getting mentioned by some important Fed speakers as being in their view of possible ranges!
Bottom Line
It is very difficult to remain bearish on Treasuries here; 4% seemed high as a target on the Ten Year and 4.2% seemed off the radar screen not so long ago. While it seems treacherous to be bearish here, there are a few things that are making it very reluctant to turn bullish:
Inflation and the neutral rate are not helping bonds and both topics, if we are correct, could put pressure on bonds.
We finished auctions of the Ten- and 30-Year, which should have been a good opportunity for markets to reverse course -- and they didn’t. That seems peculiar and is probably what concerns me the most.
I’ve been wedded to the idea of 25 basis points on Two-Year vs. Ten-Year, and while that is back to 14, that could still break through 25.
Maybe I can be “neutral” on rates, but think, when push comes to shove, still higher yields is likely the pain trade, which means, we probably get it.
Yet, I'm still extremely comfortable with credit.
On equities, I'm skewed toward laggards, equal weight and value. I'm most overweight China relative to anything else. Eyeing commercial real estate for outsized positions – not there yet, but trying to glean info from bank earnings calls. Energy, which is fading this morning after Israel indicated that they would not attack Iranian energy targets, is worth buying as the geopolitical risk coming into our election remains high.
At the time of publication, Tchir was long FXI and KWEB.
