Skirting the Truth

May 6, 2024

By Pete Biebel, Senior Vice President, Senior Investment Strategist
Print This Post Print This Post

One of the oldest stock market tenets is the Hemline Index. The theory holds that rising hemlines are bullish: An era of shorter dresses would bring higher stock prices. While there may have been some correlation between market averages and skirt lengths, there was little if any causation. It’s along the same lines as expecting a good year for stocks when an original NFL team wins the Super Bowl. One does not necessarily lead to the other.

For much of this year, the stock market has been operating on a similar logical non sequitur: The belief is that U.S. Federal Reserve (Fed) rate cuts, whenever they might occur, will be bullish for stocks. Historically, the broad stock market averages have generated higher-than-average returns in the 12 months following the Fed’s first cut. The theory assumes that a Fed cut would reduce interest rates across the board, which in turn would spur the economy, increasing corporate profits and stock valuations. The Fed controls the federal funds rate; it’s the interest rate at which commercial banks borrow and lend their excess reserves to each other overnight. By lowering that rate, the Fed can increase liquidity to hopefully stimulate the economy. Higher fed funds rates should theoretically reduce liquidity and slow economic growth.

We need to keep in mind that the key word there is “overnight.” The Fed controls a very short-term interest rate. While interest rates on U.S. Treasury bills and other short-term fixed-income securities are very highly correlated with the fed funds rate, that correlation decreases as the maturity of the securities lengthens. Many other factors impact longer-term Treasury rates, like the size of current fiscal deficits and future funding needs. With both those factors running at staggeringly higher levels, the reliability of that historic correlation should be questioned.

Expecting those two things (very short-term rates and long-term Treasury bond rates) to move in tandem is where the theory breaks down. It might work, but don’t count on it. The “higher for longer” label has been applied to the Fed’s policy on its overnight rate. I’m afraid that the more painful part of higher for longer will not be in short-term rates but in the longer end of the maturity spectrum. Short-term rates likely will be at least a little lower later this year, but longer-term rates could well be higher.

Last week, the market continued its Pavlovian response to hints of a sooner-than-later Fed rate cut. Fed action and rhetoric revealed in its policy statement last Wednesday, combined with Friday’s sympathetic economic data, had the bulls drooling. Those developments on balance pointed to improving prospects for a first Fed cut in the coming months. In turn, the major market averages all posted gains late in the week. While the Fed left its target rate unchanged, Fed Chairman Powell stated that a future hike was “unlikely,” and the Fed also reduced the pace of its balance sheet runoff, effectively lessening the impact of its “quantitative tightening.” Friday’s jobs report indicated a much smaller-than-expected increase in non-farm payrolls and a 0.1% uptick in the unemployment rate to 3.9%.

Following a stumbling start for the week, the averages all went out in style. Late-week strength enabled the S&P 500 Index (SPX) to fashion a net gain of 0.55% for the week. The Dow Jones Industrial Average (DJIA) tacked on 1.14%. The NASDAQ Composite Index (COMP) strutted higher on Thursday and Friday for the week’s net gain of 1.43%. Lower interest rates through the week helped the utilities (+3.39%) and real estate (+1.54%) sectors lead the pack, while a generally positive response to earnings announcements from some of the leaders in its sector helped technology to a third-best 1.35% gain for the week. Following the company’s announcement of first-quarter results and the expansion of its massive stock buyback plan Thursday afternoon, shares of Apple Inc. spiked higher by nearly 6% on Friday.

Despite a seemingly seamless positive week for the market, there were a couple wrinkles below the surface that made the week a little less comfortable. First was the market’s maxi/mini reaction to the Fed comments on Wednesday. SPX initially rocketed higher from near its low of the week, climbing about 1.4% in the hour following the announcement. But it then gave back all of that gain in the following 45 minutes. It made the initial knee-jerk response look like a bull trap. Second, on both Tuesday and Wednesday, the market averages fell precipitously in the final 10 minutes of trading. SPX plunged about 0.6%, and COMP tanked about 0.8% each time. Falling that steeply into the close on no news on any one day would be troubling; for it to occur in back-to-back sessions is the sort of behind-the-scenes tidbit that has the bears licking their chops. If there’s any consolation in those declines it may be that a lot of month-end portfolio adjusting comes in the form of “market-on-close” orders.

Another development worthy of note is more an observation than a wrinkle. One of the most loathed of the international equity markets has quickly and unexpectedly become the leader. China, which the majority of analysts had written off as un-investable, has been hotter than a firecracker. Over the past three months, one measure of China large-cap performance has gained more than 30%, topped off by 5.64% and 7.75% successive gains in the past two weeks. Perhaps the fever and fervor over artificial intelligence is spreading among Chinese companies as well. But some perspective is necessary. Since topping out in early-2021, that index lost more than 50% of its value and was trading near 16-year lows last January. That index is now short-term overbought for the first time in nearly three years, so even the most bullish of the new China devotees might want to wait for a bit of a pullback before diving in.

Earnings season activity has peaked, with about 80% of the S&P component companies having already reported. That flood of reports will dwindle to a relative trickle in the coming weeks, though one very prominent name, NVIDIA Corp., is not due to report until later this month. So far, earnings and revenue growth have exceeded expectations in about 75% and 34% of the announcements, respectively. While that sounds terrific, it’s actually right in line with the historical percentage beats. Companies tend to downplay their forward guidance because it’s always better to beat the consensus than to fall short of it. More important than the companies’ announcements are the market’s reactions to them. Perhaps it has been because valuations were already expensive that the general reaction this quarter has been a bit more bearish than normal.

One key development in last month’s market decline was when SPX fell below its 50-day moving average three weeks ago. The index continued lower, breaking 5100 and reaching a low of 4954 a week later. As the market has rebounded over the past two weeks, SPX has climbed back to that breakdown level. The index has bumped into the moving average several times, including last Friday, when it closed at 5128, just two points below the 50-day. We should find out fairly quickly this week whether the index will be able to sustain trade above the moving average. Doing so would increase the probability that the market’s timeout is over and an attempt at a new high lay ahead. However, failing to decisively clear the 50-day and falling back below the 5100 level would be a warning that the two-week bounce has run its course and another leg down and a lower low are likely.

This week’s economic calendar is skimpier than Twiggy’s miniskirt. Barring any jarring geopolitical warring, earnings reports are likely to be the primary catalysts through the week.

Economic Calendar (5/6/24 – 5/10/24)



Monday 5/6/2024 No Reports Scheduled
Tuesday 5/7/2024 Consumer Credit, March



Wednesday 5/8/2024 Wholesale Inventories, March, M/M



Thursday 5/9/2024 Initial Jobless Claims



Continuing Claims



Friday 5/10/2024 Consumer Sentiment, May




Links to previously published commentaries can be found at Investment Insights/Market Commentary/Market