Stocks rose on Friday erasing Thursday’s losses. For the month of July, the S&P 500 has gained another 3% adding on to June’s gains. Breadth also widened. Bonds continued to trade within a range.
By now, if you read my comments with any regularity, you know about my 2-day rule. Essentially, a trend remains in place until at least 2 consecutive daily moves of significance in the opposite direction confirm a change. Most of the time, when I discuss this, markets are searching for a bottom. In bear market times, there are often ferocious one day rallies that never morph in to a real change in direction. Those sudden rallies are often the result of short-covering. For them to be real, they need to last longer than one trading session to confirm a possible real change in investor psychology. Obviously, the rule isn’t perfect. But I have never seen a market bottom in all my years that didn’t feature a reversal of at least two days at the very bottom.
Now, we face the opposite situation. Momentum is strong to the upside. Partly it reflects belief that a recession can be avoided despite the sharp increases in interest rates. In part, it reflects momentum. The longer it continues, the more investors capitulate and step in for fear of missing out. Fundamentally, the economy has been a little stronger than anticipated. Last week’s report of 2.4% GDP growth in the second quarter was a smidge higher than anticipated. Inflation fears are waning after a series of reports in July showed subsiding wage pressure, smaller increases in shelter costs, and moderating air fares.
We don’t know if a true trend toward lower inflation is firmly in place but a growing percentage of economists believe so. That is enough to encourage traders to keep buying. How long can this run continue? I have no idea. By all historic measures, stocks are fully valued. The longer prices continue to rise, the more expensive stocks get for new buyers. I will use my 2-day guideline to judge when some sort of top is set. Last Thursday’s decline was one day, actually only a fraction of one-day. One word of caution. Bottoms are almost always V-shaped. Tops more often reflect a rolling over of confidence. The fear of losing or getting wiped out is stronger than the fear of simply missing opportunities. While I note often that stocks today are not cheap, the exuberance that marked the end of the Internet bubble in 2000 or the SPAC/IPO nonsense of early 2021 isn’t present now.
For a real top to occur, exuberance has to collide with a change in consensus economic outlooks. As noted, fears of a recession are receding, but that doesn’t mean one won’t occur. The bond yield curve is still strongly inverted. Fed policy works with a lag. It is quite possible that the full impact of all the Fed’s interest rate increases won’t happen until next year.
With all that said, as investors we buy stocks, not the economy. Even in the worst of times there are companies that continue to grow. 2023 has been marked by continued strength in consumer spending and a pickup in capital spending, as companies shift supply chains in response to the snarls created during the pandemic and political fears related to China. There are some signs that the surge in travel and spending for experiences is starting to slow down. Airfares, at least domestically, are starting to come down. Attendance at Disney World and Universal Studios theme parks in Florida is down this summer, in part due to a surge in ticket prices and in part due to the heat. Spending on goods is sporadic. Consumers are getting some help from lower gasoline prices, but they aren’t declining further. This fall student loan debt payments will start to resume. A slower economy probably suggests the downward inflation trend will continue. But it is unlikely that growth of 2.4% can be sustained as consumers build up credit card debt and save at a slower pace.
But back to the point that we buy stocks, not the economy. Our economy is still growing but it is changing. The surge in experience spending may be running its course. Chinese growth is slowing and deflation may be setting in. What we are likely to see is yet another shift in spending patterns. In 2020-2021, the hot spots were anything related to working from home. In 2022-2023, it was about catching up after being quarantined by rules restricting how we spent our time (and money). I don’t know any better today than a few months ago whether we face a mild recession or not in 2024. It probably matters less than one thinks. What I am more confident of is that substantial parts of the economy will slow while some of the sectors that suffered most in 2023 will recover. There are also economic sectors permanently changed by behavioral shifts instigated by the pandemic. I think it will be a very long time before all workers go back to the office five days per week. But in slower times, a shift in that direction is likely. Housing shortages will keep homebuilders busy, but lack of inventory will keep total transactions down and prices elevated. How we buy cars has changed as well. Tesla introduced a buy-direct model. Dealers like that. No costs to carry inventory. To be sure, car lots are filling up again, but they won’t get back to pre-pandemic levels. As a buyer, you will have fewer choices on the lot or you can custom order at a higher price and wait weeks or longer for delivery.
These are simply a few shifts. There are many more. Economic patterns shift all the time. We all know about the declines in the newspaper industry. Now demand is so low that it is becoming uneconomical for anyone delivering papers. No more paper boys on bicycles. No one delivers milk to your door anymore either. Look at the cable TV companies. Everyone is cutting the cord. Cable service as we have known it is becoming a streaming service. But to stream, one needs a broadband service. The best is cable or fiber based. Cut the cord and the cable or phone company simply charges you more for broadband. If all the cord cutters add up their broadband and streaming service costs, they are likely to find they are paying more, not less. Oil and commodity prices surged when Russia attacked Ukraine. But consumers of energy and wheat adjusted quickly, pulling prices back down. Now they are starting to climb again.
Thus, there are clouds in the sky. Some are threatening, some are not. Back to the word pivot. Good managements adjust to changing times. Weak managements don’t change; they simply blame a changing world for their misfortune. The New York Times becomes a digital news organization. Community newspapers focus on local news and events that no one else will cover. They too enter an omnichannel world. Companies that make consumer staples modify packaging and distribution. They increase automation. Tech companies increasingly focus on the use of artificial intelligence. In fact, everyone is exploring the cost, quality and time saving opportunities of AI.
2024 may be a slower growing year than 2023 but many companies will continue to grow. They will gain market share via superior execution. They will gain market share because their strong balance sheets will allow them to invest for better productivity while competitors will be locked out for lack of capital. They will identify new opportunities. No one wants to overpay to buy a stock, but building a position over time makes sense. If you want to own 25 stocks, with each being a 4% position in the ideal, start with a 1% stake and average in over a period of time. Buy in equal dollar increments, that way you buy more shares at lower prices and fewer shares when prices are high. Assuming you are betting on a successful company, you will do just fine over time.
Whatever we face, economically, in the months ahead, it doesn’t seem negative or positive enough to warrant adjusting one’s long-term asset allocation. There are signs of irrational behavior at times that are obvious signals to stay clear. The SPAC craze or negative interest rates are clear examples. None of those are present today.
Thus, I respect the market’s current momentum while noting that stocks aren’t cheap at these levels. Using dollar cost averaging is a tool to mitigate market risks. For well-run companies, there are plenty of long-term opportunities. As investors, sticking with the best is rarely a bad idea.
Today, author J.K. Rowling is 58. Wesley Snipes turns 61. Former tennis star Evonne Goolagong Cawley is 72.
James M. Meyer, CFA 610-260-2220