Big day vibes

Good morning. The world’s largest asset manager, BlackRock, and the second largest company, Microsoft, are teaming up to invest in AI infrastructure in what will be one of the largest investment vehicles ever raised. Chipmaker Nvidia is also apparently involved. AI trading, which has looked a bit shaky of late, may be finding its feet again. Email us your thoughts: [email protected] and [email protected].

Market jitters ahead of the Fed

After two and a half years, the Federal Reserve will begin cutting interest rates today. Here’s a quick summary of how we see the market going into this announcement:

Investors are betting on 50 basis points. Markets had been expecting a quarter-point cut for some time, but reports late last week that the Fed was considering a half-point cut changed the outlook. As of yesterday, 66% of investors surveyed by Bloomberg expected 50 basis points. The futures market involves roughly the same odds.

The market seems to be responding not to economic news (there hasn’t been much in recent days, other than a strong retail sales report), but rather to what they perceive to be messages from the Fed. We’ll find out today if investors overread the tea leaves.

Investors expect a soft landing. According to Bank of America’s Global Fund Manager Survey, out yesterday, 79% of fund managers expect a soft landing – the highest reading since May 2023:

It makes sense that bets on “no landing,” or keeping inflation higher while the economy moves forward, have fallen as inflation has drifted toward the target. Interestingly, however, the proportion of investors who see a “hard landing” recession hasn’t moved much – it’s the same today as it was in March, May and July.

The market has been strong lately – and technology hasn’t been in the driver’s seat. The S&P 500 has had a decent run since the market crashed in late July, despite a jitter earlier this month. It briefly hit an intraday high yesterday. For much of August, that run was led by defensives like consumer staples and health care and rate plays like real estate and financials. Technology stocks, which have fueled the S&P for much of the past two years, appeared to be falling. At the time, I said it could be a sign of regime change.

That’s still a possibility. While the market has been fueled again by tech stocks in the past week, the overall direction of travel in July has been away from tech/growth and towards defensive/play rate/value. Here is the ratio of the return on consumer staples to the return on technology and the ratio of the Russell Value Index to the Russell Growth Index:

The market can be seen as a “frightened” bull. We are still in a rising market and sentiment remains strong, but caution is creeping in. The American Association of Retail Investors’ sentiment survey peaked in January and, while remaining at a high, is much lower:

Citibank’s Levkovich Index, a sentiment indicator that is based on AAII data but also a variety of other indicators, from short interest to gas prices, also remains very positive. But he recently retreated from extreme “euphoria”:

Investors did not build leverage on their trades, as we would expect if sentiment were at an all-time high. Here’s the margin debt in US trading accounts (note that this series only runs through July):

Part of the hesitancy may be because expectations for global growth – and particularly Chinese growth – are quite low, even as the US continues. This pessimism, combined with confidence that inflation is behind us, explains the deep unpopularity of commodities:

Some jitters can also be seen in the VVIX index, which gives an indication of expected volatility in the market. It has been largely above its panic threshold of around 90 since the market crashed in late July, suggesting the market is expecting some big price moves:

Options investors are on the fence. The put/call ratio on the S&P 500, which can indicate how bearish or bullish investors are, has been in its typical range over the past few weeks:

On the face of it, this is a little surprising given the importance of today’s meeting. “Between now and the end of next year, the only event with a bigger implied (market) move is the (US) election,” said Citi’s Vishal Vivek. “We believe the likelihood of S&P options breaking even (today) is high” — or that the increases in S&P 500 puts and calls today may cancel each other out because there is no clear consensus on how the market will move.

Russell Rhoads of Indiana University Bloomington added: “Investors are simply not paying for options to a point where it looks like there’s going to be an overwhelming move one way or the other tomorrow.”

In total: The bull market continues, with sentiment and prices near highs. Investors clearly have doubts about global growth and are wary of the possibility that the US labor market may be in decline rather than normalizing. Hence the popularity of defensive actions. But these worries are on the periphery. There is more room for disappointment than for positive surprises, and the Fed will need to remain alert.

(Reiter and Armstrong)

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