U.S. stocks were choppy this week, but the big story might be the broadening of the market rally. Small-caps have outperformed the S&P 500 for 11 straight trading days, the equal weight S&P 500 index is outperforming the traditional index by a wide margin this year, and the year-to-date sector leaders are all cyclicals and defensives. In other words, tech is fading and diversification is winning again. The economic data, including the latest inflation and retail sales numbers, were fine, but the question of Fed independence is the biggest macro wild card at the moment.
Tip of the Week
With gains starting to come from other areas of the market besides tech, portfolio diversification becomes more important. If tech & growth stocks are still a significant portion of your portfolio, consider recently unloved areas of the market, including value stocks, dividend payers, and small-caps. This can help spread out and reduce risk as well as give you the opportunity to continue capturing positive returns during a market rotation.
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Market Moves
Weekly Market Snapshot:
- S&P 500: -0.4% – the rotation out of mega-cap tech continues, although market breadth last week actually looked much better than the major averages would indicate.
- Nasdaq 100: -0.9% – the cloud of uncertainty hanging over Fed independence and the geopolitical backdrop is causing investors to shift away from growth stocks.
- Russell 2000: +2.0% – small-caps have outperformed large-caps for 11 straight trading days, something that hasn’t happened since 2008.
- VIX: 15.9 – volatility ticked modestly higher later in the week, but is still failing to signal any kind of stress in the system.
- Gold: +1.7% – gold tends to rise in periods of geopolitical uncertainty and that’s exactly what we saw this week.
- 10-Year Treasury Yield: 4.23% – Treasury yields remain stuck in a range and are weighing the impact of the Fed’s threats from the White House along side an uncertain economic path.
Drivers:
CPI remains contained, which was a good sign for the markets, but it’s the stuff in Washington that’s preventing the major averages from moving much higher. The idea of a White House-controlled Fed would create incredible market instability. The administration’s push to take over Greenland is creating plenty of geopolitical animosity. Even the proposal to cap credit card rates could make the split in the K-shaped economy even wider. The rotation to non-tech and small-caps reflects that as investors seek out better value. The lack of movement in Treasury bonds, however, tells us that investors aren’t abandoning equities altogether.
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Economic Highlights
A couple of the notable themes that stood out this week:
Inflation Remains Stable But Still Elevated
The December CPI report came in roughly in line with expectations. The core rate was up 0.2% month-over-month, while the headline rate rose 0.3%. That brings the annualized rates to 2.6% and 2.7%, respectively.1
Inflation in the United States shows no sign of approaching the Fed’s 2% target anytime soon. Efforts from the Trump White House would make that even less likely. Everything that the president has suggested in recent weeks – tariff checks, his bond buying announcement, his push for the Fed to lower rates sharply, caps on credit card rates – is all inherently inflationary. Trump has been singularly focused on getting the U.S. economy to run faster, but any one of these could send inflation higher and run the risk of a 2022 repeat. With the Fed ending quantitative tightening (QT) late last year, the catalysts are all there.
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Q4 Earnings Season Gets Off To A Sluggish Start; Still Depend On Tech As The Driver
The big banks kicked off the Q4 earnings season this past week. The reports themselves didn’t deliver any big surprises, but the threat of rate caps on credit card debt are likely to limit any bullishness in this sector until the issues gets resolved.
As we get further into the earnings season, it’s clear that tech and the magnificent 7 stocks are going to need to deliver on heightened expectations. While AI optimism is still healthy, much of the upside is already baked into share prices and valuations are getting stretched to the point where there’s not much room for error.
Source: Goldman Sachs.
Take away the magnificent 7 stocks and earnings growth expectations for large-caps are pretty dull. Big tech simply has to deliver this quarter or any miss could pull the major averages sharply lower. In fact, big tech is going to need to deliver over the next several quarters. It won’t be until about a year from now where the biggest AI-related earnings growth rates start to subside and the rest of the economy starts to catch up. From a market performance standpoint, improved breadth is a good thing, but it’ll be another several quarters that the market is heavily tech-dependent.
Retail Sales Suggest A Good, Not Great, Holiday Shopping Season
U.S. retail sales in November rose 0.6% month-over-month, beating expectations for a 0.4% increase. In general, that would indicate a good start to the holiday shopping season, but there are some warning signs if you dig a little deeper.2
Sales at general merchandise and electronic stores were flat. If you exclude sales from things, such as gas stations and food stores, sales were up a more modest 0.4%. Consumers are still pretty clearly feeling the pinch. There’s plenty of evidence showing that they’re struggling, but it still has yet to show up in a major way in the headline numbers. This is likely a function of the K-shaped economy. Spending from higher net worth households is offsetting the struggles in the lower group. This makes the economy look good at a high level, but very vulnerable when you look closer.
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The Week Ahead
A few themes to watch next week:
In Summary
The markets biggest hurdle right now is a loud geopolitical backdrop. Whether it’s bluster or substance remains to be seen, but it’s certainly creating caution at the moment. The big market rotation away from tech continues as investors favor small-caps, value stocks, and cyclicals as a means of diversifying risk.
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