While the dog days of summer have arrived, investors have plenty to contemplate given a variety of developments on the political, interest rate and equity market landscapes.
Executive Summary
- Politics: We have recently experienced four “October Surprises” and it is still only July!
- Market Interest Rates: Bond traders are likely to force the Fed’s hand.
- Equities: After a strong start to the year, the equity markets have encountered headwinds, particularly in the large cap space, as equal-weighted measures and small caps have secured a bid.
Finally, the election and seasonality are bringing an increase in volatility.
The parlor games have started relative to beneficiaries of extended tax cuts and reduced regulation (cyclicals and value) in a Republican administration, with consumer stocks, clean energy and some healthcare related industries poised to outperform should the Democrats retain the White House.
At this point, we view these as speculative trades and encourage investors to maintain diversified, long-term strategies within their portfolios.
Download the Weekly Market Update
Politics
We have recently experienced four “October Surprises” and it is still only July!
To be sure, this presidential election season has been historic, with a conviction, a disastrous debate, an assassination attempt and a candidate’s withdrawal adding to the mix of uncertainty. During times like these, it is tempting to look to the U.K., which recently managed to select a new government in a matter of weeks - at a fraction of the cost - and without the attendant, seemingly unending, narrative-forming and stress-inducing media onslaught.
Despite the U.S. political drama, financial markets have performed relatively well, with market interest rates nudging lower and equities experiencing what appears to be nothing more than typical consolidation after a series of new records as we enter a period of seasonal weakness.
While the polls remain largely unchanged in a 50-50 country, much has changed relative to the historical comparisons for market performance. With President Biden’s withdrawal, the election is no longer considered a “re-election” and is now an “open election,” the historical significance of which points to higher volatility and lower return potential in the months ahead. See chart: S&P 500® Avg. Returns in Re-Election vs. Open Election Years.
History shows the late-July and early August period as a defining “break” for the S&P 500® Index during presidential election years. Re-elections tend to be more positive as investors appreciate the relative clarity ahead of the vote, while open elections typically are associated with more uncertainty and hence, elevated market volatility.
In addition, the performance of the S&P 500® in the 90-days prior to the election tends to be an accurate indicator (83% success rate) of the election’s outcome. Strategas Research Partner’s notes that since 1928, if the Index is up in the three months leading up to the vote, the incumbent candidate/party is victorious. Conversely, if the market declines during this timeframe, the opposition wins. On average, the S&P 500® declines fractionally (-0.66%) for the three-month period in open election years compared to the gain of +3.66% in re-election years.
Of course, more surprises are possible over the next 100 days, so let’s keep the focus on fundamentals including the direction of the economy, interest rates and corporate earnings when making investment decisions.
Market Interest Rates
Bond traders are likely to force the Fed’s hand.
Since the better-than-expected June CPI report, the yield on the 2-year U.S. Treasury bill has declined by approximately 35 basis points, to ~4.40%. The benchmark 10-year Treasury note fell roughly 10 basis points to 4.20%, further steepening the yield curve and bringing a positive slope within sight. See chart: U.S. Treasury Yield Curve.
While the benchmark 10-year Treasury factors into all manners of financing throughout the economy, we view the 2-year bill as more indicative of the direction of monetary policy. To this end, the spread between the upper bound of the Federal Funds rate (5.50%) and the 2-year Treasury is now greater than 100 basis points, suggesting the necessity for monetary policymakers to act soon.
We look for this week’s FOMC meeting to likely send a signal for a September rate cut, as policymakers need to balance the stronger than expected second quarter GDP report with trends for weakening inflation and employment data. Though market expectations include policy accommodation through next year, we suspect the Fed may prove more cautious, likely reassessing the impact of two rate cuts in the coming months, which would bring the Federal Funds rate in line with nominal GDP – approximately 2.0% GDP with ~3.0% inflation.
Equities
After a strong start to the year, the equity markets have encountered headwinds, particularly in the large cap space, as equal-weighted measures and small caps have secured a bid. See chart: S&P 500® Index.
We believe the weakness in the S&P 500® over the past few weeks is reflective of a combination of events and not just AI or the elections.
Second quarter earnings are coming in below expectations with little in the form of guidance to justify consensus expectations for 4Q and 2025. Corporate spending on AI has been significant, valuations in the space are elevated and investors are beginning to question the potential AI payoff. Consequently, traders are taking some profits off the table and seeking returns elsewhere.
The small cap space has been a big beneficiary of this trend, with strong momentum gains relative to large caps (~1,000 basis point) over the past few weeks. To be sure, small caps can benefit from Fed rate cuts in the coming months, but its conceivable monetary policy makers are likely to reduce rates 1-2 times, without a protracted easing cycle in 2025.
In addition, the profit landscape in small cap stocks is broad. For example, the Russell 2000 Index has approximately 40% of its constituents without earnings, while in the S&P 600, just 15% or so are unprofitable. Therefore, we encourage investors to go “up in quality” on their small cap exposures.
Finally, the election and seasonality are bringing an increase in volatility. The parlor games have already started relative to beneficiaries of extended tax cuts and reduced regulation (small caps, cyclicals and value) in a Republican administration, with consumer stocks, clean energy and some healthcare related industries poised to outperform should the Democrats retain the White House. At this point, we view these as speculative trades and encourage investors to maintain diversified, long-term strategies within their portfolios.
Be well and stay safe!
IMPORTANT DISCLOSURES
Comerica Wealth Management consists of various divisions and affiliates of Comerica Bank, including Comerica Bank & Trust, N.A. Inc. and Comerica Insurance Services, Inc. and its affiliated insurance agencies.
Comerica Bank and its affiliates do not provide tax or legal advice. Please consult with your tax and legal advisors regarding your specific situation.
Non-deposit Investment products offered by Comerica and its affiliates are not insured by the FDIC, are not deposits or other obligations of or guaranteed by Comerica Bank or any of its affiliates, and are subject to investment risks, including possible loss of the principal invested.
Unless otherwise noted, all statistics herein obtained from Bloomberg L.P.
This is not a complete analysis of every material fact regarding any company, industry or security. The information and materials herein have been obtained from sources we consider to be reliable, but Comerica Wealth Management does not warrant, or guarantee, its completeness or accuracy. Materials prepared by Comerica Wealth Management personnel are based on public information. Facts and views presented in this material have not been reviewed by, and may not reflect information known to, professionals in other business areas of Comerica Wealth Management, including investment banking personnel.
The views expressed are those of the author at the time of writing and are subject to change without notice. We do not assume any liability for losses that may result from the reliance by any person upon any such information or opinions. This material has been distributed for general educational/informational purposes only and should not be considered as investment advice or a recommendation for any particular security, strategy or investment product, or as personalized investment advice.
Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The investments and strategies discussed herein may not be suitable for all clients.
The S&P 500® Index, S&P MidCap 400 Index®, S&P SmallCap 600 Index® and Dow Jones Wilshire 500® (collectively, “S&P® Indices”) are products of S&P Dow Jones Indices, LLC or its affiliates (“SPDJI”) and Standard & Poor’s Financial Services, LLC and has been licensed for use by Comerica Bank, on behalf of itself and its Affiliates. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services, LLC (“S&P”) and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings, LLC (“Dow Jones”). The S&P 500®® Index Composite is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, or their respective affiliates and none of such parties make any representation regarding the advisability of investing in such product nor do they have any liability for any errors, omissions, or interruptions of the S&P Indices.
NEITHER S&P DOW JONES INDICES NOR STANDARD & POOR’S FINANCIAL SERVICES, LLC GUARANTEES THE ADEQUACY, ACCURACY, TIMELINESS AND/OR THE COMPLETENESS OF THE WAM STRATEGIES OR ANY DATA RELATED THERETO OR ANY COMMUNICATION, INCLUDING BUT NOT LIMITED TO, ORAL OR WRITTEN COMMUNCATION (INCLUDING ELECTRONIC COMMUNICATIONS) WITH RESPECT THERETO. S&P DOW JONES INDICES AND STANDARD & POOR’S FINANCIAL SERVICES, LLC SHALL NOT BE SUBJECT TO ANY DAMAGES OR LIABILITY FOR ANY ERRORS, OMISSIONS, OR DELAYS THEREIN. S&P DOW JONES INDICES AND STANDARD & POOR’S FINANCIAL SERVICES, LLC MAKE NO EXPRESS OR IMPLIED WARRANTIES, AND EXPRESSLY DISCLAIM ALL WARRANTIES, OR MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE OR AS TO RESULTS TO BE OBTAINED BY COMERICA AND ITS AFFILIATES, OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE S&P INDICES OR WITH RESPECT TO ANY DATA RELATED THERETO. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT WHATSOEVER SHALL S&P DOW JONES INDICES OR STANDARD & POOR’S FINANCIAL SERVICES, LLC BE LIABLE FOR ANY INDIRECT, SPECIAL, INCIDENTAL, PUNITIVE, OR CONSEQUENTIAL DAMAGES INCLUDING BUT NOT LIMITED TO, LOSS OF PROFITS, TRADING LOSSES, LOST TIME OR GOODWILL, EVEN IF THEY HAVE BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES, WHETHER IN CONTRACT, TORT, STRICT LIABILITY, OR OTHERWISE. THERE ARE NO THIRD-PARTY BENEFICIARIES OF ANY AGREEMENTS OR ARRANGEMENTS BETWEEN S&P DOW JONES INDICES AND COMERICA AND ITS AFFILIATES, OTHER THAN THE LICENSORS OF S&P DOW JONES INDICES.
“Russell 2000® Index and Russell 3000® Index” are trademarks of Russell Investments, licensed for use by Comerica Bank. The source of all returns is Russell Investments. Further redistribution of information is strictly prohibited.
MSCI EAFE® is a trademark of Morgan Stanley Capital International, Inc. (“MSCI”). Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.
FTSE International Limited (“FTSE”) © FTSE 2016. FTSE® is a trademark of London Stock Exchange Plc and The Financial Times Limited and is used by FTSE under license. All rights in the FTSE Indices vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE Indices or underlying data.comerica.com/insights
