Market review 24.07.27
Make macro boring again
Hello everyone,
The message I’ve been writing so far this year is that we want to remain bullish stocks but that we are late in the bull market. Maybe the latter part is not entirely correct.
Today, I want to explore what the next couple of years could look like, where the opportunities could be, and set realistic expectations.
Let’s begin.
The Intermarket
We’ve examined how prices of key commodities (e.g., lumber, wheat, corn, gas, etc.) have returned to pre-2020 levels.
The year-over-year change in PCE, the Fed’s preferred measure of inflation, hit a 40-year high in June 2022 and peaked above 7%. Currently, this measure is sitting at 2.5%, which is about the historical average and not far from the Fed’s 2% target.
Bond yields and interest rates climbed rapidly in 2022 to combat high inflation. Rates have remained elevated for the past two years to ensure inflation is tamed and PCE reaches the target level or close to it.
Below is the yearly chart for the US 10-year Treasury Yield (TNX).
Notice how TNX peaked at the upper Bollinger Band (BB). If PCE inflation settles at 2-2.5%, it’s very realistic that TNX settles at the mid-BB level of roughly 3% on the above chart and stays there for years.
Bond yields cooling off is in line with Commercial Hedgers getting record-long bonds in August last year and remaining very long:
This is The Great Normalization. Macro becomes boring. Consumers and businesses have more certainty about the future and more breathing room on loans.
Let’s see what this could mean for risk assets.
Fundamentals
By late 2022, when it became clear that inflation was coming down but that rates would remain stubbornly elevated until PCE reached below 3%, institutions piled into quality large-cap stocks with large cash balances and healthy growth rates. They avoided debt-laden small-caps.
This trend persisted for almost two years. We’re now at the point where the winners over the past year hit egregiously high valuations and have seen heavy insider selling. The laggards hit attractive valuations and have seen insider buying (especially in the rate-sensitive areas of banks, REITs, and biotech).
Examples of the former: Quality software stocks such as CRWD, NET, and SNOW exceeded 22x forward sales multiples in recent months - this is where the top quartile of software multiples peaked in 2021. Meanwhile, insiders have sold over $300M in each of these stocks over the past year.