Shifting Sands: Investors Move From Big Tech Amid Rate Cut Speculation

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

The 2024 election has been dominating the national news for weeks, and there was yet another major development this weekend with President Biden’s decision not to seek a second term. Investors should expect more short-term market volatility as a result of the president’s announcement. Echoing what we wrote just one week ago, investors are best served by sticking to their long-term plans in moments such as these.

Last week, equities were mixed as investors continued to move out of the so-called “magnificent seven” and into previously overlooked, cyclical asset classes like Small and Mid-Cap stocks. This move was in response to increased investor confidence about a 25-basis-point rate cut at the Fed’s September meeting. Should the much anticipated rate cut materialize (and we suspect it will), investors believe it could mark the beginning of a sustained unwinding of the Fed rate hike cycle that began in the spring of 2022. As a result, many believe the economy will thrive as the drag of high interest rates is lifted. The thinking goes that as economic strength broadens, so will the list of winners in the markets, including previously overlooked asset classes.

While we acknowledge a series of rate cuts would increase the odds of a potential soft landing, our view is more cautious, as we are not convinced a September rate cut will necessarily mark the beginning of a sustained rate cut cycle. That’s because the Fed is unlikely to declare victory until it has seen several months of easing inflation. Additionally, with wage growth still running at a level above what the Fed believes is compatible with inflation running at a sustainable 2 percent pace, we think the Fed will want to see more signs of slack in the labor market.

While the Fed waits for that slack to show up, there are growing signs that the economy is slowing. Indeed, Leading Economic Indicators (LEI) from the Conference Board fell 0.2 percent in June, the fourth straight month of decline and the 27th of the last 28 months. Over the first half of 2024 the LEI has fallen by 1.9 percent. While this is a smaller decline than its 2.9 percent contraction in the second half of last year, the latest level still suggests slowing economic growth lies ahead.

What’s more, the latest retail sales numbers from the U.S. Census Bureau show overall retail sales remained flat from May’s upwardly revised level of 0.3 percent but were better than Wall Street estimates. Despite the flat overall number, the details were a bit stronger, with sales excluding autos and gas up 0.8 percent after last month’s 0.3 percent advance and April’s decline of 0.1 percent. The latest report shows retail sales are up 2.3 percent on a year-over-year basis, down from the upwardly revised 2.6 percent pace in May, which overall is slowing and is less than the inflation gain. Sales figures are adjusted for seasonal variation and holidays but not for price changes. That means that year-over-year sales have risen slower than inflation. Ten of 13 categories measured saw increases, led by non-store retailers. The mixed retail sales data comes on the heels of two months of weaker consumer data. Consumer spending has been a driving force in the post-COVID recovery, and we will be watching to see if the recent weakness is an emerging trend as depleted savings and rising credit card balances begin to affect consumers.

Meanwhile, continuing unemployment claims continued to edge higher last week; 243,000 initial claims were reported, bringing the four-week moving average to 234,750. While the number was likely inflated by Hurricane Beryl hitting the Texas coast, overall claims remain in an uptrend. Importantly, in a sign of labor market weakness, continuing claims rose by 20,000 to 1.87 million, which is the highest level since November 2021, when the labor market was recovering from COVID. With labor being a lagging indicator, we fear the Fed is going to have a difficult job of perfectly threading the needle and not cutting too early versus waiting too long to see labor market weakness which tends to trend.

Wall Street wrap

Beige Book suggests modest economic growth: The latest release of the Federal Reserve’s Beige Book, which provides real-time anecdotal assessments of business conditions across the country, showed that the pace of economy rose slightly from the prior reading in the majority of the 12 Federal Reserve districts. While seven of the districts reported slight to modest growth in activity, five reported flat or declining activity, which was three more than during the last period.

Given the impact a tight labor market and elevated wage growth have on inflation, it’s noteworthy that several districts reported some slowing in the pace of wage growth. Overall wage growth was still characterized as modest to moderate in most districts. The slowing of wage increases was attributed to increased worker availability and less competition for workers. Similarly, hiring appears to have eased, with most districts reporting flat employment or modest growth. Lower labor turnover rates were cited as one of the reasons for the downtick in hiring. As it relates to the trend in employment, several districts noted that employers expect to be more selective in hiring and may not backfill existing open positions.

Pertaining directly to inflation, most districts reported modest price growth, with two regions reporting only slight increases. Once again, several sources in the districts noted consumers pushing back on price increases, with several retailers resorting to price discounts.

Homebuilders’ confidence moves lower: Mortgage interest rates hovering just below 7 percent continue to weigh on homebuilder optimism. The latest sentiment reading from the National Association of Home Builders came in at 42, down one point from June and the lowest level since December 2023. With little relief in sight from high mortgage rates, homebuilders are increasingly turning to price cuts to spur demand. The latest survey shows 31 percent of builders offered price cuts, up from June’s level of 29 percent in total; the latest survey shows 61 percent of respondents reporting offering some sort of concession, unchanged from June.

The downbeat mood of builders is not expected to change anytime soon. With expectations that the Federal Reserve will cut interest rates in September, we will be watching this index for signs of improving optimism.

Housing starts increase: The latest housing starts data from the U.S. Census Bureau shows residential starts rose 3 percent in June from the prior month to a 1.35 million annualized rate. On a year-over-year basis, starts were down 4.4 percent. Single-family housing starts shrank by 2.2 percent from May’s revised pace to a seasonally adjusted, annualized rate of 980,000 units. Meanwhile, multifamily starts (buildings with five or more units) were 360,000, up 22 percent from May’s revised pace but down 23.4 percent year over year.

Total building permits also rose in June by 3.4 percent to 1.45 million. Single-family permits declined 2.3 percent from the prior month to 934,000. Multifamily permits came in at 460,000, an increase of 19.2 percent from the prior month.

The week ahead

Monday: The Chicago Federal Reserve Bank releases its national activity index. The report looks at economic activity across the country and related inflationary pressures. Last month showed an uptick in progress, although the three-month trend moved lower. We’ll be paying close attention to indications of whether the recent improvement was statistical noise or a sign of improvement for business conditions.

Tuesday: We’ll get a look at existing home sales mid-morning from the National Association of Realtors. This report, along with the new homes data released on Wednesday, should give a clearer picture of whether the housing market remains stalled due to high interest rates.

Wednesday: We’ll get an update on the health of manufacturing and services in the U.S. when S&P Global releases its Flash Purchasing Manufacturers Index reports for June. Activity rose last month, while prices continued to climb, albeit at a slower pace. We will be watching for signs to determine whether the uptick in expectations seen in last month’s survey results was a temporary statistical blip or the beginning of a trend. Prices paid will also be a point of interest for us.

The U.S. Census Bureau will release data on new home sales for June. We’ll be looking at this data to assess the impact that fluctuations in mortgage rates have had on demand for newly built homes.

Thursday: The Bureau of Economic Advisors will release its first estimate of gross domestic product growth for the second quarter. Estimates call for overall economic growth to clock in at 1.9 percent after last quarter’s 1.4 percent. We will be looking for any significant divergence from consensus estimates.

Data on durable goods orders for June will be released to start the day. We’ll be watching for signs of the direction of business spending in light of signs of slowing economic growth.

Initial and continuing jobless claims will be out before the market opens. Continuing claims trended higher last week, and we’ll continue to monitor this report for signs of eroding strength of the employment picture.

Friday: The June Personal Consumption Expenditures Price Index from the U.S. Commerce Department will be out before the opening bell. This is the preferred measure of inflation used by the Federal Reserve when making rate hike decisions. Given the downtick in Consumer Price Index during the quarter, this measure of inflation is expected to come in flat on a month-over-month basis. We’ll be monitoring to see if the latest data shows a change in the pace of disinflation.

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