Switzer on Saturday

The rotation steps up a gear, but should you worry?

Founder and Publisher of the Switzer Report
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This week for stocks has been driven by rotation that’s raising the question: is this the start of a correction? And an unhelpful shock for stocks from came from left field was a global outage by cybersecurity technology company Crowdstrike, which has taken the systems of many companies temporarily out of operation.

For the record, its share price was down close to 13% in one trading day, but the surprise has made many market players have thoughts about corporate vulnerability, not just from cyber criminals but from our very dependence on a handful of critically important big tech businesses.

Locally, the Optus outage in 2023 reinforces the argument. Add the global outage for Crowdstrike to this and it has to make you wonder how our switch to alternative energy supplies could create outages or blackouts that again could make businesses and share prices vulnerable.

Back to the rotation that looked less dramatic for market indexes overnight. All four major US indexes were down based on increasing expectation or complacency that the Fed will cut interest rates in September. This is possibly a classic case of how a market can ‘buy the rumour and sell the fact’. This means that the market has been going up on the belief that rate cuts will eventually come and now that those cuts are closer than ever before, some smarties could be taking profit.

Let it be emphasised that the Fed boss Jerome Powell has been saying a lot more than usual, which is pointing to rate cuts being close.

This is how Reuters reported the central bank’s messaging to the market: “Powell and other Fed officials say they want to begin cutting rates before inflation actually hits 2% since the impact of monetary policy takes time to reach the economy. Waiting too long, they fear, could keep interest rates too high and slow things more than necessary.”

This is the opposite of jawboning, which is generally seen as central bankers using communication to reinforce rate rises to help lower spending and get success from monetary tightening policies.

Reuters also looked at what Citi’s experts have interpreted from these Fed messages: “We expect a strong signal in July that cuts will begin at an upcoming meeting,” the analysts predicted. “It is likely September if the economy evolves as expected.”

According to the money market, the expectation of a rate cut in September is at 90%. This followed a good CPI last week, when the measure of inflation declined 0.1% from May, putting the 12-month rate at 3%, around its lowest level in three years.

Interestingly, despite this higher anticipation that the much-looked-for rate cuts seem ‘oh so close’, the S&P 500 was on track for the worst week in three months before the closing bell. Of course, this could be over-interpreted as a sign that a correction or pullback is coming, especially when you throw in the history of  pre-US election market action, which coincides with the more challenging months of August, September and October for markets.

Also there must be a bit of post-assassination reaction as the chances of Donald Trump becoming US President again would be starting to worry some company CEOs and the investors who are long those companies. The would-be president has told the Fed that he’d prefer no rate cut before the election, which Jerome Powell has seemingly ignored, telling the market that politics won’t determine the timing of rate cuts — economic data will.

What we’re seeing is a litany of market-hitting and market-helping forces, but this from Glen Smith, chief investment officer at GDS Wealth Management on CNBC, sums up the big driver of recent US market action: “The stock market is experiencing a long overdue rotation. Investors are taking money out of big tech stocks which have performed so well and moving that money into other areas of the market.”

This is a transitional phase for the market and is actually good news that the rotation is giving more breadth to the US rally, which has helped and will help our market sneak higher as we await the eventual start of our rate cuts, which will give us another leg up for stocks.

Over the next few weeks, we’ll see US reporting and our companies will do their full-year show-and-tell in August as well. The outlook for US companies is good, while at home it could be a mixed bag. But given interest rates haven’t bitten as hard as was hoped by the RBA, we could see some better-than-expected profit results.

This from Nicholas Bohnsack, founder of the US-based Strategas Research Partners, is a sensible take on the market: “From a tactical perspective July and August would appear a good opportunity to take stock of the current fundamental environment, resist the temptation to (over)react to every ebb-and-flow of the political discourse and, ultimately, focus-in on the areas of thematic momentum that are likely to carry through year-end and into 2025.”

CNBC wisely headlined this observation with “Strategas remains bullish on market, economy…”, which is also a wise way for investors to think about how they should play stocks for the next 12 months.

Lower interest rates, historically, are great for stocks, especially if there isn’t excessive talk about a recession on the horizon, which is certainly the case now in the US and here.

To the local market and the S&P/ASX 200 index seemingly had a bad week but actually rose 0.15% to finish at 7971.60, which means it’s up 4.51% year-to-date and 8.85% for the past 12 months. Our market wasn’t helped by the US market rotation out of big tech stocks into other companies and sectors, and the poor growth story out of China didn’t help either.

Home builder Lifestyle Communities lost 13.94%, with the AFR telling us that the company “…pulled all forward earnings and operational guidance, blaming its decision on the media and uncertainty over its construction business.”

And the owner of Afterpay, Block, dropped 4.3%, after it “announced it’s set to close down the operation of its Cash App peer-to-peer payments business in the UK.” (AFR)

China didn’t help our miners, and commodity prices dipped. BHP lost 4.79% for the week to $41.76, while Rio slumped 5.36% to $113.99.

Friday wasn’t great for REITS, with “Goodman Group shares losing 0.8 per cent, Dexus down 2.4 per cent and Charter Hall Group sliding 2.1 per cent”, the SMH reported.

However, Dexus was up 0.88% for the week to $6.84.

For more of Friday’s action, here’s the SMH again: “Mercury NZ (up 4.9 per cent) was the best megacap performer, followed by TechnologyOne (up 1.82%) and plumbing equipment supplier Reece (up 0.8%).”

What I liked

  1. This from AMP’s Shane Oliver: “The good fundamental news is that global inflation is continuing to fall with a global monetary easing cycle falling into place.”
  2. Despite the too strong jobs report here, this from Oliver is worth noting: “Reflecting the slowdown in forward looking indicators our Jobs Leading Indicator points to slower jobs growth ahead”.
  3. Fed Chair Powell reiterated a dovish message noting that “the three [inflation] readings in the second quarter do add to confidence” that inflation is moving sustainably to target.
  4. The IMF again revised its global growth outlook up slightly. It has 2024 at 3.2% and 2025 at 3.3%.
  5. The Fed’s Beige Book had anecdotal evidence that reinforced the message of slowing growth and easing inflation, which is good for future rate cuts.
  6. Oliver again: “It’s still early days in the US June quarter reporting season with only 13% of S&P 500 companies having reported so far but 82.5% have beaten expectations against a norm of 76%.”

What I didn’t like

  1. The strong employment number of 52,000 in June, which keeps live the arguments that the RBA should raise interest rates.
  2. Local housing starts and completions fell in the March quarter, confirming the poor indicators from approvals.
  3. Chinese data for the June quarter points to a further slowing in growth. GDP growth slowed to 4.7% year on year.
  4. US retail sales were stronger than expected in June, which isn’t great for rate cuts.

Good & bad news for stocks

I liked this from Shane Oliver: “Good and bad news for investment markets. The good news is that US June quarter earnings reports are likely to be strong, inflation globally is still falling, and more central banks are heading towards rate cuts, and this should lead to improved valuations and shares anticipating stronger growth in 2025. The bad news is that valuations are stretched, recession risks remain high, geopolitical uncertainty particularly around the US election is high and we are coming into seasonally weak months for shares. So, while we see more upside in shares on a 6–12-month view, the risk of a significant correction as we come into the seasonally weaker period from August is high.”

This is a very realistic take on investing for the year ahead.

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This from CBA’s Gareth Aird: “For the Reserve Bank of Australia (RBA), the June unemployment rate is broadly in-line with their May forecast of 4.0%, but annual jobs growth is stronger than their estimate of 2.1%.”

But despite this he pointed out that Thursday’s “labour market data slightly shifted investors’ expectations towards another cash rate hike from the RBA in August, with futures implying a 20% probability from 12% before.”

Chart of the Week


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Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.