• The stock market managed to close the week on a positive note
  • Defensive sectors are showing strength
  • The chances of a FED interest rate cut were pushed back to November

Investors have shown remarkable resilience on Friday! Despite the initial PCE (inflation) data meeting expectations and triggering a stock market rally, a subsequent significant selloff led to continued volatility. However, in a testament to unwavering investors’ optimism, equities surged higher in the final 30 minutes of trading. The S&P 500 ($SPX) and Dow Jones Industrial Average ($INDU) closed higher, while the Nasdaq Composite ($COMPQ) recovered from a wide price range to close flat.

The stock market’s performance is a fascinating interplay of many factors, making it a complex subject of study. While it is not always possible to pinpoint a specific reason for market movements, a few potential factors could have contributed to the climb in the stock market during the last 30 minutes on Friday: earning reports, friendly inflation data, or, most likely, a rebound from a 2-day sell-off and an oversold market.

The reality is that the stock market, although it remains in an uptrend, may encounter some short-term volatility. Yes, Friday’s recovery and closing were solid, and the fact that the S&P 500 Index and the Nasdaq held the 20-day EMA (exponential moving average) is technically important. However, Technology (XLK) was the worst performer of the week, down -1.78%, while the Real Estate sector (XLRE) and Utilities (XLU) were the top performers. During the month of May, Utilities (XLU) was the top performer. And YTD (year-to-date), XLU is the second-best performer. These defensive trends, if persistent, could have short-term implications for investors to consider. More on this later.

In previous articles, I mentioned that we expect the stock market to rotate between Phase II and III in the economic cycle during the second half of the year and even into early 2025. This is still the case, and we remain bullish for the rest of the year. Although the stock market did not collapse during the mentioned rotation period in the past, the problem was that volatility spiked as GDP decelerated and inflation accelerated in Phase III. With inflation accelerating, the rhetoric of the FED regarding monetary policy and interest rates becomes the most important factor in determining stock market direction. If the FED overreacts, Phase IV, where both GDP and inflation decelerate at the same time, becomes a reality, and the stock market collapses. If Phase IV were to happen (keyword: IF), would the FED’s overreaction be possible? Yes. Is it probable? No one knows.

In addition to an inverted yield curve, currently at -0.40%, if Treasury Yields and the US Dollar regain their short-term uptrend, then the above scenario may become a reality. For those underestimating the negative effects of inflation, remember that at the beginning of the year, between four and six interest rate cuts were expected starting in May/June. All those cuts have vanished, and now the futures market estimates only one cut by the end of the year. If this one cut is compromised by a little tiny acceleration in inflation, then what? I am not trying to be a party pooper, but as a Risk Manager with a fiduciary responsibility to protect your capital, my job is to figure out where the next crisis may come from, mainly when the Yield Curve remains inverted in anticipation of an economic recession.

The table below shows the three-month performance of the eleven sectors in the S&P 500 Index, including the index itself (SPY), Nasdaq 100 (QQQ), and Dow Jones Transportation Average ($TRAN).

It is important that Technology (XLK) and Consumer Discretionary (XLY) retake leadership. XLK is about 29.3% of the S&P 500, and XLY is about two-thirds of GDP; therefore, the importance of these two sectors for a sustainable bull market. Utilities (XLU) and Consumer Staples (XLP) are among the most defensive sectors in the index. If this rotation of capital from growth sectors into defensive sectors continues, volatility will increase. Remember that volatility and stock prices move in opposite directions. Higher volatility lowers stock prices and vice versa. In a thriving economy, Transportation should not be at the end of the line.

Please remember that our forecast may change as economic data becomes available.

Consider not being fully invested, taking on smaller position sizes, and holding a higher cash allocation.

Thank you for the opportunity to serve you. We appreciate your confidence and trust in our conservative investment strategy and risk management approach while dealing with the inevitable volatility of financial markets. We are grateful for your trust in our team.

Please feel free to contact us should your personal circumstances change or if you have any questions.

Check the Main Trends of stock indices, volatility, yield, currencies, and more here.

(*) The Greenwich Creek Capital “Index Trend Table” is not meant to be used in isolation, it is part of a more complex set of variables and it is not designed to provide trade entry and exit points.

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Saul A. Padilla, RIA

Saul A. Padilla, RIA

Registered Investment Adviser and founder of Greenwich Creek Capital Management LLC, bringing over 37 years of experience in managing discretionary and non-discretionary investment portfolios for wealthy families and institutions. His main focus is to protect invested capital by re-balancing the allocation of cash, equities, fixed income and commodities, while closely monitoring macro-economic indicators and market trends to determine the transition phase between the completion of a Bull Market and the beginning of a Bear Market. He started his career in early 1987 mainly managing family financial investments.