The Fed Rate Cutting Cycle Has Already Been Priced Into The Market

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8/25/24

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Powell embraced a shift towards cutting rates during his Jackson Hole speech on Friday. After all, the market has been anticipating this pivot for two years. The market has been front-running the rate-cutting side of the equation for what feels like forever. Do we believe that rate cuts aren’t already priced into equity valuations?

With the S&P 500 trading at 22 times next year’s earnings, can we say rate cuts aren’t factored in? Also, the PE ratio of the S&P 500 today is almost double what it was during the 1994 soft landing campaign.

Another factor to consider is that the next twelve months (NTM) EPS growth estimates for the S&P 500 are rolling over, whereas in 1994, the growth rate was accelerating into 1995. In 1994, we had a low PE ratio paired with accelerating growth, which is the opposite of today. PE ratios tend to anticipate growth; as they anticipate slowing growth, they often trade ahead of expected growth, and come down.

Another interesting thing about EPS growth is that it tends to track the 10-year Treasury rate over time. This is likely because a falling or rising 10-year rate often signals the pace of economic growth.

The EPS growth also tends to follow breakeven inflation expectations because these expectations measure economic growth.

It used to be that China’s credit impulse led earnings growth, but the credit impulse has wholly died and has been non-existent since peaking in 2020, with recent data showing it has vanished altogether.

In fact, the SOX index, which represents the semiconductor sector, was heavily tied to China’s credit impulse. At this point, whether it is, is unclear.

Or perhaps the surge in U.S. spending has helped to offset some of the decline in China’s credit impulse.

The point is that the market has clearly already front-run the Powell Pivot, especially for the major indexes. PE multiples are stretched, and earnings growth rates, based on the available data, appear to be rolling over. At the same time, economic growth is certainly slowing, as evidenced by the declining rate of inflation. From a fundamental standpoint, the pullbacks we’ve seen in the market so far make sense, as does the rebound. This seems to be a period of transition, similar to what was observed in the winter of 2022.

I noticed yesterday that some social media influencers were discussing how bearish engulfing patterns might not be as bearish as they seem. However, the bearish engulfing pattern observed this past Thursday seems similar to the previous pattern starting in July 2023.

Thursday, July 27, 2023, and Thursday, October 12, 2023, stand out as two instances of bearish engulfing patterns.

Then there were also bearish engulfing patterns on Thursday, April 4, 2024, and Thursday, May 23, 2024.

There were the bearish engulfing patterns on Thursday, June 20, 2024, and Thursday, July 25, 2024.

Then there was this week’s bearish engulfing pattern on Thursday, August 22, 2024.

Now, if you go back through the chart, you will see that these patterns all occurred on a Thursday and were typically followed by a positive day on Friday. However, it wasn’t until the following Wednesday that the real impact was felt. Since October 2023, there have been five bearish engulfing patterns followed by a positive Friday, with the sell-off not starting until Wednesday of the following week. The one fake-out appeared to come in May 2024.

So, I guess we won’t know the outcome of this past Thursday’s bearish engulfing pattern until Wednesday, which, coincidentally, is the day Nvidia reports its results.

Good luck!

-Mike

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