Market Journal: The Week Ahead

September 1, 2024

Discussion

The Outlook

The S&P 500 closed Friday at 5648, 23.7 and 20.4 times 2024E and 2025E EPS of $238 and $277. Historical fair value metrics would put the high end of SPX’s fair value at 17.5 times earnings; and to adjust for what is likely overly optimistic projected growth for 2025 (16.4%), let’s say a good earnings stream to capitalize is the 2024/2025E EPS average, or $258. This puts SPX fair value at 4515.

With the bond market projecting around 200 bps of rate cuts through the end of 2025, expectations for the Fed’s upcoming rate cutting cycle are in a maximally dovish posture for what is still a relatively strong macro. Call it Peak Fed.

And with NVDA’s stock price reaction to a still-bullish earnings report, following a marked deterioration in AI semiconductor relative strength over the preceding weeks and months (SMCI being the case in point), it’s clear the “AI Trade” has reached a pause point at best, and a medium-term top at worst. Call it Peak AI.

Peak AI matters for two reasons. First, US AI equities are a global attraction, so it’s not as simple as: capital rotates from MAG7 to LAG493 with limited impact on SPX itself. As AI optimism peaks and the USD declines as a result of FED rate cuts, foreign capital is likely to leave the US equity market in a relatively steady fashion going forward. Second…

As Cem Karsan has highlighted in recent months, the AI Trade has been the epicenter of the upside call speculation that has helped “pin” SPX in a tight range on the way up, fueling massive dispersion beneath the surface and underwriting a gargantuan amount of VOL selling…which brings us to the third “Peak”: Peak VOL Selling.

Again leaning on Cem Karsan’s VOL market expertise, in addition to the AI Trade, H4L FED rate policy has underpinned consistent selling of structured products, the primary driver of SPX “pinning”. As rates come down, the attractiveness of structured products will diminish at the margin.

Adding it all up: The outlook for SPX over the next 12 months is one of a likely grinding cyclical bear market down to fair value by late 2025 (5648 to 4515 is exactly -20%). If inflation enters a second wave that forces the Fed to resume rate hikes, this grinding bear market could very well turn into a recessionary bear market that takes SPX down more than -35%.

The sustained upside case for SPX from current levels is the Fed cutting back to a 3% neutral Fed Funds rate by early 2025 in an outright effort to reaccelerate economic growth to ensure the labor market does not slip into contraction…which brings us to the tactical outlook for SPX and a pivotal week ahead.

The Week Ahead

With Chair Powell’s decisive “whatever it takes” pivot at Jackson Hole toward keeping the labor market in its current “full employment” configuration, monthly NFP prints are now of out-sized importance to the tactical SPX outlook, starting with this Friday September 6. The set-up here is interesting.

At $563 SPY is trading well above its $547 20dma and chopping around in a classic tactical topping formation.

Meanwhile, the bond market is assigning a 30% probability to the Fed launching its rate cutting cycle with a 50 bps cut in September in response to a weak September 6 NFP report, despite…

…the Fed and its allies communicating quite clearly that it favors a “measured” approach to rate cuts in order to preserve on-going “progress” on inflation.

Something along the lines of the following tactical path for SPY makes sense from here:

1. Pullback to the 20/50dma circa $545-550 ahead of the September 18 FOMC meeting in response to a not-weak-enough-for-a-50 September 6 NFP report

2. Rally back to $565-570 on a dovish September 18 Powell, which sets up…

3. The formal retest of SPY $510-520¹ ahead of Election Day, a decline that prompts the Fed to cut by 50 at the November FOMC

4. Once election uncertainty is relieved and the Fed cuts by 50, the stage will be set for a move up to SPX 6000 by year-end, the final rally before the move down to 4515 over the course of 2025

2018, 2019, and 2020 act as critical historical context for equity market volatility even with supportive policy support in place. Once volatility enters the market as it did in early August, it tends to take multiple pullbacks for market participants to become comfortable with sustained upside. This time is unlikely to be different.

WOTE Administration

Real-time analysis of and portfolio management around the tactical path will be conducted behind the paywall discussed below.

WAM Positioning

Core WOTE Asset Management (WAM) strategies are currently positioned as follows based on the above analysis: