19 Aug 19th August 2024

Weekly Index Movement

S&P500	+3.9%
Nasdaq	+5.4%
Aussie All Ords	+2.5%

Stock traders do make me laugh. The current focus on short-term leads to the majority of traders doing the wrong thing.

Last week I was writing about the largest down week for a couple of years. This week I am writing about the largest up week for a couple of years. If you had closed your eyes for the period you would think nothing has happened. But if you watch your account everyday, it would have been a rollercoaster. There is something to learn there.

Stocks fell two weeks ago because Japan raised rates by 25bps and some soft economic numbers started rumours of recession in the US.

Last week inflation numbers showed things are getting back on track.

The trend is definitely our friend when it comes to US inflation. Although it is a full percent above the Fed’s 2.0% target, policymakers can take comfort that it is declining again after its Q1 blip.

This opens the door for Powell to reduce rates at the September meeting. There is some talk of a 50bps cut, but that won’t happen. He will go low and slow to ease into it.

Especially after Thursdays announcement of July Retail Sales which roared back by 1% in a stronger than expected result. Walmart earnings backed up the strength of the consumer. Walmart CFO John Rainey said

“We see, among our members and customers, that they remain choiceful, discerning, value-seeking, focusing on things like essentials rather than discretionary items, but importantly, we don’t see any additional fraying of consumer health,”

He raised full-year sales forecasts on the back of this.

This puts the recession question to bed. As I have always said, it isn’t going to happen. The economy is too strong.

All of which is why stocks are back to where we started before things got silly two weeks ago. Last week I said it was likely we would get one more dip before the rally resumed. I was wrong. It took traders just a matter of days to switch back to buying mode once more.

So, the next question is, what do we buy to take advantage?

We are mid-way through Q3. Earnings season is officially over and the best performing large-cap sectors have been

• Real Estate (+9.0%)
• Utilities (+8.8%)
• Financials (+5.7%)

All three are interest rate sensitive. Real Estate and Utilities are basically bond market substitutes due to their bond-like dividend yields.

Large-caps are back to where they were before the silly two-weeks but small caps are still 5% lower. This tells me traders are less reluctant to quickly jump back into the positions they added in July when small-caps soared. It means we are not quite at full risk on mode yet.

You can see the same thing playing out in our model portfolios. The Top 30 Strategy (small-cap) is down -2.4% , and the Global Growth (large-cap) is up 0.4% while the Dividend Growth Strategy is up 5.7% in August.

But you don’t want to buy what has been, the trick with stocks is to understand what other people will want to buy in the future. It is called the Keynesian Beauty Test.

John Maynard Keynes was a very famous economist and his theories are what the western worlds economic policies are built upon. In his 1936 book, The General Theory of Employment, Interest and Money (you can see how interesting the books I read are) he gave a key insight into his investment process:

• Imagine a contest where you are shown pictures of 100 faces
• You are asked to choose the 6 most attractive faces.
• The winner is the one who picks the 6 faces that win the most votes.

The naive approach to winning this contest would be to pick the 6 faces you think are most attractive. A more thoughtful approach is to consider which faces are most appealing to the population at large rather than simply you, as winning is about correctly guessing what the majority of others will pick.

This why I mentioned that Ukrainian stock last week. It is out of favour now, but, once the war is over, others will want to buy it. I just don’t know how long this will take. I am fairly sure it will happen one day though.

What is likely to happen for the rest of this year is more confirmation of a resilient economy and the start of an easing cycle in rates. Other investors know this. Other investors also know we tend to see the highs of the year occur in Q4.

Therefore, the most obvious buys are large-cap tech and small caps. These are the sectors you want to buy now, before the herd. One could argue and say the herd has already bought large-cap tech which is why it is close to old highs. Which would leave small-caps as the preferred choice for the rest of the year.

Of course, you don’t have to put it all in one basket. You could do something like 60% large-cap tech through an ETF like VGT or QQQ and 40% small-cap through an ETF like IJS or IJR.

Whichever way you do it, make sure you are fully invested from here on out

Last comment for this week – there are no signs yet of a war in the Middle East. Oil is down at $74 a barrel. If there was any inkling at all that Iran was about to upset everyone, Oil would be moving higher, not lower. The Oil price is a much better indicator of potential future problems than a talking head on the radio.

Warning

Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account and might not be suitable for you.