August 19, 2024 – The 2024 Paris Olympics wrapped up this month featuring standout performances from sharpshooter Yusuf Dikec, breakdancer Raygun, and the ever present Snoop Dogg. By standout performance we mean meme-worthy entertainment.
Alas, now society’s collective attention moves to the world’s next big star-studded event, the next Federal Open Market Committee (FOMC) meeting, which will be held on September 17th and 18th. This momentous event is notable as it will feature the Fed’s next phase of monetary policy, with significant potential effects on markets and the economy.
The next FOMC meeting is consequential as it will likely feature the first rate cut from the Fed since the Covid pandemic-led market panic in the spring of 2020. During the onset of the pandemic, in addition to reducing interest rates to zero, monetary authorities released near unprecedented economic stimulus, which ultimately led to out of control inflation starting just a couple of years later and the ratcheting up of interest rates to a 23-year high of 5.0% to 5.25% by 2023.
Source: MacroTrends
The implications for the Fed’s much-speculated upcoming rate-cutting cycle are significant. On one side, some fear the Fed will keep monetary policy too tight for too long, causing pain for the labour market and ultimately instigating a recession. On the other side, investors fear that the Fed may ease too quickly and risk causing another bout of inflation, repeating the mistakes of previous central bankers and prolonging the pain of restrictive monetary policy.
Ultimately, the Fed will want to engineer the much sought-after soft landing, which entails normalizing interest rate policy while keeping inflation in check and the economy out of a recession.
Earlier this month, consumer price figures indicated the inflation rate fell to 2.9% in July, the lowest rate of price growth in three years. In addition, the Fed’s preferred measure of inflation, represented by the price index on personal consumption expenditures (PCE), fell to 2.5% in June.
The market now believes that inflation is well on its way to the Fed’s 2% target, granting the central bank the “permission” to cut rates at its next meeting in September. A rate cut from the Americans will follow similar moves from the Bank of Canada, the Bank of England, and the European Central Bank, which have all commenced their rate cutting cycles in the past couple of months.
Speculators are betting with a near certainty of a rate cut from the Federal Reserve next month, ascribing a 74% chance of a 25bps reduction and 26% odds of a larger 50bps cut.
With a reduction in the fed funds rate in September all but assured, market prognosticators have moved on to speculate what the path of the Fed’s upcoming rate cutting cycle will look like.
Currently, the market is pricing in four rate cuts throughout the rest of the year, with a jumbo 50bps cut earmarked for December. Over the next twelve months, the market expects the Fed to notch down the fed funds rate by approximately 200bps.
Source: CME
Unfortunately, the market’s crystal ball tends to be quite murky, and market participants are quick to change judgment seemingly with every economic data release. Ultimately, the Fed remains data dependent, and data regarding the economy will guide its policy decisions. It was not too long ago when investors had high rate cut expectations, only to be disappointed by strong economic data that caused the Fed to hold rates higher for longer.
In any event, it is improbable that interest rates will decline to the unprecedented rock-bottom levels of three years ago. In addition, while the Fed only controls the short end of the curve, it is market participants who control all other aspects of the yield curve. With that in mind, the current 10-year Treasury yield of 3.9% already implies a smooth landing to a sub-3% fed funds rate, if we add a historical average term premium of 100bps that longer-term bond investors should demand for taking duration risk.
So, while investors can expect short term rates to fall, longer term yields appear to be already pricing in an inflation rate of 2% and the normalization of monetary policy.
Nonetheless, risks abound. For example, the stock market was spooked on August 2nd when the Bureau of Labor Statistics reported a job gain of just 114,000 in nonfarm payrolls in July, well below economists’ expectations. The U.S. unemployment rate ticked up to 4.3% in July, increasing 60 bps from its low at the start of the year, triggering the Sahm Rule recession indicator. The unexpectedly weak jobs report, along with a subsequent Bank of Japan rate hike, sent speculators into a bit of a tizzy, causing a quick stock market correction and one of the largest VIX surges on record.
Clearly, market participants are walking on egg shells. Although the economy continues to perform well, and stock markets continue their upward rise, investors are nervous as we approach the Fed’s upcoming rate cut next month and the subsequent monetary easing cycle to follow.
With that in mind, a prudent approach is to hedge one’s bets, which entails including short positions to offset (at least partially) one’s long market exposure to reduce risk. Ergo, we highlight one top-decile stock expected to outperform and one bottom-decile stock expected to underperform in this month’s AlphaRank Top Stocks.
OUTPERFORM: Meta Platforms Inc. (NASDAQ: META), formerly known as Facebook, is a leader in digital advertising, with its platforms serving billions of users globally. The company is known for its flagship social media platforms: Facebook, Instagram, WhatsApp, and Messenger. META is making its second appearance on Top Stocks, with its first appearance on June 18, 2023. Since highlighting the stock more than a year ago, its shares have rallied 87.7%. Some would think that after that market-beating performance, much of the juice has been squeezed out of the stock. However, META’s current top quantitative ranking across all 3,500+ liquid North American equities, based on proven drivers of return, supports the case for its stock outperformance to continue. Disclosure: Long META in the Accelerate Absolute Return Fund (TSX: HDGE, HDGE.U).
UNDERPERFORM: Interfor Corp (TSX: IFP) is one of the largest lumber producers in the world, with operations primarily in North America. The company produces a wide range of lumber products used in residential, industrial, and commercial applications. The lumber industry is highly cyclical, and a slowdown in housing markets and the corresponding decrease in lumber demand has negatively impacted Interfor’s profitability, leading to operating losses. In addition to its volatility, the lumber industry is highly competitive and capital intensive, leading to significant operational and regulatory risks. IFP’s bottom quantitative ranking indicates potential continued stock underperformance. Disclosure: Short IFP in the Accelerate Canadian Long Short Equity Fund (TSX: ATSX).
The AlphaRank Top and Bottom stock portfolios exhibited mixed performance last month:
- In Canada, the top-ranked AlphaRank portfolio of stocks gained 7.0%, outperforming the benchmark’s 6.1% rally by 0.9%. Meanwhile, the bottom-ranked portfolio of Canadian stocks gained 5.8%, underperforming the TSX 60 by 0.3%. The long-short portfolio (top – bottom ranked stocks) generated a return of 1.2% for the month and nearly 145% over the past five years.
- In the U.S., the top-decile ranked equities surged 7.7%, outperforming the S&P 500 by 6.5%. However, the bottom-ranked also gained 7.7%, leading to a flat performance for the long-short portfolio. Over the past five years, the top-ranked U.S. equities have gained more than 120% while the bottom-ranked portfolio has dropped by a quarter.
AlphaRank Top Stocks represents Accelerate’s predictive equity ranking powered by proven drivers of return. Stocks with the highest AlphaRank are expected to outperform, while stocks with the lowest AlphaRank are anticipated to underperform. AlphaRank assigns a numeric value to each security from zero (bottom-ranked) to 100 (top-ranked) based on selected predictive factors. All Canadian and U.S. stocks priced above $1.50 per share and $100 million in market capitalization are evaluated. In both the Accelerate Absolute Return Fund (TSX: HDGE) and the Accelerate Canadian Long Short Equity Fund (TSX: ATSX), Accelerate funds may be long many top-ranked stocks and short many bottom-ranked stocks. See AccelerateShares.com for more information.
