Let me start by apologizing for the irregular market commentary since October. Our marketing team (Georgia) had her second baby on September 27. He decided to come a little early and she has been out on maternity leave working on growing him up since then. He is doing great and she will be back full time on January 1! During the interim we have been doing one commentary a month compared to the usual weekly.
This schedule hasn’t been much of a problem as stocks of most types rallied throughout the fall. Right now, however, we are seeing some increased volatility and a pretty significant drop in market breadth. What that means is fewer and fewer stocks are carrying the load. To me, this is never a good sign and can be indicative of a correction (which may be upon us as we speak).
Big tech has once again been the fuel that has kept the broad indices moving higher. The Nasdaq is up 30% so far this year and has outperformed everything else for the second straight year. That in and of itself is not the problem. The problem is when it continues to go up and value stocks, dividend payers and other cyclicals go down. This is what we have seen over the past month. The DOW Jones index (DIA) has now been down nine days in a row, for its longest consecutive losing streak since 1978 (per a CNBC article that ran today). Healthcare (XLV) is a major component of the DOW and is down more than 5% since the murder of United Healthcare’s CEO on Dec. 4 (CNBC).
Part of this recent diversion is also due to interest rates rising once again. The 10-Year Treasury Yield has climbed all the way back up to 4.40%. It started the year at 3.95% and reflects another year of losses for bonds and relative underperformance by diversified portfolios, which we (at Cabana) manage. According to a Bank of America article in 2023, this back-to-back-to-back loss represents the longest stretch of losses since 1787. Yep, you read that right 1787. To say that bonds and other fixed income assets have struggled since 2022 is a massive understatement. Unfortunately, the bond bloodbath impacts lots of other asset classes. It affects financing, earnings, liquidity, insurance premiums, real estate and access to capital. All of this plays into the divergence we see between big tech and other sectors. It may be that big tech and the AI phenomena are immune by virtue of a hyper-growth curve, but I doubt that. Eventually, other parts of the economy need to support technology and that is why a lack of market breadth is concerning.
The silver lining right now is that a recession does not appear to be around the corner and the consumer is relatively heathy from a debt-to-equity standpoint. This is why it seems to me that any immediate volatility in stocks will be short-lived. In my opinion, we need some real weakness to show up and put out the inflation fire once and for all. This will finally drop interest rates and perhaps provide the final reset to our economy that we have been waiting for over the past two years. My bet is that we get this sometime in the first quarter of 2025.
Lastly, let’s talk about energy. We are holding energy (XLE) in most of our portfolios, and it has been pounded this year. Typically, energy rises in a growing economy and tracks rising yields. I have included a chart of XLE and the 10-Year Treasury Note below. As you can see, they track each other… up until recently. So, what is the reason for the disconnect? It may be the idea that the Trump administration is going to “drill, drill, drill”. It may be that the threat of tariffs implies a slowdown in global economic activity. It may be that economic strength is not what it appears to be, and a recession could be waiting in the arms. Or maybe it is just a temporary wonder. I don’t know, but I can tell you that energy historically does well in a strong economy. This is worth watching.
At Cabana, we remain bullish but are preparing to reallocate should a more serious pullback occur.
XLE and the 10-Year Treasury since March via Stockcharts.com:
Terms to know:
- XLE is the Energy Select Sector SPDR® Fund, which seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Energy Select Sector Index (the “Index”).
- DIA is the SPDR® Dow Jones® Industrial AverageSM ETF Trust, which seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Dow Jones Industrial AverageSM (the “Index”).
- XLV is the Health Care Select Sector SPDR® Fund, which seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Health Care Select Sector Index (the “Index”).
