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Big part of stock market unconvinced economy is going anywhere

by Clarence Jones

Title: Cracks in the Stock Market Reflect Dubious Confidence in American Growth

Amidst the enthusiasm surrounding artificial intelligence (AI) and its potential impact on various industries, a closer look at the stock market reveals a lack of robust confidence in American economic growth. While AI-related companies like Tesla Inc. and Nvidia Corp. continue to soar, banks and industrial companies struggle to make substantial gains. This disparity is evident in benchmark indices that minimize the influence of mega-cap companies, showing meager growth. Additionally, small-cap stocks, which traditionally indicate the health of the economy, are displaying worrisome signals rarely seen in the past two decades. These underlying trends raise concerns about the broader market’s conviction in the future of the economy.

Uneven Performance in the Stock Market:
The lackluster performance of banks and industrial firms compared to the tech sector’s rapid rise suggests that there are hidden cracks beneath the market’s surface. Matt Miskin, co-chief investment strategist at John Hancock Investment Management, points out that the market is experiencing relative weakness in small-cap stocks and broader underperformance, indicating a lack of breadth. This trend is in contrast to historical patterns where small-cap stocks lead in recovery periods.

Small-Cap Stocks and the Russell 2000:
The Russell 2000, a widely followed small-cap stock index, has recently fallen behind an index of the 1000 largest-capitalization stocks for two consecutive months. This underperformance suggests that small-cap stocks are on track for their second-worst annual performance since 1998. Typically, the stock market’s performance relies on the strength of small-cap stocks as they generate a significant portion of their sales within the US. However, even as economists become more confident in the Federal Reserve’s ability to engineer a soft landing, the market’s underbelly remains unconvinced.

Concerns and Alarming Signals:
The recent week’s performance highlights the uncertainty within the market, with the S&P 500 and Nasdaq 100 experiencing slight declines. Smaller firms have struggled to keep pace with the broader market’s rally led by tech giants. Liz Ann Sonders, a strategist at Charles Schwab & Co., notes that only about 40% of Russell 2000 stocks are trading above their 200-day moving averages, compared to over 90% during the market’s recovery from the 2020 trough. This discrepancy raises questions about the strength of the economy.

Conflicting Economic Indicators:
While many economic indicators suggest strength, the August inflation rate exceeded expectations, leading economists to anticipate further interest rate hikes by the Federal Reserve. Some forecasters are also reevaluating their economic projections and recession predictions after positive reports on consumer spending and residential investment. However, Goldman Sachs and the Federal Reserve Bank of Atlanta both suggest that the market might be sensing something the data has not yet revealed.

Implications and Strategies:
Given the prevailing uncertainties, some market strategists recommend defensive measures. Bank of America strategists, for example, advise investors to consider assets like regional banks and small caps that have already priced in a potential economic downturn. These assets may be better positioned to weather a recession or, in the absence of a recession, provide significant upside potential.

Despite the exuberance surrounding AI and the immense success of tech giants, the performance of banks, industrial companies, and small-cap stocks reveals a lack of confidence in American economic growth. The stock market’s top-heavy advance raises concerns about the overall breadth of market participation. As economic projections and recession probabilities fluctuate, investors should remain cautious and consider defensive strategies to navigate potential headwinds in the market.

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