To The Moon

• Traders now expect 3 rate cuts by the end of 2024, compared to only 1 rate cut expected one month earlier. There is a 90% chance of a September rate cut, up from about 70% earlier, while the probabilities of rate cuts in November and December are above 50%.

• Other than softer-than-expected inflation data, I reckon a weaker-than-expected labor market is the key driver for spiking rate cut expectations.

   

Source: CME Fedwatch

Why might the labor market be weaker than expected?

1) April and May job numbers revised down sharply.

• The US labor market initially added 165K and 272K jobs in April and May respectively, but recently, the non-farm payrolls were revised down to 108K and 218K for those months.

• In other words, there were 111,000 fewer jobs in April and May than previously estimated, suggesting the labor market may not be as robust as initially portrayed.

May: 272K >> 218K

April: 165K >>108K 

2) The Beveridge curve indicates the unemployment rate may rise.

• The Beveridge curve shows the relationship between job vacancies and the unemployment rate in an economy.

• Based on the April job vacancy rate and unemployment rate, the US is now situated near the flatter part of the Beveridge curve.

• To put it simply, if job vacancies continue to fall, it risks the unemployment rate increasing significantly.

   

3) The Sahm Rule Indicator suggests that we are near a recession.

• The Sahm Rule  is an economic indicator that signals the start of a recession when the 3-month moving average of the unemployment rate rises by 0.5 percentage points or more relative to its low during the previous 12 months.

• Currently, the average unemployment rate over the past 3 months is now 0.43 percentage points higher than its low point over the past year, suggesting that the US is near a recession based on the Sahm Rule.

   

 What is the impact of rising rate cut expectations?

1) Tech sell-off

Tech stocks, especially large tech companies, are facing a sell-off after an impressive rally this year as investors rotate their funds into laggard stocks.

2) Funds rotating into Real Estate, Financials, and Industrials sectors

Financials, Real Estate, and Industrials sectors increased (+3.77%), (+4.87%), and (+5.13%) in the last week.

For those interested in these sectors, the Financial Select Sector SPDR Fund (XLF ETF), Industrial Select Sector SPDR ETF (XLI ETF), and Real Estate Select Sector SPDR (XLRE) are some of the largest sector ETFs to gain exposure.

3) Small caps are finally attracting investors' attention.

• The iShares Russell 2000 ETF ( $iShares Russell 2000 ETF(IWM)$ ), representing smaller companies, has risen by 10.44% in the past week.

• Historical data suggests that the shift from large-cap tech to small-caps could persist for roughly four weeks, offering potential investment opportunities.

• When there was a rotation from October 27 to December 27, 2023, the IWM ETF rose by 26.27%.

 Conclusion:

• I am unsure how long the rotation will last.

• It may be a bit late for investors to start learning about the investment thesis of small caps, Real Estate, Financials, and Industrials sectors if they have not already acquired ample knowledge about these sectors.

• If investors do not have strong conviction in the rate cut beneficiary sectors, it might be a better investment strategy to wait for a better entry price to accumulate tech stocks/ETFs such as the Magnificent Seven, VanEck Semiconductor ETF ( $VanEck Semiconductor ETF(SMH)$ ), TSMC $Taiwan Semiconductor Manufacturing(TSM)$ , ARM $ARM Holdings Ltd(ARM)$ , Broadcom $Broadcom(AVGO)$ , ASML, and AMD.