The equities train keeps on rolling
Equities keep grinding higher, with the leadership baton passed to small caps (smaller companies) this week. Interest rate markets now expect a roughly 95% chance of a quarter point cut in September in the U.S., and futures imply at least one more by the middle of next year. And the likelihood of a rate cut in Canada is now around 80% before the end of the year. While these numbers have been highly unsettled lately, volatility swings have faded fast in the stock market. The VIX (the most popular equities volatility indicator) is at its lowest since December, and the MOVE index (a volatility indicator for fixed income) is back at early 2022 levels. Individual investors have been steady net buyers since late May, averaging about US$3 billion a day. Ninety per cent of companies have exited their blackout period (when they cannot buy back their own stocks), and August is typically a peak time for repurchases. Under the surface, a lot of investors have bet against Russell 2000 stocks (an index made up of smaller companies). This means that if these stocks perform surprisingly well, there could then be a surge in stock purchases of those smaller companies. If you add to this the growing calls for rate cuts — including those from U.S. Federal Reserve (the Fed) Secretary Bessent for rates to be 1.5 to 1.75 percentage points lower —the positive case for stocks remains very compelling into the year-end. And that’s even as we approach a more difficult seasonal period in September (listen to our podcast, “The summer slump explained”, for more details).
After better-than-expected Consumer Price Index (CPI) data, producer prices delivered a shock. The Headline Producer Price Index (PPI: the change in selling prices for U.S. producers) rose 0.9% month over month in July, the biggest monthly gain since 2022, pushing the year-over-year pace to 3.3%. Core PPI (which excludes volatile items, such as energy) matched that 0.9% monthly jump, which lifted the annual rate to 3.7%. Goods prices climbed 0.7%, with food up sharply, led by a near 39% surge in fresh and dry vegetables. Data from the Personal Consumption Expenditures Price Index (PCE), which is the Fed's preferred gauge for inflation, is messy. While some components have eased and others stayed firm, the broad message is that businesses are absorbing a meaningful chunk of tariff and input costs, rather than passing those costs on to the consumer all at once. If this continues, it will cushion consumers and help the Fed's case for cutting interest rates. If it flips, either earnings will compress, or inflation will reaccelerate. For now, the market is leaning toward the former, making a September rate cut more likely, but this is precisely the kind of report that keeps the policy debate lively.
Chinese equities have grown 15% since their April lows, with margin balances back to highs last seen in 2015 (margins are loans made to investors to buy more equities). Low savings interest rates and record household savings are putting capital into stocks, particularly shares in smaller companies, which are favoured by individual investors. Government policies have not delivered a blockbuster stimulus, but incremental steps to curb price wars and rein in overcapacity are helping sentiment, as is a slow thaw in trade rhetoric. The pessimistic take on this is that earnings have not yet caught up with prices, and sector performance remains uneven. The optimistic take is that liquidity can bridge the gap longer than skeptics expected, plus equities are benefiting from additional domestic investment input.
Looking ahead, momentum, buyback firepower and the likelihood of imminent interest rate cuts are still doing the heavy lifting as regards market buoyancy. However, high producer inflation data is complicating matters, so the next PCE and payrolls data will matter as regards how September will pan out. Positioning is tight, especially with smaller companies, which will make the next macro surprise unusually important.
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