Yahoo Finance

Stocks losing some steam in the final trading day of the week, pressured by disappointing housing data out before the bell. But for the week though, it's a very different story. The S&P 500 and the Nasdaq are both still on track for their best weekly performance in nearly a year since last November. For more, we want to bring in Emily Roland, John Hancock Investment Management's co-chief investment strategist. Emily, it's great to see you again. So, talk to me about this bit of a reversal. Obviously, taking a look almost two weeks ago at this point, we had a massive selloff. Some of that sparked by concerns about deterioration in the labor market, and then of course you had the unwinding of the Yen carry trade. But here we are, almost two weeks later, and it looks like there's a lot more optimism playing out in the market. What does that tell us just about where momentum lies?

Yeah, it certainly feels like a distant memory, Shona, of that selloff that we saw a couple of weeks ago on growth fears. What we have right now is a reversal in sentiment where good news is good news for markets. So good news on the economic front, we saw CPI coming in in line with estimates, PPI, which actually kind of stole the show over CPI on Tuesday, coming in much lower than expected. So that disinflation narrative is still intact. At the same time, we saw some slightly better data across things like retail sales, suggesting the consumer remains intact. You saw initial jobless claims, which had spiked the previous week, slowing down, again suggesting that the labor market is holding in there as well. So it certainly feels like a good news is good news environment. The Fed's still on track to potentially cut rates. We think it's 25 basis points in September, which is kind of a, you know, preemptive cut, which the market loves, and it's really reviving hopes that we can have this soft landing play out.

And it's reviving some of the buy the dip mentality as well. That's permeating very strongly right now. Emily, where are some of those opportunities that you're seeing investors really flow into?

Yeah, it's pretty interesting to watch, you know, risk taking is certainly coming back into fashion this week. We've seen small cap stocks surging. You know, a lot of those are unprofitable, they're lower quality. We do want to fade that. We're seeing again, uh, you know, a weaker dollar, which is a bit of a surprise, given the fact that the data overseas is actually worse than it has been in the United States. That's spurring risk taking and causing a rotation into international equities. So more cyclical areas of the market, more risk on trades happening, momentum taking center stage here. We would actually be looking to prune risk, looking for higher quality areas of the market, companies with great balance sheets, tons of cash, good return on equity, an ability to maintain margins in an environment where we think margins are going to be shrinking from here. We're finding a lot of that in mega cap tech, which frankly is where the earnings is. You know, looking at earnings year over year, small caps are actually negative 16% year-over-year earnings growth, where large caps have held in there. The tech space alone this quarter coming in at 18% earnings growth versus 11% for the S&P 500. So the fundamental story around tech is there, but of course it's still expensive. So we're looking to diversify from tech with other areas that are on sale but still offering quality.

Emily, is there anything, just in terms of the data that we've gotten out recently, or even within the fundamentals, some of the stuff that you were just talking about, that is a risk or could derail some of the sentiment? Because it doesn't seem like that is the case now.

Well, the challenge, Shona, is that right now the music is still playing, and it really doesn't stop until you see a spike in initial jobless claims, which comes together typically with high-yield bond spreads widening. So one of the features of the market selloff that we saw last week was that high-yield bond spreads jumped to about 380 basis points, and now we're back down to 320, which is well below the 20-year average of 500 basis points. So that's just a fancy way of saying that the credit markets are telling you there's no problem whatsoever here, no chance of a liquidity event, a financial accident, everything's fine, defaults will remain low. What you typically see are, these are the two of the most timely indicators, and once they spike, and it can happen quickly, in fact Austin Goolsbee talked about this this morning that the labor market deterioration can happen really quickly, it's usually too late to adjust portfolios. So the music is loud right now. Everybody's still celebrating disinflation. Investors love it when inflation comes down, but we have to remember that there's kind of a nasty side effect to inflation moderating, which is that profit growth is slowing. So revenue growth, which was awesome when we had inflation because companies could pass higher prices along to the end consumer, revenue growth is slowing at the same time that costs are still elevated. So companies' margins are being contended with right now, and if you want to maintain profitability, um, you've got to defend those margins, and that typically involves cutting costs. And as we know, the big biggest cost that most companies have is labor, it's people. So the last shoe to drop in every economic cycle is that the unemployment rate or initial jobless claims sharply move higher, and it's tough to anticipate that because it happens so fast. So that's the reason we want to lean into higher quality assets and look to bonds to do some more heavy lifting in portfolios from here.