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The First Cut Is The Deepest

Market Musings

By Scott Poore, AIF, AWMA, APMA
Chief Investment Officer, Eudaimonia Group


Be careful what you wish for, is the theme for this week's musings.  The market got what it has hoped for from the Fed, now we'll see if history repeats or if this time it's different.  This week's musings is inspired by the 1976 hit, "The First Cut Is The Deepest" by Rod Stewart.  Here's some trivia about the song:

  • Stewart's version was actually the 3rd of 4 different recordings of the song.  The original artist, P.P. Arnold, first recorded the song in 1967.  Keith Hampshire recorded a cover in 1973 that wasn't well received by the public.  Stewart recorded the song in 1976 and it reached #1 in the U.K. and #21 in the U.S.  Sheryl Crow released her version in 2003, making it to #14 in the U.S.
  • The song was originally written by Cat Stevens, who introduced it to Arnold.  Arnold was a former member of the Ike & Tina Turner Review.
  • Stewart recorded the song in Muscle Shoals, Alabama, where he also recorded "Sailing" and "Tonight's The Night."
  • The song is about a guy who wants to start a relationship with a girl, but has been hurt by a prior relationship.

"I still want you by my side
Just to help me dry the tears that I've cried
And I'm sure gonna give you a try
And if you want I'll try to love again
Baby, I'll try to love again but I know

The first cut is the deepest
Baby, I know the first cut is the deepest
But when it come to being lucky she's cursed
When it come to loving me she's worst"

Here's what we've seen so far this week..

The First Cut Is The Deepest.  The market finally got its first rate cut from the Federal Reserve since 2020 and it was higher than most were expecting in 50 basis points.  So now, we get to sit back and interpret what is behind the 50 bps rate cut.  It has been our contention that the Fed is already behind the curve on rate cuts (more on that in a minute).  Had the Fed started cutting mid-to-late last year, they probably could have cut 25 bps, maybe paused, then cut another 25 bps and waited for the results.  Instead, here we are, in what some are terming as a "panic" cut.  According to Fed Chairman Powell, "Nothing in our projections that suggest we are in a rush (cutting cycle)."  Well, that would be all well and good, except for the fact that the Fed's own "Dot-plot" suggests two more cuts this year and another 100 bps next year.  That sounds fairly "rushed" to me.  So, is the Fed seeing something investors may not be seeing?  If we look at the KC Fed's Labor Market Conditions Index, while not in negative territory, clearly the Index is on the decline.  When that index begins to decline, tough economic times typically follow.  Why?  When companies & consumers have overspent during good economic times, bubbles form.  When the bubbles burst, consumers begin scaling back spending, which in turn hurts corporate profits, leading to layoffs, leading to consumers without any income, hence, you slip into recession.  As we've state the past several weeks, these cycles take time to manifest, so it's not like we're going to fall off the cliff immediately.  In fact, the National Financial Conditions Index still shows loose financial conditions.  However, the Financial Stress Index, also maintained by the Fed, is starting to inch higher into positive territory, meaning stress within the system may be building.  The Index does float up and down from time to time, but if we start to see a clear trend above the neutral line (0.0), it would definitely be something of concern.

Still Want The Consumer By Your Side.  While Retail Sales came in higher than expected last week, we're beginning to see some signs of consumers being more selective in their purchases.  From an inflation standpoint, that's a good thing, as we pointed out last week that Producers appear to be keeping the margin between PPI & CPI.  However, there are additional signs that consumers are scaling back.  Restaurant and Bar sales have declined for the past couple of months.  We would need to see a couple of more months worth of data to see a clear trend, but it's a cautionary flag.  While consumer credit showed an increase last month, we're seeing greater charge offs on loans to individuals.  The level of charge offs is reminiscent of the pre-cession levels of 2007-2008.  If those levels continue to elevate at the same time consumer credit/spending slows, that would be a reason for concern.  While the NY Empire State Manufacturing Index turned in surprisingly positive results this week, the survey among companies di produce some red flags.  Chief among them was the expected Capital Expenditures moving forward, which dipped below positive territory.  If we continue to see the number of Job Openings decline along with corporate spending dip, that would be a sign the economy is slowing.  While equities responded to the Fed's rate cut by heading higher on Thursday by more than 1%, there definitely seems to be a repositioning going on under the surface.  The flows into bond funds during the prior week was considerably higher than equities.  In fact, large cap equities saw heavy outflows last week, while aggregate bonds saw significant inflows.  We'll see if that turns into a broader trend, but while we still have some "dip buyers" in the tech space, well diversified portfolios are likely to out-perform concentrated positions going forward.

And I thought some of the latest fashions were bad...
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Disclosures

The information contained herein is for informational purposes only and is developed from sources believed to be providing accurate information. The opinions expressed are those of the author, are for general information, and should not be considered a solicitation for the purchase or sale of any security. The decision to review or consider the purchase or sell of any security should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional.

Forecasts or forward-looking statements are based on assumptions, may not materialize, and are subject to revision without notice.

Any market indexes discussed are unmanaged, and generally, considered representative of their respective markets. Index performance is not indicative of the past performance of a particular investment. Indexes do not incur management fees, costs, and expenses. Individuals cannot directly invest in unmanaged indexes. The S&P 500 Composite Index is an unmanaged group of securities that are considered to be representative of the stock market in general. 

Past Performance does not guarantee future results.