What suddenly changed so that markets were worried about growth, crisis and the yen carry trade? Almost everything happening at the same time?
Hugh Johnson: Well, I think there’s always going to be some kind of news that will trigger a correction. Frankly, the market had been doing well for a long time, but it got to a level where it was a little bit expensive or overvalued, so it was very vulnerable to bad news. And of course, we got that bad news on Friday when they came out with a very low increase in nonfarm payrolls, a very weak number, and then a very important, obviously unexpected increase in the unemployment rate.
The rise to 4.3% was unexpected, which caused stock prices to fall sharply, perhaps as long expected, and caused bond prices to rise significantly, as well as interest rates to fall. If you look closely at the numbers, you can see that the markets, both stock and bond, are either pricing in or not pricing in three cuts to the Federal Funds rate or interest rates by the US Federal Reserve in the fourth quarter, in September, November and December. And the Fed did just that, almost exactly, to the nearest 5 cent.
I think this really tells us that, number one, there is a risk of recession. I think it’s too early to say, but there is a risk of recession and in response to that risk, the Fed is expected to cut rates three times in 2024. And remember, after the three rate cuts in 2024, they are expected to cut rates four times in 2025, or one per quarter.
That’s recession fears. They’re somewhat well-founded and a little exaggerated, but still, expectations that the Fed will cut interest rates in response to somewhat-founded fears may be a little premature.
The US stock market has two big parts: the high-tech sector, which includes global companies like NVIDIA, Microsoft, Meta, and the real economy, which includes construction, oil and gas, and other sectors. Which market do you think is more vulnerable to stock selling amid fears of a recession?
Hugh Johnson: Well, what we saw prior to this was, number one, the small caps that we saw prior to this sharp correction started to recover. The second thing we saw along with that was, of course, the relative underperformance of technology, the so-called Magnificent Seven, and then the spread, or dispersion, of market returns. When this thing is over, when the correction is over, and I don’t think it’s going to last that long or be that severe, but when it’s over, I think we’ll see something like the spread in the stock market come back.
In other words, it will spread across a variety of sectors. The problem with technology, of course, is that as you start to see it manifest itself in the expectations for artificial intelligence and the bottom line of people who are really investing in artificial intelligence, you start to see it. In particular, when you look at the numbers for Microsoft, for example, we’re not really seeing it. I want to caution you guys, artificial intelligence is certainly important, but it’s a progression to a payoff, and the productivity payoff is going to be linear, not exponential.
This is going to take some time, but we’re suddenly starting to realize this now, and I think that’s why we’re seeing a movement and a shift away from so-called AI technology companies and into the broader stock market.
And I think that’s what will get us through this correction, and hopefully, again, I say fingers crossed, it won’t take too long.
Now, speaking on behalf of emerging markets, historically, when there is a recession in the developed markets, emerging markets have always benefited. Markets like India tend to see more inflows than outflows when there is a recession in the US and developed markets and interest rates are at their peak. Do you think there is any chance that capital will start to come back to emerging markets?
Hugh Johnson: Yes, that’s correct. And that’s the historical record. You’re right. The record shows that this happens especially as a result of economic contractions and recessions, as well as corrections in the stock market and in the United States.
But we’ve seen the US relative performance outperform for long periods of time. I would like to see the relative performance of emerging markets start to improve before I make that shift or bet. Yes, you can see that based on history. You’re right. You can see that shift and it will show up in relative performance. But it’s taken a long time for emerging markets to outperform or even close to the S&P 500, so I would like to wait for that to start to develop first.
