Rise and shine everyone.

Chair Powell is dovish once again, and with that, the probability of a September cut continues to increase. We heard from him yesterday, about how the last three months of inflation data have come in better and heading towards the “good data” that the FOMC has been looking for. He also spoke about now focusing on the second part of the dual mandate - unemployment. With the labor market starting to cool, the Fed now needs to keep an eye on that data to respond if there is a drastic weakening in the labor market.

Historically, unemployment tends to rise very quickly… almost like the floodgates opening. And this brings on a recession. It is, however, sometimes a chicken & egg situation - does unemployment rise quickly because the economy is in a recession or does the surge in unemployment bring on the recession?

Either way, there is far more discussion about a hard landing now as the markets are thinking that if the Fed does not cut by September, we’re likely going to see the “long and variable lags” of the rate hikes put pressure on the labor market and growth.

The other news dominating the headline is, of course, the assassination attempt on the life of former President Trump. While a very unfortunate incident, this has improved his odds of winning the election in November and with that, we’re seeing the market front run some of those policies.

We’re seeing:

• Energy lead

• Small Caps soar (double effect of the Fed easing and Trump winning)

• Bitcoin reverse higher

• And we also saw yields spike Monday - due to the uncertainty and, I want to say the possibility of stronger growth and higher inflation.

We’ve been warning about small caps, in particular small cap growth. Does this rally change our minds?

I would say not completely. We like this rally, and we want to see that the market is broadening out now, with EPS growth leading over multiple expansions.

However, we still have questions on whether this rally is sustainable. We ask, is this just a rally to trade or one to invest in? There are a few issues to consider here:

1. We have not heard from the regional banks yet. and they make up a large segment of the Russell 2000. Investment banks have reported solid numbers led by the trading desks but, NIMs are still struggling, as is wealth management. BofA just reported a decrease of 3% in NII. Wells Fargo reported a 9% decline in NII.

2. Yields are not drastically lower, and therefore, we’re likely to continue to see unrealized losses on the balance sheets of regional banks as well.

3. The Yield Curve remains inverted and at some point, investors will demand term premiums and which may push longer rates higher, and pressure on small cap growth.

4. The Russell 2000 is still in an earnings recession.

But, the chart looks interesting here and the overhead resistance for the IWM is still some ways off. So, this could actually make a good trade here. But I would keep stop losses in place.

However, if we’re looking at it in terms of an investment - we’d prefer small-cap value.

Here’s a great chart that Mayhem shared yesterday. It shows that the difference between Large Cap Growth and Small Cap Value is at its highest since the year 2000. This tells us that there’s potential for a “catch-up” and rotation trade.

Calendars

(news taken from Reuters, FT, Bloomberg; Calendar from Trading Economics)