Stock Market Outlook: Energy Stocks Surge, Nvidia's Resistance And Fed Rate Cuts Impac

*Analyzing the markets with Richie Naso, a Wall Street veteran of over 40 years and former member of the NYSE.

DJIA 52-wk: +19.57% YTD: +9.83% Wkly: +2.80%

S&P 500 52-wk: +26.42% YTD: +17.95% Wky: +4.02%

NASDAQ 52-wk: +29.00% YTD: +17.80% Wkly: +5.95%

Nvida: 52-wk: +171.30% YTD: +140.51% Wkly:15.82%

The Stock Market Is Priced for Middling Returns from Here On:

The Fed kept rates close to zero for nearly a decade following the 2008-09 global financial crisis, then took them above 2% before heading back toward zero during the Covid-19 pandemic. When a combination of stimulus cash, rebounding consumer demand, and supply chain kinks sent inflation to double-digit percentages, the Fed quickly raised rates to their recent peak to cool demand.

Rising rates could have cut into stock prices, but instead, the S&P 500

SPX

-0.19%

returned 35% over about 2½ years, led by Nvidia

NVDA

-1.59%

, up 375% on soaring demand for AI chips. (Another of the S&P 500’s AI companies, Super Micro Computer

SMCI

+4.59%

, gained 937% over that stretch despite a recent tumble, but it was added to the index only this year. More on Super Micro here.)

The argument for a half-point rate cut now was that inflation had cooled to 2.5% over the year through August, while job growth had slowed. The Fed’s two jobs are to promote stable prices and maximum employment. Jobs need more attention than inflation at the moment, the thinking goes. But just as rising rates didn’t hurt stocks, don’t expect falling rates to now send stocks to rapturous new highs.

For one thing, the effect on stocks of the first rate cut during a cutting cycle depends greatly on whether the economy is headed for a soft or hard landing. During past hard-landing cases, stocks lost an average of 6% over three months following initial rate cuts, according to BofA. Signs of a hard landing now are few, but credit-card and car-loan delinquencies have risen, and private-sector hiring looks weak.

The bigger obstacle for stocks is that they’ve gotten expensive. The S&P 500 traded recently at 23.7 times trailing operating earnings, versus a 35-year average of 19 times. That means that stocks are already pricier than they were when rates were near zero. In the near term, the stock market’s valuation is a poor predictor of price swings, but over the long term, it’s as reliable an indicator of returns as researchers have found. JPM’s forecasting model takes the S&P’s current plus-size price to mean that it will return 5.7%, on average, over the next decade. That compares with 11% since World War II.

What to do? Two suggestions: nothing, and something. I prefer nothing. Last week in this space, I touched on my investing strategy of tactical sloth, and in past columns, I’ve discussed my philosophy of financial nudism. Strip portfolios to the bare essentials—cheap index funds tracking quality stocks and bonds will do—and do as little as possible for as long as possible. Timing downturns is impossible. Waiting them out isn’t. Note that JPM’s even longer-term return forecast—8.1% a year, on average, over 20 years—implies sunnier days eventually.

For more tactical investors, BofA recommends overweighting defensive and dividend-rich sectors like utilities and real estate investment trusts, along with stocks with high free cash flow, like those in the Pacer U.S. Cash Cows 100.

COWZ

-0.92%

exchange-traded fund. For bonds, it likes the simplicity of long-term Treasuries along with something decidedly more complicated called AAA-rated collateralized loan obligations, and found in the Janus Henderson AAA CLO ETF. (More on CLOs here.) BofA also recommends overweighting a market that knows a thing or two about lost decades for stocks: Japan.

There are some wild cards here. U.S. corporate profit margins have nearly doubled over the past 30 years. Globalization gave companies expanded access to cheap labor markets. To try to attract or keep jobs, countries slashed their tax rates. Effective U.S. corporate tax rates have fallen below 15% from about 35% in the mid-1980s. Concentrated industries abound. Historically, when power has shifted greatly in favor of companies, the result has been political backlash, fueled by public anger. Think trustbusting Teddy Roosevelt, whose presidential term coincided with publication of The Jungle by Upton Sinclair, with its unsavory details about Chicago’s meatpacking plants.

The backdrop is different now. “Consumers do not appear to have problems relying on the services and products of the top two smartphone brands, app stores, search engines, online merchants, cloud managers, online video music streamers, ETF producers, passive mutual fund managers, and banks,” write JPM’s strategists. If conditions change and corporate profit margins revert toward their historical average, even modest return expectations for the next decade could prove too high.

Energy Stocks Are Taking the Lead.

There’s a vibe shift taking place in energy, and it’s changing the kinds of companies investors like. Oil producers and refiners, which have led energy stocks higher since the pandemic, have fallen out of favor. Pipelines, which had been laggards, are on the rise and look poised to gain more.

There are a few reasons for the change in sentiment. The first is that the outlook has worsened for oil and refined products like gasoline. Crude oil prices have been falling in recent months as global demand for gasoline and diesel has declined and China’s economy has decelerated.

The supply-demand setup for next year looks even more bearish. Oil production is on track to surge around the world in 2025, and demand growth looks tepid. Analysts have been reducing their outlooks for oil prices in the past few weeks. Several think crude oil could fall to around $60 per barrel by the end of next year, from about $75 today.

Refiners are also struggling, because they’re making less money than they were last year from selling products like gasoline and diesel. On the Gulf Coast, where the bulk of U.S. fuel is processed, margins are less than half what they were in 2023. When margins drop, refiners tend to curtail production. But there are signs that they’re continuing to operate at high utilization rates, ensuring a longer period of weak margins, according to Mizuho Securities analyst Nitin Kumar.

Interest rates are another factor that have led to a change in sentiment in energy. With rates on Treasuries and other low-risk assets starting to fall, investors are looking for other sources of steady income with limited risk. Pipeline stocks tend to pay high dividends without as much exposure to commodity prices.

Pipelines, which are grouped with other infrastructure providers as midstream energy companies, had been lagging behind other energy companies until recently. Some suffered because they cut their dividends after the pandemic started. And others struggled because their dividends didn’t look attractive compared with lower-risk investments like Treasuries once Treasury rates rose. Kinder Morgan

KMI

+0.93%

, among the largest and best-known pipeline companies, is still trading below its level from before the pandemic, years after other energy stocks like Exxon Mobil

XOM

-0.63%

regained those prices.

That’s starting to change. The Alerian Midstream Energy Index, a basket of pipeline and infrastructure stocks, is up 22% in the past six months. Kinder Morgan has risen 21% and is now less than 5% off its prepandemic levels. The Alerian index has a dividend yield of 5.3%, and some pipeline experts consider that yield safe even in the event of a significant oil selloff.

“I think midstream is a more bullish story because it’s growing volume slow and steady, and it’s not as price-sensitive,” said Greg Reid, lead portfolio manager for Westwood Group Holdings’ energy investment team. In the past six months, midstream stocks have had a “slightly negative” correlation to the price of oil, a rare occurrence, Reid said.

Midstream companies are less exposed to prices than producers and refiners, because much of their compensation is based on volumes. As long as volumes don’t crash, pipelines should be in good shape.

Some investors are getting the message. Citigroup analyst Spiro Dounis wrote this month that “we’ve observed some migration into midstream from both generalists and energy-dedicated investors” because of falling rates and the industry’s protection from commodity price risks. “Midstream welcomes you all.”

It’s time to welcome them back.

It wouldn’t surprise me if they kept the market going higher or if they puke. Historically, the end of September and October are weak. Last week’s action could prove to be a short-term major trap.

Quick hits observation.

NVDA should have gone through 120.00, which is an important resistance area with the stock market at this level.

DATA: Barron’s print edition page 28 9/23/24 Market Week Avi Salzman

Paragraph one: Barron’s print edition 9/23/24 page 9 The Stock Market Is Priced for Middling Returns from Here. Jack Hough

Paragraph two: Weekend Wisdom Zacks online edition 9/21/24 “The Times They Are A-Changin” Bryan Hayes

Paragraph five: Barron’s print edition 9/23/24 page 29 Energy Stocks Are Taking the Lead. Avi Salzman

Paragraph six: Closing comments are just my observations

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