Few things are as fun as a block party. No matter your age, being able to hang out in the street brings a certain sense of freedom. Add in good weather, some music, homemade food, maybe some double dutch, and you’ve got a bomb day. 

But they always start off a little slower. People warm up to each other as the day goes on—with cordial hellos and reminders of names with some of the further off neighbors. Fast forward to 6pm and everyone is vibing, maybe even with a strong karaoke session. Then, as the sun sets, everyone cleans up and heads back inside until next time.

Economic cycles tend to follow a similar pattern—warming up after a recession before feeling solid growth. Then it peaks and re-groups in a contraction before hitting a bottom, getting ready for the next cycle. The heights, drops, and length of time in each vary, but historically, the markets and the economy have generally followed this path (with different timing).

It still remains to be seen whether the economy is slowly, well, slowing, because it’s just trending back towards average (many refer to this as a “soft landing” or “no landing”) or heading in a worse direction (aka a “hard landing”). In the former, it might look like a line that temporarily dips in the middle of an expansion. In the latter, it would mean we are in a slow contraction. The lack of clarity stems from mixed economic data that does not clearly point to a recession or an “average” backdrop. 

I’ve seen the current unclear time referred to as a “transition” period. And it makes sense as we could be transitioning from some unprecedented things over the last couple years relative to history (e.g. a global pandemic, unprecedented stimulus, supply chain talk, highest inflation since the early ‘80s). Though, recently, many charts look “off” and investing, at least to me, feels a little more confusing. Let me show you what I mean.

• Markets are up this year–but mostly because of several large-cap technology stocks (with the AI trend). This can be seen in the difference between the S&P 500 Index returns, which is most influenced by the largest companies, and the S&P 500 Equal Weight Index, which gives the same weight to all stocks in the index. The difference between these two lines has widened quite a bit, in favor of the largest companies, especially since April. Will this go back to “normal”? I think there is a chance smaller companies rally in the short term to bring the difference closer together. But it doesn’t mean the longer-term direction is decided.

• Interest rate changes, and changes on the expectations of future rates, tell us the market keeps changing its mind. Markets expected Federal Reserve interest rate cuts until recently. Now they expect rates to stay where they are–which is what the Fed had been saying for a while now. We expected the market to come to the Fed in that argument, but is it because everyone now thinks the economy won’t slow? Or worse, the economy won’t slow and inflation will stay elevated? I think the latter in the short term. Longer term, rate cuts could come as long as inflation falls.

• And the recent upward direction of longer-term interest rates aren’t having the typical effect. The chart below compares the 10-year treasury yield (in blue) to the Nasdaq Index (in red). They have been mirror images of each other—when rates have gone up, Nasdaq values have gone down and vice versa. Except for the last month or so. You can see the blue and red lines have both trended up—rates have gone up while the Nasdaq has also risen. Is it the AI trend or something that will revert back to normal? I think this will revert back to normal.

The next three-to-four months should bring some clarity. Valuations look pretty high at the broad index level, but that has never been a good indicator of market direction in the short term. So from here, economic data (like jobs and inflation) and general market attitude may be the elements that push the market around and potentially down one of the paths (soft or hard landing). We are watching them closely. The good news is, historically speaking, Q4 tends to be a positive quarter. 

And that just happens to be when the next block party is planned for in my neighborhood.