Million-Dollar Gold Bar

Here are some of the biggest stories from last week:

• The market-implied odds of a recession have jumped.
• S&P 500 firms outside the Magnificent Seven are finally delivering earnings growth.
• A bar of gold is now worth $1 million after the metal's price hit a new record high.
• The US dollar fell to its weakest level since December 2023.

Dig deeper into these stories in this week’s review.

Macro

Traders increasingly see a US recession as imminent. That’s according to a JPMorgan model that shows the market-implied odds of such an event based on what’s priced in across seven different asset classes and subclasses. And as you can see from the graph below, the odds of a downturn have risen sharply across the board over the past few months. All in all, JPMorgan’s model estimates the market-implied probability of a recession at 31%, jumping from 20% in March. A similar one from Goldman Sachs puts the odds at 41%, up from 29% in April.

The increase in recession risk from both banks’ models reflects the greater extent of rate cuts that have been priced into markets since the latest employment data revealed a slowdown in US job growth last month. Making matters worse, the labor market report also triggered the “Sahm Rule” – an eerily accurate recession signal, set off when the unemployment rate’s three-month average rises by half a percentage point from its lowest level in the past year. And with most investors having all but ruled out a US downturn, the news sparked a sudden rush to price in that risk across markets earlier this month.

Looking at the specific assets in JPMorgan’s model, base metals – non-precious ones that are widely used in industrial applications, like copper, nickel, and aluminum – are currently pricing in the highest chances of a recession, at 67%. In other words, the prices of these commodities are quite depressed in anticipation of an economic downturn. But it means they have a lot of upside potential if the US dodges a recession.

In contrast, US junk bonds (or as their proponents like to call them, “high yield” bonds) are pricing in just an 8% chance of a US recession – the lowest of the bunch. You can see why in the chart below, which shows that the yield spread between junk bonds and their Treasury equivalents is a lot narrower than it has been on average over the past two decades. Put differently, the additional yield that junk bonds are offering above safe government bonds to compensate for their extra risk is way below their 20-year average. That means they’re not adequately pricing in the chance of a recession – and they may have a lot of downside potential if the US economy does enter a downturn.

Stocks

The US second-quarter earnings season is now largely over. And, according to FactSet, firms in the S&P 500 delivered year-over-year earnings-per-share (EPS) growth of 10.9% last quarter – the fastest pace of profit expansion since the end of 2021 and the fourth straight quarter of positive growth. Looking underneath the hood revealed some more good news: a long-awaited profit recovery for the companies that were left out of the AI frenzy.

See, the Magnificent Seven tech giants – Alphabet, Meta, Tesla, Apple, Nvidia, Amazon, and Microsoft – have been driving most of the S&P 500’s earnings growth lately. Take the seven out, and the rest of the index’s EPS have actually shrunk on a year-over-year basis for the past five quarters. However, EPS for these 493 companies are estimated to have grown by 7.4% in the second quarter from the same time last year, according to Bloomberg. Profits for the Magnificent Seven, meanwhile, are predicted to have risen by 35%. It's a solid pace, no doubt, but it marks a heavy slowdown from the even bigger gains seen over the past year.

So with earnings growth now spreading to the broader market, it could further fuel the ongoing rotation away from large-cap stocks and into smaller companies and other market laggards. Case in point: Bloomberg’s index of the 500 biggest US stocks excluding the Magnificent Seven (the “Other 493” index) is at an all-time record high. The giant tech firms themselves, meanwhile, are still 8% below their high.

Commodities

Gold has been red-hot lately, and it’s not hard to understand why. First, the dollar has been weakening in anticipation of US interest rates declining, and gold is priced in dollars. Second, bond yields have been falling since May, reducing the opportunity cost of owning gold, which doesn’t generate any income. Third, gold has been seeing increased safe-haven demand amid heightened economic and geopolitical risks, fueled by renewed recession fears, US election uncertainties, elevated China-Taiwan tensions, and ongoing conflicts in the Middle East and Ukraine. All these factors have helped send gold’s price up by more than 20% this year, hitting a new record of $2,522 per ounce on Tuesday. As a result, a standard gold bar, typically weighing about 400 ounces, is now worth a cool $1 million for the first time ever.

Rising gold prices and falling interest rates show that traditional drivers, like bond yields, are falling back into place again. Earlier this year, the metal’s price went up even as yields increased, which, understandably, caught many investors by surprise. But that was mainly because central banks – especially in emerging markets – were stockpiling those 400-ounce bars as protection against the impacts of inflation, and as a way to diversify their reserves away from the dollar.

FX

The US dollar had a strong start to the year, rising 4.4% in the first half as the resilience of the world’s biggest economy surprised investors who had expected more than six quarter-point rate cuts heading into 2024. But the greenback has since given up all of those gains, and this week it fell to its lowest level against a basket of currencies since December 2023. The drop comes as investors brace for the Fed to start lowering interest rates next month, and as the S&P 500 recovers from its losses earlier this month following a weak US jobs report that sparked fears of an imminent recession. Since then, calmer markets and more durable economic data have pushed some investors back into risky assets and away from perceived safe havens, such as the dollar.

Next week

• Monday: US durable goods orders (July), UK markets are closed for the summer bank holiday.
• Tuesday: US consumer confidence (August).
• Wednesday: Eurozone M3 money supply (July). Earnings: Nvidia, Salesforce, CrowdStrike.
• Thursday: Eurozone economic sentiment (August).
• Friday: Japan retail sales and industrial production (July), Japan unemployment rate (July), eurozone inflation (August), eurozone unemployment rate (July), UK M4 money supply (July), US personal income and outlays (July).