VRA Investment Letter: Good News is Bad News, as the US Economy Accelerates to its Best Readings in 5 Years.

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VRA Market Update: Good News is Bad News…Once Again 

Here we go again..and it’s the exact point that the president has made often…good economic news is perceived as bad news for the stock market. 

With multiple economic data points released yesterday, broad-based acceleration in the economy...the strongest data in five years...is clearly picking up speed. US manufacturing PMI expanded sharply to 57.0 vs. 53.6 estimated. Again, this is the strongest manufacturing reading in roughly five years. Services sector activity also jumped unexpectedly, to 58.7 vs. 56.0 estimated. That’s a 59-month high. This is what America First looks like. 

Services are the largest part of the US economy, so this is significant. Composite PMI at 58.4, which combines manufacturing and services, is also the strongest business-activity reading in more than five years.The numbers indicate that demand and output are accelerating across both goods-producing and service businesses, rather than the economy being carried by one sector (like data centers). This data also underscores the Atlanta Fed GDPNow estimates of 5.1% Q3 GDP growth. On the news, interest rates surged to their highest levels in more than 20 years with 10-year yields hitting 5.14%. 

Were it not for our perverse system of expectations, brought to us by decades of upside-down central bank policies, data like this would result in a stock market that welcomes it and pushes prices higher. Instead, the expectation is that this level of economic growth will force the Fed to hike rates further, under the wrong-headed belief system that economic growth causes inflation. It most certainly does not. This is something that the 3 Amigos are each well aware of with Trump, Bessent and Warsh stating often over the years that inflation is a money printing problem, not an economic growth one. It will take time for Warsh to change minds at the Fed, but this is what Warsh is doing with the creation of his 5 task forces means to properly interpret data and the resulting economic frame work to follow. 

VRA Bottom Line: the good news is that higher rates will not have an impact on economic growth, even as it might have a short term effect on the markets. As we continue to make the case, during the strongest US bull market in history (1995-2000) 10 year yields averaged 6.1% with several spikes over 7%. In addition, during the best year in Nasdaq’s history (1999) while the Fed was hiking rates by 170 basis points, Nasdaq still roared 135% higher. 

Soon, we’ll be out of the worst month of the year. We expect that front-running of bullish seasonality, Q4 fund flows and Q3 earnings will take place into months end. October is the most bullish month of the year in midterm election years, with November the 2nd most bullish month. Add the fact that the next 3 quarters are the most bullish 9 months of the entire 4-year election cycle and we expect smart money investors to front-run what’s to come. With Q3 earnings expected to be even better than Q2, our call for a melt-up environment into the midterms and year end remains in place. 

We are likely witnessing the final shakeout in equities prior to the coming move higher. This latest dip is an opportunity. We also learned last night that the AAII Sentiment Survey remains overwhelmingly bearish, with a reading of just 32.7% bulls and a big 48.1% bears. We’re seeing similar readings across all sentiment surveys. This is the wall of worry that bull markets like to climb. 

As the Semis Go, So Goes the Market

If you’ve been with us for a while you know how important the semis are, to both market direction and timing. We’ve been pounding the table on this group, and the semi ETF (SMH) has rallied over 9% since the Fed rate hike last Wednesday. We expect the upward movement to pick up speed into Q4.

While a slight pause in this group would not surprise, that’s about all we should get, as Q3 is coming to an end. What follows will be end of quarter window dressing with Q4 fund flows that will see investment dollars continuing to fly into this group, followed by the beginning of Q3 earnings reports (starting in roughly 3 weeks).

While you won’t hear much of this in the financial mainstream, remember that corporate earnings are up 36% on the year, surpassing even our target of 30%, with the Atlanta Fed forecasting GDP growth of 5.1% in Q3. From the start of the year we’ve said that we’ll get our first 5% GDP read in 2026. Were it not for the Iran war, that would have already occurred, but our high confidence call remains that by year end we’ll be a 5% final read on GDP growth.

This week's breakout in the semis was important. Below we see a clean symmetrical triangle breakout in SMH. A move through $600 will make our next targets $643 and then $672, with a measured move that should take SMH to $748 (in Q4), or 25% higher from year into year end.

VRA Bottom Line; from the bear market lows of 10/13/22…a low that we called on the day…we’ve been the most bullish strategists in America, putting up average gains of 38% year over this time frame. The war, and resulting $100 oil prices and downward pressure on the broad market, resulted in a period of 6 months where the VRA Portfolio has barely kept up with the broad markets. We expect that by year end we will produce gains that will result in the VRA outperforming the market in 20/23 years from our inception. We are positioned exactly as we want to be going into Q4 and year end. With investor sentiment flashing fear to extreme fear, our contrarian views have us salivating for what’s to come. We remain long and strong and expect a melt-up environment into the midterms and year end.
 

Finally for today, if you missed Tyler live from the floor of the NYSE, here’s that video. As Tyler said, for 4 years we’ve made the case that this period represents “the Innovation Revolution meets the Roaring 2020’s” and the resulting gains will surpass the gains of 1995-2000. Job well done Tyler.

https://x.com/therriage18/status/2102536010169208951?s=20


Until next time, thanks again for reading. 

Kip

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