In the second quarter of 2024, loan loss provisions at the six largest US banks increased the most since 2020 and car repossessions in June (drivers over 60 days late on payments) rose 23% year over year and were +14% compared to the pre-pandemic first half of 2019. See Car Repossessions Surge 23% as Americans Fall Behind on Payments.
Car repossessions rocketed higher in the first half of the year, a sign of rising consumer distress as the Fed weighs rate cuts. Here is a direct video link.
Over the past 32 months, economically sensitive small and medium-cap stock indices have underperformed the largest-cap tech-heavy indices (price x shares outstanding) to a degree not seen since the last tech bubble in 1998 through March of 2000.
Indeed, global fund flows (shown below since July 2023, courtesy of The Daily Shot) have concentrated in the tech sector (in yellow) and the seven most expensive US shares: Apple, Microsoft, Nvidia, Amazon, Google A, Meta and Google B, at the expense of other sectors. 
The chart below, courtesy of my partner Cory Venable, shows price changes from January 2022 for the S&P large-cap index (in black, with a record 31.2% concentration in the seven most expensive tech cos) and the S&P 500 equal-weighted index (in blue, where each component has an equal contribution to the overall price change of the index) versus the S&P 600 small-cap index in green. We can see that by the end of June, the S&P small-cap index was down 8% since January 2022, the S&P 500 equal-weight was flat and the S&P 500 +15% (after surging since last October).
Then, in the past five trading days, as US economic data has continued to weaken and the odds of a Fed easing cycle have risen, capital has been rotating out of tech into small and mid-cap indices, which have a near 50% weight in so-called “defensive” sectors: financials (18.5%), industrials (17.5%) and health care (10.4%).
We have seen this move before. In a world of funds and managers that are perpetually long equities at all times, ‘active management’ means marginally shifting capital weights from one equity sector to another. Their bogey is ‘relative performance,’ which means trying to beat benchmark indices on the way up (nearly impossible, after fees) and trying to lose less than benchmarks in bear markets (nearly impossible since most lack meaningful allocations to the few asset types that appreciate when equity markets drop–like cash and government bonds).
Below, we see a similar sector rotation occurred during the early months of the 2000 to 2003 bear market (small-cap prices in red and large-cap prices in blue).
The US Fed did a final hike in May 2000 (pausing at 6.5%) and did not announce a first cut until January 2001 (-50 bps to 6%). Above, we can see that the tech-heavy S&P 500 (with record over-valuations similar to today) held up through the summer of 2000 before tumbling into April of 2001 as a recession spread. Capital flows migrated from large-cap “growth” (where company revenues and earnings are hoped to increase at a faster rate than the average peer) into small-cap “value” stocks (considered cheap relative to fundamentals).
Then, in the fall of 2001, terrorists hit, and reality dawned that the weak economy and cash crunch were negative for all sectors. From October 2001 to April 2002, long-always equity funds and managers continued shifting from “growth” into “value” sectors before panic finally spread. Then, virtually all stocks fell in a dash for cash through the spring of 2003. The Fed continued slashing its policy rate until June 2003, when it stopped at 1% for a year.
Yes, small-cap stocks had relative “outperformance” over the highly overvalued large-cap indices in the 2000-2003 bear market, but they still fell 36%, compared with 50% for the S&P 500, 80% for the Nasdaq and 48% for Canada’s TSX. In the 2007-09 cycle, both small and large-cap indices, US and Canadian, tumbled 50%+.
Historically, it’s been typical for large-cap stocks to outperform small-cap stocks (see light blue bars below, courtesy of Bank of America) and for “value” to outperform “growth” (dark blue bars) when unemployment is low and optimism high heading into a Fed cutting cycle, and in the initial months after cuts begin. But, it ends up being relative losses.
In every case, investment-grade bonds outperformed stocks of all sizes and sectors (see gold bars above) in the year before and after Fed cuts. The stock-focused finance sector prefers to ignore such facts.
Markets are betting that the Fed will start easing its policy rate in September and, as typical, government bond prices have been rising since last October.
In the seven cutting cycles since 1969, the stock market fell an average of 24% in the 195 days after the first Fed cut. In the three incidents where stocks entered the cutting cycle at valuations near present highs (1973, 2000 and 2007), stock indices declined by 30 to 55 percent while central banks did everything they could to ease.
History warns of the “relative value” trap and equity losses yet to come.
Consumer spending drives just under 60% of Canadian GDP growth and consumer spending fell across all categories in June–discretionary and essential (shown below courtesy of RBC). Warm weather and declining interest rates did not entice spending as hoped. Overall, second-quarter retail sales were negative.
Fewer Canadians have renovated their homes amid a sluggish housing sector, while food services spending posted weak growth on a three-month moving average. Hotel spending softened and tourism demand is still sitting below pre-pandemic levels.
Canadian Treasury bond prices have been rising since last October (lowering yields and fixed-term loan rates) and the Bank of Canada began easing short-term rates last month. Still, the year-over-year growth in residential mortgages has been the weakest since the 2001 recession, 23 years ago (courtesy of the latest CMHC report and chart source).
With unemployment at 6.4% and expected to rise through 2025, and households heavily indebted (Canadian household debt to GDP ratio below since 1970 in red, versus the US in blue), lower interest rates are unlikely to stimulate spending for some time. 
The average annual interest payments per Canadian household have risen 66%+ in the past 2 years, by far the sharpest increase in more than 24 years (shown below since 2000).
Canada has dug itself into a period of tough slog. RBC explains in Warmer Temperatures Failed to Ignite Canadian Consumer Spending in Q2:
“…we don’t expect a turnaround in the near term. While the Bank of Canada’s cutting cycle is underway after an initial 25 basis point cut in June, interest rates are still very restrictive as homeowners grapple with the impact of mortgage renewals. It will take time for the impact of BoC cuts to ease consumer pain.
Similar problems are undermining US consumption (which drives 70% of US GDP growth and the world’s largest economy). See Big Banks Warn of Weakness among lower-income Consumers):
Consumer sentiment remains “stubbornly subdued” and fell to an eight-month low of 66, according to the latest University of Michigan survey released on Friday.
Profits at Citi’s US consumer lending business, which includes credit cards, plunged 74 per cent from a year ago. The bank’s chief financial officer, Mark Mason, said consumer spending was slowing overall, with account balances now lower than they were before Covid.
US consumers were more cautious than they had been in a while, he added. “We are not seeing the same growth in consumer spending that we had in prior quarters,” said Mason. “There was less traffic in the retail venues that we partner with.”
Best to accept facts, respect the business cycle, and be prepared for opportunities that inevitably come out of the depths of recessionary periods.
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