One of the headwinds for the market over the last few weeks has been the more hawkish commentary from Fed officials. This follows the surprisingly hawkish tone struck by Fed Chair Powell at the October meeting. As a result, the odds of a December cut have tailed off from a near-lock to a coin flip. It is not just the strength of the hawks’ arguments that are important, but the fact they appear to be convincing members of the committee who are generally less worried about inflation.
The shift in tone from the Fed has helped push up real (inflation adjusted) interest rates. It is not a coincidence that the S&P 500 topped the day before yields rose in response to the October Fed meeting. They have kept rising since. This is a risk for stocks for now.
Earnings season is not quite over with retailers still due to report over the next couple of weeks, and the closely followed Nvidia results are due out tomorrow. Corporate profits continue to be strong and are forecast to accelerate. Outlooks are improving rapidly. This has been a strong quarter for triple plays (beat EPS, beat revenues, raise guidance) with more than 10% of stocks reporting that outcome. Unfortunately, the average stock has not moved on good earnings during the current drawdown. But forward guidance is giving us confidence that strong profit growth can eventually spark another rally phase.
A TALE OF TWO MARKETS
As we mentioned in our last commentary, what is going on under the surface of the stock market is distinctly different than the major market indexes which are still trading in the neighborhood of all-time highs. Through yesterday, the S&P 500 is up 13.4% YTD but about one-third of S&P 500 stocks are down at least 20% YTD (source: Bespoke Investment Group). Technology and AI stocks have been the most volatile and are taking it on the chin for the third time this year. Some quantum computing stocks, darlings for AI believers, are down 50% in two weeks!
Investors should ask themselves an important question here. Is this market environment more similar to 1996 or 1999 of the dot.com bull market? If 1996, we may have 3-4 good years left for this bull. If 1999, we may be at the end of the cycle and investors should prepare for a bear market for the reasons bears are so quick to offer: valuations, the supposed AI “bubble,” etc.
Because we think the AI thesis has years left to go, we are in the 1996 camp. In our view, the market is giving us another chance to buy tech and AI stocks at big discounts to their October peaks. Some of these stocks are now trading in bear market territory, even high-quality mega-caps like Meta. One of the greater benefits to our economy from the AI boom is greater productivity which we are just starting to see. This trend may have years to run.