Quick Look:
- Stocks Reach Record Highs: Corporate earnings drive the stock market to unprecedented highs despite ongoing inflation concerns.
- Cooling Inflation: PCE price index slowed to 2.5% in June, sparking optimism for potential Federal Reserve rate cuts.
- Economic Growth: The U.S. economy grew at an annualized rate of 2.8% in Q2, exceeding expectations and fueling speculation on Fed policy.
The financial markets have been a whirlwind in 2024, with corporate earnings driving stocks to unprecedented highs despite the persistent shadow of inflation. Investors have had to temper their expectations for the number of rate cuts by the Federal Reserve this year, but recent data offers a glimmer of hope. Inflation has shown signs of cooling, sparking optimism that the Fed might cut rates as soon as September. This shift has prompted Wall Street to explore opportunities beyond the Big Tech giants that have dominated this year’s market landscape.
Inflation Data and Market Reactions
Recent weeks have seen promising inflation data, giving investors reasons to be cautiously optimistic. The Fed’s preferred gauge for inflation, the PCE price index, slowed to 2.5% for the year ending in June. This deceleration in inflation has been a beacon of hope for investors, signalling that the era of soaring prices might be tapering off.
In response to the encouraging inflation data, the Dow surged by 654 points, or 1.6%, on a particularly buoyant Friday, having soared over 800 points earlier in the day. The S&P 500 and Nasdaq Composite also saw gains, rising 1.1% and 1%, respectively. However, despite these daily gains, the week ended with the S&P 500 and Nasdaq dipping, while the Dow managed to notch a modest increase.
Resilient Economic Data and Fed Speculations
The robust economic data adds to the market’s optimism. This optimism remains resilient, even as interest rates hover at a 23-year high. The recent slowdown in inflation has bolstered hopes. Specifically, these hopes are that the Fed could tame rising prices without plunging the economy into a recession. This balancing act is delicate and has rarely been achieved since the 1990s. Economic indicators further fuel this optimism, which is crucial for market confidence.
Data released on Thursday revealed impressive growth. Specifically, the economy grew at an annualized rate of 2.8% during the second quarter, exceeding predictions. These developments have led to heightened speculation about the Fed’s next moves. Consequently, the upcoming policy meeting is expected to provide more clues next week. Although the Fed has suggested only one rate cut for the year, traders are betting differently. According to the CME FedWatch Tool, traders are betting on up to three rate cuts.
Big Tech Under Pressure
Despite the overall positive outlook, the week for Big Tech stocks has been rough. Usually, prospects for rate cuts signal good news for the stock market, as lower borrowing costs ease pressure on company balance sheets. However, the recent selloff in tech stocks tells a different story.
This week, the S&P 500 and Nasdaq experienced their worst daily performances since 2022. This decline was primarily due to the selloff of the “Magnificent Seven” tech stocks. These tech titans have dominated the market over the past two years. Consequently, their significant weighting has dragged down major indexes. The situation is compounded by a disappointing start to the earnings season for these companies. Specifically, Tesla and Alphabet have faced substantial hits. Tesla’s shares plummeted by 12.3%. This drop followed a report of a significant decline in profits. Meanwhile, Alphabet’s shares fell by 5%. Although Alphabet beat earnings expectations, it missed revenue targets for YouTube ads.
Small-Cap Stocks on the Rise
While Big Tech struggles, small-cap stocks have been quietly gaining momentum. Smaller companies, which typically suffer under high interest rates due to their higher floating rate debt, are starting to see a turnaround as the Fed appears poised to ease its rate hikes. The Russell 2000 index, which tracks small-cap stocks, has surged by 10.4% this month, significantly outperforming the S&P 500.
Investors diversify their portfolios to include sectors likely to benefit from lower rates. Homebuilder stocks, for instance, have seen increased interest. With cooling inflation, there’s hope that the Fed will cut rates, alleviating the tight housing market that has seen homeowners reluctant to sell due to favourable pandemic-era mortgage rates. This dynamic has driven home prices to record highs, but lower rates could stimulate more activity in the housing sector.
The Future of Big Tech and AI Investments
Investors have been concerned about the heavy reliance on a handful of tech stocks, particularly as these stocks have been instrumental in driving market gains. The “Magnificent Seven” contributed to about 60% of the S&P 500’s total return in the year’s first half. However, recent setbacks suggest that the market’s rally might need to broaden beyond tech.
Despite the recent tech selloff, there needs to be a clear end in sight for major tech firms’ heavy investments in artificial intelligence (AI). Companies like Alphabet and Tesla continue to pour substantial resources into AI development, yet the financial returns from these investments still need to be discovered. AI advancements have focused more on cost savings and efficiency than direct revenue generation.
During Alphabet’s recent earnings call, the focus was on when AI would significantly boost revenue for large corporations. Many in the industry echoed this sentiment: the risk of underinvesting in AI outweighs the risk of overinvesting as the competitive landscape evolves rapidly. As the AI race heats up, it remains to be seen how and when these investments will translate into tangible financial benefits for these tech behemoths.
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