From the Fed’s September rate cut decision to market concentration, valuations, and risk, there’s plenty to speculate on in the markets and economy today. AAMA President, Bob Baker sat down with AAMA Chief Investment Officer, Phil Voelker, for a clear take on where we really stand. See the full conversation below:
Let’s kick things off right away and talk about what’s happening at Jackson Hole — what can we expect from the Fed meeting this week?
I don’t have to say it, but there’s been a lot of controversy and political theater going on with the Federal Reserve and the administration.
Jackson Hole has been consequential at times in the past. But we’re guessing that this time it will not be. It’s highly controversial, with the financial media making a big headline out of it. But since we have basically one month to go for the next FOMC meeting, I’m going to guess that Powell’s speech is going to be pretty benign. It may be more procedural — a long-term planning kind of thing — but probably won’t get into interest rate discussions. I think that’s appropriate, because between now and the Fed meeting on September 17th, we’ve got another payroll report, another CPI, PPI, and GDP flash, as well as JOLTS numbers. So there’s a lot of data that’s due over the next month that could help shape monetary policy.
If that September meeting were to happen today, it appears that the Fed doesn’t have much motivation to cut rates, because the labor market is still in good shape. Unemployment is relatively low and stable, and inflation has been creeping up in the Fed’s favorite gauge (Core PCE).
The last report in June made a four-month high at 2.8% annualized. The CPI Services ex Energy (similar to the Fed’s favorite gauge) reading, which was just reported a week ago, also made a six-month high at an annualized rate of 4.4%, up from 1.3% in February.
In summary, there’s nothing positive in the near-term trend of inflation. Stock markets are making new highs and financial conditions are loose by any metric. Because of this, I think the Fed could very easily build a case to stand pat again, and not lower interest rates.
The other thing to put into perspective, as we’ve discussed over the past year, is if the Fed were to cut rates in September, the most important aspect of that is how long markets react.
Last September, after a 50 bps cut, everybody will remember that the ten year basically went straight up and ended a hundred basis points from the day they cut rates. Mortgages went up as well. So the long market was disturbed by the size of the cut and was not casting a vote of confidence in the Fed’s inflation fighting efforts. The long market looked at the cut as premature.
Let’s move over to earnings. Much of the earnings reports are in for the second quarter. What’s the general trend and your insight on that?
Most of the quarter has been reported and it did show improvement year-over-year in the S&P 500. But we have a two-tier market today.
As everybody knows, the Magnificent 7 has provided over half of the growth in the market in the last year and represents a very concentrated position within the S&P 500. This is also affecting earnings.
For example, in the second quarter the Magnificent 7 have estimated year-over-year earnings growth of 26% (we are still waiting on NVIDIA). But when you look at the other 493 stocks in the S&P 500, the average year-over-year earnings growth is just 1%.
Prices have been concentrated and earnings have been concentrated. If estimates come to fruition in the next year, earnings are projected to level out at 10% growth for both components as we approach year-end.
How will these trends impact the market in the short-term?
It is hard to say, exactly. However, the market is highly valued. The large tech stocks are highly valued. The remaining 493 stocks are relatively highly valued. In general, it simply means that the market is more vulnerable to disappointing news. That doesn’t mean we are going to have a significant correction. It does mean the risks are higher and if we do have disappointments, either company by company or for the wider economy, the market reaction would likely be greater on the downside.
Let’s shift over to AI. Recently we conducted an exercise to generate custom index data through an AI query. Upon digging into the returned data, we found that it was mostly inaccurate. This is surprising, considering what’s being spent on AI development. Can you provide some insights on the AI trend and impacts on the market?
As everyone knows, there’s been a lot of hype around AI.
AI has actually been around for more than 20 years. We’ve all experienced call handling services and chatbots. There’s been a lot of investment in the space, both in software and in hardware (chips), as well as data centers and electricity generating capacity — to the tune of hundreds of billions of dollars. This has impaired free cash flow for a lot of these large companies, but it has also been an investment across many companies in many different sectors.
We’re getting reports, and anybody can find these, that the results have been somewhat disappointing. Like many new things, the trend is not what it is made out to be on day one.
There are companies that are seeing some success. Generally, it’s in smaller, simple and repeatable tasks. A lot of this applies to customer services, much to our frustration at times. Broader results are very mixed, and I would say in general disappointing from what has been expected.
Time will tell.
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The information and opinions in this report have been prepared by the investment staff of Advanced Asset Management Advisors (AAMA). This report is based upon information available to the public. The information herein is believed to be reliable and has been obtained from sources believed to be reliable, but AAMA makes no representation as to the accuracy or completeness of such information. Opinions, estimates and projections in this report constitute AAMA’s judgment and are subject to change without notice. This report is provided for informational purposes only. It is not to be construed as a recommendation to buy or sell or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy in any jurisdiction in which such an offer or solicitation would violate applicable laws or regulations.
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