Stocks rallied a bit on Friday breaking last week’s losing streak. It wasn’t a rally with lots of conviction, but it did take some of the edge off of a sour mood. Bonds participated as well, as yields backed off from recent peaks, but rates are back up this morning as are oil prices.
Investors will focus on two key events this week, Nvidia’s earnings report Wednesday after markets close, and Jerome Powell’s speech at Jackson Hole on Friday. If there has been one earnings report that shaped the way markets have behaved this year, it was Nvidia’s last earnings report in May. Generative artificial intelligence (AI) had become a speculative topic earlier, sparked by interest in ChatGPT. But the ability to write school term papers wasn’t going to be enough to get businesses engaged to invest in the technology. Nvidia’s earnings report immediately changed everyone’s view. In its February report, the company had noted headwinds from declining interest from crypto mining and video game producers. But by May, demand for AI applications overwhelmed everything else. That’s actually an understatement. Demand escalated so rapidly surprising even Nvidia’s management that it set off one of the most violent segment rallies in memory. Anything that touched AI literally took off. While the August correction slowed momentum a bit, all eyes will be on Nvidia’s report Wednesday. Obviously, expectations are much higher this time around. How much of the AI surge is hype and how much is real will be the focus.
The reality is probably a lot of both. Properly used, artificial intelligence requires an application to sift through an immense amount of data, and do so in milliseconds. It requires precisely the high-speed graphics processors that Nvidia makes. While many companies are actively investing in AI applications, how many are ready to engage incorporating AI into core software offerings? How often do you call, get a robot who asks you questions, and then suffer through the back-and-forth nonsensical Q&A while yelling “agent” or “representative” into the phone? AI will help. Or, suppose you are a lawyer who needs to document precedent for a big case. Decades ago, you sent an associate to the law library. More recently, it was a Lexus/Nexus search. But with AI you can dig deeper beyond simply listing cases that are relevant. You can get to the right precedents so much faster and tighten an argument so much better. AI can even help to generate the software code that will improve AI’s outcomes. But the key question is how fast is this all evolving? Wednesday will give us some direction. If the hype is overblown, the reaction will be immediate. But if the surge continues, only limited by Nvidia’s capacity to produce chips, it will be extended.
The other big event this week will be Powell’s speech Friday. It will set direction for Fed policy for the coming months. Before the next FOMC meeting, there will be several new data reports that will add to the mix. Powell, as always it seems, has a fine line to draw. Recent inflation data suggests significant cooling, especially in regards to goods and commodities, with oil prices being the only significant outlier. Wage inflation, while cooling a bit, still remains too high to believe inflation is headed for the Fed’s 2% target anytime soon. That doesn’t mean the Fed has to keep raising rates at every meeting. In fact, most believe it will pause again in September. It can afford to. In addition, there have been signs of increasing financial stress that bear watching. Loan defaults are rising but are not yet at alarming levels. Banks are tightening lending standards in part as a result of the bank failures earlier this year, and in part due to regulatory pressure. Money supply continues to shrink as the Fed keeps a focus on reducing the size of its balance sheet. Higher interest rates slow the growth in mortgage applications and consumer spending. It’s hard to keep building one’s credit card balances when interest rates are over 20%.
Late August is peak vacation time as well as a period with little economic data to provide market direction. Thus, it can be a volatile time. September, seasonally, is the toughest time for markets. Right now, despite all the interest rate increases the Fed has implemented to date, the economy keeps chugging along at a 2%+ growth rate. Reduced savings rates and higher debt service costs suggest that can’t go on forever, but there are few signs so far that the consumer is slowing down. The government might shut down at the end of September but that is a Congressional battle that no one is going to pay much attention to until a week or so before the deadline.
Thus, the two events noted in today’s letter will take on outsized importance this week. The third item to watch is any significant change to 10-year Treasury interest rates. They have risen sharply in recent weeks, putting pressure on stock prices. Where they head over the next few weeks is beyond my pay grade. If Powell’s speech Friday is more dovish or hawkish than expected, it could be a big swing factor. He will do his best not to change outlooks too much.
Without much in the way of earnings or economics reports beyond those already noted, we are in for a few weeks where stories that don’t make headlines suddenly leap to the front page. One place to watch is China. Property developer and lender problems are escalating, a function of weak demand, too much debt, and too much supply. Contagion is starting to escalate the problem although it is mostly contained within China. Nonetheless, China is the world’s second largest economy. When it sneezes the risk of catching a cold increases everywhere.
Today, singer Kacey Musgraves is 35. Google co-founder Sergei Brin turns 50. Sex and the City actress Kim Cattrall is 67.
James M. Meyer, CFA 610-260-2220