It was a golden week for equity investors. Stocks surged as Democrats cheered on their nominees in a party only those heavily invested in politics could enjoy. Substantively, the convention revealed nothing. That wasn’t its intent. The goal was to energize its base and clearly it accomplished that goal.
It was also a week of mostly favorable economic data. Inflation seems tamed, retail sales rebounded, and jobless claims suggested no imminent recession. Bond yields fell, although the yield curve remains inverted up to about 3 years. The only shocking number was a restatement by the Labor Department that showed that our economy added more than 800,000 fewer jobs in the year through March than originally reported. Thus, monthly employment growth that appeared to average over 240,000 jobs per month actually only added a bit over 170,000 jobs per month. That was still a number consistent with a soft landing but hardly suggesting a robust economy. Now we know why workers are no longer getting the wage increases for shifting jobs, and why more and more workers seem to have difficulty finding suitable jobs that match their skills.
It was also a week of earnings from big retailers. For the most part, the numbers were decent. It appears decent was more than many investors expected. It’s hard to label the results of Home Depot# or Lowes# as robust. Indeed, their comparable store sales declined, extending a weak trend that has been in place for more than two years. But both stocks rallied nonetheless. Wal-Mart had solid results mostly on the back of strong grocery sales. The big winner of the week was Target, but others, like Macys and Urban Outfitters were disappointments. Nonetheless, the bottom line is that retail is OK, not solid but OK. That fits with the idea of a soft landing, not a recession.
On Friday, Fed Chair Jerome Powell essentially said that barring economic data that contradicts recent trends between now and the mid-September FOMC meeting, you can count on the first rate cut since the pandemic. The pace of cuts and the extent are still to be determined, but one can see a Fed Funds rate below 4% in a crystal ball in the not-too-distant future. One caveat. The next President may or may not be able to implement big spending programs, depending on the makeup of Congress. The Fed views its mission, in part, to counterbalance an overly expansive fiscal policy that would add significantly to debt and, perhaps, reignite inflation. Thus, while one can easily see a cut in the Fed Funds rate to 4.0-4.5% by inauguration, what happens beyond that will be dependent in part on the course of fiscal policy in 2025.
Thus, for the past week or two, we have been overwhelmed with a lot of feel good news. Solid employment, decent retail sales, lower bond yields, a movement from hate to hope in the Presidential race, and good earnings. Does that mean new highs are inevitable?
In the short run, that could happen. Most averages have recovered the July/August hiccup triggered by the unwinding of the yen carry trade. Lower bond yields have been a big help along with a string of better economic numbers. But just as the pessimism a few weeks ago was both extreme and unwarranted, perhaps the euphoria that has reasserted itself is a bit overdone.
A key this week will be the earnings report from Nvidia#. This has been Wall Street’s darling for the past 18 months. Its stock has surged, but so have its earnings. The obvious question is when will the accelerated demand for its chips, which help build out the infrastructure to support the AI world of tomorrow, start to moderate? It’s unlikely that it happened this past quarter judging from reports of Nvidia’s top customers who have already reported. But that’s backwards looking. What investors will be focused on is what management says about the future. Is any moderation yet in sight? Probably not. Then the next question is how will the Street react to earnings that will most probably beat current forecasts? If great numbers elicit a muted response, that could well pause the current market rally. On the other hand, results far better than estimated could lead to another leg up for both Nvidia and the whole tech sector.
Nvidia and related AI names have not only been the market leaders for the last 18 months, they have delivered the vast majority of earnings growth for the entire S&P 500. Someday, if not this week, that will change. That doesn’t mean Nvidia won’t continue to grow, but rather the pace of growth will moderate, perhaps rather significantly over the next 2-3 years. That leads to an obvious question. Where will investors find future economic and stock market leadership? There is no obvious answer. Recent leadership has broadened to include REITs, utilities, some consumer staples names, banks, and healthcare. These stocks have gotten a boost from rotation, but are they achieving earnings acceleration? Not really.
As we get ready to leave summer, there are reasons to believe that the joys of the last few weeks may not be quite so sustainable. The Presidential campaign is going to morph from slogans to issues. Neither side appears to have economic answers that look all that appealing. Both like to spend. Neither has a way to pay for the giveaways. Labor markets are weakening. A surprising number of workers are nervous about job security. Excess savings have been used up. Buyers are more cautious. After the August rally, stocks once again are priced for perfection. Short-term trend oscillators are near record highs suggesting too much short-term optimism.
But a short-term pullback isn’t a calamity. Too much optimism is never good. A partial retracement of the August recovery could set the stage for a better market going into year end. Perhaps the September 10 debate will reveal a few strengths and warts. It’s easy to promise goodies in a campaign; telling voters how they will be paid for might raise a few eyebrows. As always, though, debates are less about substance and more about style. Harris will tell a story of optimism with that glowing smile of hers. Trump, if he can stay on point, will show that giveaways alone are an economic catastrophe. If he wanders into election fraud and name calling, he will have a tougher time. It’s important to note that how investors read the debate can be very different than how the general public views the outcome. Investors want to focus on dollar and cents issues, taxes, and deficits. Most of the public wants to hear what’s in it for them. Some Democratic favorites, like student loan forgiveness, are not particularly popular with the general electorate. The debate’s substance will matter, but the real focus will be on ensuing polls that suggest any change in odds of a victory for either side. Then the focus may shift to the makeup of Congress. While history suggests markets do well when one side controls both the White House and Congress, I doubt investors will be happy, at least initially, if either party makes a clean sweep.
The bottom line is that with markets priced to perfection, it won’t take much to make the next several weeks a bit bumpy. But assuming a soft landing can be achieved, there are few reasons to expect the stock market by year end to be lower than it is today.
Today, Melissa McCarthy is 54 years old.
James M. Meyer, CFA 610-260-2220