The Fed’s balancing act
The Federal Reserve’s focus is shifting from solely fighting inflation to considering employment conditions. Recent jobs reports, indicating a slowdown in hiring and a slight increase in unemployment, has sparked some recession concerns. But the unemployment rate has been low by historical standards, while core inflation remains above the long-term average. Although inflation hasn’t been entirely tamed, progress has been made, allowing for potential easing of monetary policy.
The current situation is unique as the Fed isn’t reacting to a collapsing economy or financial crisis. Instead, the upcoming rate-cutting cycle aims to ease restrictive monetary policy. Investors expect gradual and smaller rate cuts compared to previous crisis-driven downturns, with the Fed being highly data-dependent in its decision-making. The path for rate cuts might not be consistent, with potential pauses interspersed with cuts.
This dynamic provides a setup for lots of market volatility which will be driven by investor reactions to the economic reports that weigh heavily on the pace and magnitude of Fed rate cuts. Further weakening of labor markets may be viewed negatively in contrast to prior weak reports which were deemed positive by investors for the accelerated rate cut implications. Likewise, any signs that inflation is not continuing towards the Fed’s 2% target could also spark a violent market reaction.
Nvidia remains the market’s shining star, but expectations are high
Last night, Nvidia reported its most recent financial results. Earnings and revenue growth beat estimates, but its stock price fell after issuing a strong, but not strong enough, outlook for the current quarter. Sales were up 15% Q/Q and 122% Y/Y to $30B while profits more than doubled to $16.5B. Nonetheless, investors were slightly disappointed by the outlook for profit margins for the back half of the year.
The AI infrastructure investments being made by Nvidia’s customers are incredible and will no doubt deliver a profound impact on the future of almost every business. Customers are in a race to replace their current old technology with faster, more efficient, accelerated computing technology. Nvidia’s CEO noted that we are in the midst of a $1 trillion investment cycle that will modernize data center infrastructure over the next few years.
Consumers are saving less
The economy has been chugging along better than many expected at the beginning of the year. In fact, today’s 2Q revised GDP report showed that the economy grew at 3%, higher than the 2.8% that was expected. However, the personal savings rate (savings as a percent of disposable income) has declined from 4.0% to 3.4% since January. The long-term personal savings rate has averaged 8.5%. The main reasons for the recent decline are high inflation and rising interest rates. The low savings rate and exhausted excess cash balances in consumers’ bank accounts won’t be reversed quickly by the forthcoming Fed rate cuts. Moreover, if unemployment rises, consumer spending may weaken further.
The U.S. economy is driven by consumer spending which comprises about 70% of GDP. Consumers have been increasingly relying on credit cards and other revolving credit to maintain their spending patterns. Credit card delinquencies have now risen in each of the last 11 quarters. About 3.3% of total outstanding credit card balances are now at least 30 days delinquent, which is the highest since 2011. So, despite persistent talk of a ”soft landing,” there continues to be a real risk of recession.
Market valuations are high
The recent market rebound has provided investors some relief, but this summer’s volatility serves as a reminder of the importance of monitoring portfolio allocations. Economic deceleration is becoming evident, with a notable downward revision to the U.S. nonfarm payrolls tally. However, investors seem to interpret this as a sign of a softening but still-resilient labor market. While the U.S. economy is expected to grow in the second half of 2024, challenges to accelerated growth are increasing. Defining a “soft landing” may be difficult in this context.
Second quarter earnings were mixed, with some notable winners and losers. For the most part, companies have maintained solid profit margins. But we note from the most recent batch of corporate earnings conference calls, that expense management played a critical role in helping steer profits. Slowing consumer spending, combined with an increase in corporate layoffs, will be something to watch.
As we enter the historically weak performance month of September, the S&P 500 trades for approximately 23x 2024 expected earnings, which may limit upside in the near term. The 10-year U.S. Treasury yield is now 3.8% and near the lows of the year, which has supported stock prices so far. There is a presidential debate scheduled for September 10, and the widely anticipated Fed rate cut expected to be announced on September 18. Let’s buckle up for the ups and downs of September while keeping our focus on the long term.
Actress Rebecca DeMornay (Risky Business) turns 65 today. Supreme Court Justice Neil Gorsuch turns 57 and Brian Chesky, CEO of Airbnb is 43 today.
Christopher Gildea 610-260-2235