Broker Check

Market Insights – Week Ending May 24, 2024

May 28, 2024

Market Summary –

Heading into the extended Memorial Day weekend, the S&P 500 and Nasdaq reached new all-time highs; revitalized by another impressive earnings release on Thursday from Nvidia (NVDA). Bolstered by continuously strong demand for AI, NVDA shares surged 10% and renewed confidence in other semiconductor and AI-related names, as well as the beloved mega-caps. On Friday, the broader market was ultimately unable to follow through on further momentum from NVDA, despite the stock itself rising another 2.5%. Investor sentiment leaned towards consolidation based on near-term valuation worries and profit-taking action prior to the extended weekend.

Key Market Themes

As we near the mid-point of the year, I’d like to briefly share 5 key themes we are monitoring:

Persistent Inflation & Monetary Policy

Inflation is the main character in this story and has been for a few years now. Post-pandemic, a myriad of factors contributed to the surge in inflation: Elevated energy prices, supply-chain issues impacting supply and demand, rising housing costs, and most notably, pandemic-era government stimulus. Inflation began rising aggressively beginning in March 2021 and peaked in June 2022. Today, core inflation hovers around 3.5% - a level it has maintained for nearly a year now - and is the reason the Federal Reserve has maintained its higher-for-longer rate stance well into 2024.

After a late start, the Fed first raised rates in March 2022 and would proceed to raise rates another ten times. This has helped tame inflation – but not sufficiently towards the Fed’s 2% target mandate. Consequently, rate cut expectations were quickly revised to two or three before year-end, down from six to start the year. The Fed recently signaled that another rate hike is unlikely, but the timing of rate cuts remains an uncertainty. With sticky inflation and an exceedingly strong economy, the Fed is in a difficult position and forced to take a wait-and-see approach.

Resilient U.S Economy

While the Fed’s hiking cycle has helped bring inflation down from its peak, the unusually strong US economy – characterized by a strong labor market and resilient consumer spending – has had three major impacts.

(1) It has helped offset restrictive monetary policy as inflation has declined without impacting the broader economy. Despite a downtrend, economic activity measured by GDP has accelerated during the Fed’s hiking cycle and is on pace for above-trend growth of 3.5% for the second quarter.

(2) At the same time, the strength of economic growth has contributed to sticky inflation in the form of the wealth effect - perpetuated by elevated housing values and record stock market highs.

(3) The strong economy has been supportive of earnings growth and the market’s hopes for a soft-landing scenario.

Ultimately, the Fed will need to see evidence of a slowing economy, likely in the form of a weakening labor market, to justify rate cuts.        

AI-enthusiasm, Earnings Growth, and Valuations

Resilient economic growth has helped push both corporate earnings growth and the stock market to record highs. Momentum from AI-related growth stocks, led by Nvidia (NVDA), has propelled the market since the lows in October 2022; all against the backdrop of elevated inflation, interest rates, and broader recession worries.

The rapid growth amidst the Fed’s restrictive hiking cycle has given some near-term valuation concerns. Valuations are estimates and should always be taken with a grain of salt – as the recent rally has shown us, the market can remain “overvalued” for much longer than participants think. The debate on whether an index or company is overvalued should instead be viewed from a portfolio and risk perspective.

Elevated valuations and all-time market highs simply present a greater near-term risk should an unforeseen event occur – which we are largely indifferent towards as long-term investors, due to how we position our portfolios. Still, we remain cognizant of known risks, such as a re-acceleration in inflation, the potential for mega-cap earnings disappointment, and general geopolitical risks.

Week Ahead

This week, focus will be placed on the Core PCE inflation report for April on Friday, which is the Fed's preferred gauge for inflation. As usual, the market will be interpreting how the data may impact the Fed's next rate decision on June 12.

On the earnings front, the cloud-computing bellwether, Salesforce (CRM), reports fiscal Q1 earnings on Wednesday followed by the hyper-retailer, Costco (COST), on Thursday.

 

As always, if you have any questions or comments please do not hesitate to reach out.

 

Respectfully,

Michael Neill, CFA