Markets mid-summer slide wallops technology
July, as promised, has turned out to be a month where financial markets have been buffeted by fireworks on various fronts. A gambit of data from inflation to economic growth combined with a new American brand of populism has led to some unexpected market consequences.
The good news first. In the second quarter, gross domestic product grew well above economists' expectations at an annualized pace of 2.8%, compared to forecasts of 2% growth. The 'core' Personal Consumption Expenditures Index (PCE), which excludes food and energy, grew by 2.9% in the second quarter. That was above estimates of 2.7% but significantly lower than the 3.7% gain in the prior quarter.
On Friday, the monthly PCE data came in as expected edging up 0.1% month-over-month in June following a flat reading in May. However, the core index was a bit higher than forecasts at 0.2% versus expectations of a 0.1% increase. While still an increase, it is the slowest pace of inflation since March 2021. It is doubtful that the data will convince the Fed to change monetary policy sooner than the market expects.
On the political front, my prediction that President Biden might relinquish his candidacy in favor of his vice president, Kamela Harris, proved to be true. The impact on the financial markets has been negligible thus far, but the odds of a Trump win have gone down somewhat. As a result, the fervor to buy areas of the market that might benefit from a Republican sweep has subsided a little.
I believe that to make investment decisions at this point on who will win or lose the elections is largely fools' gold. Far better that we focus instead on something more tangible like the expectations that the Federal Reserve Bank will likely begin to cut interest rates at their next meeting in September.
We will know more about this in the coming week when the FOMC meets again on July 30. While there is only a 6% chance that the Fed will cut interest rates at this month's meeting, the odds are almost 100% that they will cut interest rates in September. That bet is what has investors buying small-cap stocks, which benefit the most from the loosening of monetary policy.
In the meantime, stocks have done what I predicted. The S&P 500 Index declined by 5% or so with NASDAQ falling almost double that amount. However, the Great Rotation that I discussed in my last column is alive and well.
The Russell 2000 small-cap index outperformed as did other forgotten areas like financials, real estate, and industrials. On the downside, the darlings of the market over the past months, FANG and AI companies were clobbered as did the technology sector overall.
You might think that if some sectors were up, while others were down, the overall market would balance out. Not so. Market capitalization is the key. Over the years, the growing weight of this handful of tech stocks in just about all of U.S. equity indexes has been extreme. The entire market cap of the Russell 2000 Index, for example, is equal to the market cap of just one of the FANG stocks. As such, no matter how much small caps gain, they can never make up for the declines in the technology sector.
In the short term, where FANG and AI technology go, so goes the markets. On the surface, the carnage in some stocks was nasty, but in the grand scheme of things a mere bump in the road considering the gains we have enjoyed thus far in the stock market this year.
The question you may be asking is whether the selloff is over. I sense that we still have more to go, but we could bounce first before rolling over again. This volatility could last until the Fed meeting late next week. At that point, with possibly more visibility on rate cuts, the market could find support.
Bill Schmick is a founding partner of Onota Partners, Inc., in the Berkshires. Bill’s forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners, Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or e-mail him at billiams1948@gmail.com. Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal.