The Weekend Edition # 142 - Is a September Fed cut plausible?

Welcome to another issue of the Weekend Edition!

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Here's what we cover

• Market Recap - Still not done

• Fed Preview: What could bring on a September cut

• Earnings - Not as stellar

• Closing Thoughts - Next week is crucial

• Calendars

Market Recap - Still not done

July 22- 26, 2024

This was a week of turmoil. The markets entered that window of weakness that we warned about last weekend and tech earnings seemed to have made things worse.

The markets recovered on Friday after the PCE report, and likely a bounce from being oversold. But, the better-than-expected numbers and worse-than-expected earnings from Tesla and Google saw the market sell-off quite significantly on Wednesday and Thursday. On the macro side, strong growth implied the Fed may delay rate cuts. However, the odds of a September rate cut have now been priced in and there are those who are speculating about a cut even next week. It’s unlikely given the now stickier core PCE numbers.

Despite the recovery on Friday, on a week-to-date basis, we see risk-off prevail when we look at sector rotation. Defensives top the list.

Next week, we have 40% of the S&P 500 reporting earnings and the Fed meeting. Moreover, we have the BoJ meeting earlier on Wednesday and they are set to announce the tapering of bond purchases. There’s also some discussion that they could hike (we think unlikely) but, this has caused strength in the JPY and weakness in the Nikkei, alongside pressure on tech because of the chips restrictions. The price action in Japan this week is based largely on traders front-running the BoJ next week. (We will have a detailed post on this ahead of the meeting on Wednesday).

And then we also have the Bank of England meeting on Thursday. While there has been skepticism over the last few weeks, the odds of a rate cut have now increased to 50%. Between the Fed, BoJ and BoE, we could see turbulence in the US Dollar.

Fed Preview: What could bring on a September cut

After the CPI posted a negative month-on-month print, the odds of a September rate cut have been priced in. Furthermore, the unemployment data continues to show a rate of 4.1% which remains higher than the Fed’s projection and we signs of some weakness in the labor market.

On the other hand, Friday’s PCE inflation numbers showed some signs of stickiness at the core level coming in higher than expected, and no change from the previous month. And the stronger GDP report, suggests that the economy is still okay although a few of the earnings reports we’ve received suggest otherwise.

There are still some who think that the Fed may even cut as early as next week, which we don’t think is likely. If that were to happen, the market would probably consider it as a sign of weakness in the economy or some sort of credit event on the horizon, which the Fed sees but we don’t. Next week is simply too early.

But, let’s take a look at the for and against a September cut, vs a December cut.

Arguments for a September Cut

• The labor market is weakening more than we see on the surface. The downward revisions of nonfarm payroll additions make the picture weaker than what we’ve been led to believe.

• Anecdotal evidence from earnings tells us that consumer spending is slowing, particularly for the lower-income groups. Increases in unemployment could exacerbate that.

• Fiscal spending

• Economic Growth is set to weaken in the second half of the year, and we will only know Q3 numbers after the Fed’s September meeting. If the real GDP growth number comes out materially weaker, it’s likely the Fed will already be behind the curve, and have to cut more drastically. A September cut will give them some “insurance”.

Arguments against a September Cut

• The Fed’s own projections show inflation remaining higher than what we’ve seen in the last two readings. Core inflation still remains sticky. Shelter inflation has not decelerated as much as expected. And, base effects for this year are yet to kick in and the Fed may likely want to wait just three more months, which could make a major difference

• A cut that close to the elections could seem political, and many may argue it’s being done to help the Democrats win the election. (Although, I’m sure the Republicans will welcome a cut as well!)

• Even though unemployment is gradually weakening, it’s not weak. Neither is economic growth. As long as real GDP growth remains positive, and it is set remain so for 2024, the Fed can make the argument for not cutting until December. The unemployment rate will need to rise materially, for the Fed to take drastic action.

If the Fed cuts in September, then this meeting will likely be the one where they give us hints of that. While we do expect some dovishness from Chair Powell (can’t remember the last time he was very hawkish), there’s a good chance that he doesn’t provide any signal but rather lets the Fed Speakers and perhaps, the Jackson Hole event be the methods to telegraph a cut.

Earnings - Not as stellar

According to FactSet, the blended earnings growth for Q2 is 9.8% YoY, which is still higher than the estimate of 8.9% YoY, coming into the quarter. But remember that blended earnings are actual + estimates, and we have only heard from 41% of the S&P 500 companies and next week is when we get the bulk of results.

Big Tech is still strong on an absolute basis but, on a YoY basis we’re starting to see some slowdown and that’s causing people to consider some profit-taking ahead of Microsoft, Apple, Meta, and Amazon - all of which report next week.

Last week, we had a number of companies drag down the markets because of misses or less-than-stellar guidance:

• Visa down -4% - first Revenue miss since the pandemic

• Google down 5% - light on YouTube revenues, no change in CapEx guidance for AI

• Tesla down 12% - miss on EPS; no CapEx guidance for AI

• Ford down 18% - double miss

• Lamb Weston down - 28% - double miss

• Edwards Lifesciences down -31% - Miss on Revenue

• Dexcom - 40% - missed on revenue and lower revenue guidance

There were some positive news as well:

• Valero Energy + 5.50% - higher EPS, higher buybacks, lower net debt

• 3M +23% - double beat and raised guidance (this is ex-the healthcare unit)

• Charter Communication +16%

• Norfolk Southern +11%

A look at the summary of sectors shows us that Financials have actually outperformed when compared to estimates and materials have underperformed. We are yet to hear from the major energy companies so tally there is not a fair representation.

Earnings Next Week:

Closing Thoughts - Next week is crucial

If last week taught us anything, it’s that earnings matter. With 40% of the S&P 500 reporting this week, we are likely to see quite a bit of volatility in the market. What we really need to see is an earnings recovery. Thus far, even though the blended earnings growth has come out better than estimated, the misses have been punished severely.

The rest of the Mag 7 reports next week (ex-NVDA) and the market is going to want to see some strong numbers to restore their faith in the earnings growth of 11% -14% projected for the year.

The macro data now presents a mixed picture. GDP growth has come in strong, inflation remains somewhere in the middle while the jobs market seems to be gradually weakening. If the macro data weakens though, there may be cause for alarm as the Fed will once again be late to the party. They’d have to take drastic action to cut rates, which won’t be great for the market in the short run.

Election years tend to see even more pressure during September and then again towards the end of October. The chart below is a bit dated (Jun 2024) but you can see the seasonality factor in election years.

We’ve had overall strength in the market this year though, as you can see. However, a disappointing earnings season from the biggest companies could very well add pressure given the seasonality factor and a mixed macro picture.

Have a great week ahead!

Sincerely yours,

Ayesha Tariq, CFA

There’s always a story behind the numbers.

Articles this week from MacroVisor

Calendars

US Earnings Calendar - Above, under Earnings Section

US Economic Calendar in Eastern Time (Source: Trading Economics)

None of the above is Investment Advice. I may or may not have positions in any of the stocks or asset classes mentioned. I have no affiliation with any of the companies other than explicitly mentioned.