Financial markets continue to have some volatility, with changes in interest rate expectations, slowing economic indicators, and corporate earnings all influencing investor appetite and risk positioning heading into year-end. After digesting a slew of data in early October, markets settled into a holding pattern over the last few weeks as they await some key events in the weeks ahead. Notably, there is an updated CPI inflation print tomorrow, which will be closely watched by a market guessing the Fed’s next move. There is also an earnings report from chip designer Nvidia, which will be key to determining the staying power of the AI trade which has driven so much this year. Then, to close out the year we’ll have a final jobs report and Fed rate decision, which at this point markets already believe will confirm the end of rate hikes.
While interest rates have remained in focus all year, they are particularly important right now given the inflection point the economy finds itself. The latest data is finally starting to show the long-awaited slowdown occurring, with labor data, manufacturing, and other data points showing an economy broadly feeling the impact of tighter financial conditions. While consumers continue to spend, they are becoming more discerning, and companies are likewise communicating a more defensive posture with weaker sales guidance on earnings calls.
This is why the upcoming inflation and jobs reports are so important: If the Fed is satisfied that they are achieving their objective then they will likely stop increasing interest rates, which in turn will take pressure off the slowing economy. This is how the economy could still achieve a “soft landing”, with inflation coming back to target but without causing a recession in the process, a bullish outcome. But if these data remain too hot, then the Fed is likely to push back on the market’s assumption that they are done hiking. And this has been the major reason for volatility in recent weeks, as investors hedge their bets.
Corporate earnings remain front and center as well in terms of determining the next move for the market. As we’ve mentioned in prior updates, virtually the entire return in the S&P 500 this year has been driven by just a handful of large cap tech names, most of which are major players in AI technology. Enthusiasm as to what this powerful new technology means for these companies, as well as how other sectors that can employ it, has powered the market higher. As a result, markets are laser focused to see if this growth is real and sustaining, and so far, the signs have been cautiously optimistic.
Microsoft, for example, has nearly retaken the lead from Apple as the world’s most valuable company due to the growth in its cloud and enterprise businesses that are integrating AI. Nvidia, the key supplier of the logic chips used for AI, has continued to beat expectations throughout the year as demand dramatically outstripped supply. As a barometer for the emerging technology, its earnings report next week will be key to determining if this theme of Technology outperformance continues or whether we’re in for a period of more normalized trading.
Performance this year in AI-related stocks has underscored not only how innovation is accelerating but also how lop-sided its impact can be in markets. A similar theme played out in the pharmaceutical space, where new weight loss drugs caused dramatic movement in some stock prices as well as a reassessment of everything from snack foods to air travel. While the verdict is still out on the scope and speed of these innovations, we believe this theme of disruption in markets is likely to continue going forward.
This is the basis of some rebalancing we’ve done in recent weeks, which will ensure exposure to the most critical companies upon which this higher innovation economy is unfolding. Their ownership of key infrastructure is making them as indispensable to this emerging 21st century economy as railroad, telephone, and energy companies were in the 20th, even as the normal twists and turns of market cycles causes volatility in their stock prices.
As year-end approaches, we will continue to remain vigilant for opportunities to add value in portfolios. We are also currently taking advantage of market movement to proactively manage realized gains for tax season. As a result, you may continue to see some trading in portfolios but please don’t hesitate to reach out if you have any questions.