What We're Talking About This Week!

• Weekly Market Reset

• Key Economic Reports This Week

• Dividend Landscape

• Market Outlook

Weekly Market Reset

NVIDIA’s earnings report seemed to have hit all the right notes, but when expectations are so high, it becomes a bar that’s nearly impossible to clear. That’s what happened with the AI giant last week, which saw its stock drop by roughly 8%. That prevented the S&P 500 from producing much more than a minor gain on the week, while the Nasdaq 100 was firmly in the red, but the equal weight S&P 500 was up nearly 1%. It’s been a choppy process, but we are seeing smaller companies and non-tech/magnificent 7 names starting to build and hold on to outperformance over the major averages.

With Q2 GDP getting revised upward to 3% and inflation remaining controlled, I think we have to discuss the possibility that the Fed pulled off the soft landing. I’ve made no shortage of complaints about the Fed’s inability to keep up with changing conditions in the past, but their decision to keep interest rates elevated to combat stubborn inflation instead of cutting like the markets wanted seems to have been the right one. Powell needed the economy to continue maintaining its positive growth rate in the meantime and it did. Now comes possibly the harder part - normalizing monetary conditions without rocking the boat. If inflation stays in the 2-3% range, the Fed Funds rate probably needs to drop by about 200 basis points to get back into equilibrium. The smarter, in my opinion, would be a series of quarter point cuts well into 2025 that would take a slow and gradual approach. A half point cut would be understandable if this week’s non-farm payroll report shows more weakness, but maintaining balance should be the goal for the Fed.

Other observations: Almost every defensive and cyclical sector is in overbought territory, so I wouldn’t be surprised to see some moderation there in the coming couple of weeks. A lot of investor money is still flowing into tech, but financials have also seen a lot of net inflows, especially on a relative basis over the past few weeks. I’m sure the prospect of rate cuts is a big reason for this as lower rates should ease financial conditions and improve lending demand. Small-caps aren’t nearly dominating the way they were back in July, but we’re still seeing some strong residual demand for small-cap ETFs. On a relative basis, they’re still outdrawing large-caps with small-cap value and blend looking particularly strong. Don’t sleep on international stocks here either. They’ve quietly been outperforming the S&P 500 for the past two months as improvements in Europe and Japan start to gain a little traction. The economic conditions in both of those regions are still quite tenuous, so the current uptrend should be considered so as well.

Key Economic Reports This Week

I’m not sure we should put much faith in the non-farm payroll numbers given what we’ve seen with the annual revisions recently, but we’ll get the August figure later this week nonetheless. If the final number comes in at the consensus 163,000, that’ll be a good, not great, report. But given what’s happening with the constant downward revisions, I’m not sure we can get excited about almost any number. The BLS has lost a lot of credibility, but it’s what the markets going to have to work with for the time being. If we see another uptick in the unemployment rate, I think a 50 basis point cut in September will be squarely on the table.

We’ll also get the latest monthly PMI readings, which should confirm what we already know - the services side of the economy is holding up relatively well, while manufacturing still looks weak. With Q2 GDP getting revised upward last week, inflation showing continued moderation and consumer spending still chugging along, there are few signs that a recession is imminent, yet the warning signs are building. Chase, for example, is now refusing to allow customers to use their credit cards to pay off “buy now, pay later” purchases. I think while spending remains steady, people are are increasingly extending themselves financially and struggling to come up with the means to pay for those purchases.

Dividend Landscape

Dividend stocks had a solid week relative to the broader market, but it continues a pattern of hot and cold performance. Based on U.S. large-caps quick rebound from the recent VIX spike, it doesn’t seem like investors are willing to give up on previous winners, such as growth and tech, so easily. The fact that high yielders are still doing comparatively better than more conservative dividend strategies suggests that there is still risk-on sentiment underlying this market.

But I can’t help but notice that last week’s leaders were all defensive and cyclical sectors. Tech hasn’t fully comeback to where it was this past summer relative to the S&P 500 and if growth remains out of favor for an extended period, that’s the right kind of environment for dividend stocks to start picking up some steam. While NVIDIA’s 8% drop last week serves as a reminder that the magnificent 7 isn’t infallible, we probably need to see some sort of economic catalyst, perhaps another weak labor market reading later this week, in order to see a sustained sentiment shift.

Market Outlook

Treasury yields moved higher again last week as the economy continues to look resilient, so I envision a scenario where riskier equities pick up a little momentum while defensives ease. If we get a strong jobs report on Friday, I think yields will shoot higher again and tilt the scales back to a quarter-point hike instead of a half-point one. I think we’ll see jobs being added again, but we’re well past the peak.

Overall, the weakening labor market and consumers getting overextended are the two biggest risks that will continue to underpin this market. Healthy GDP and subdued inflation will probably keep a cap on volatility for now, but the economy is increasingly finding itself on a weak foundation.

Looking better for: growth, quality, junk bonds

Looking worse for: Treasuries, consumer staples, gold