Palumbo Pulse August 12th, 2024: Now What?

We seem to have averted disaster from Japan, at least for a while, but the tide may have turned on the Tech rally. It’s been an interesting two weeks, to say the least. The stock market can’t seem to make up its mind whether it wants to continue the rally or take a breather. Here are several things that could define the market’s course from here.

The Yen Carry Trade

The Bank of Japan, which raised interest rates to…. (drum roll)… 0.15%, was the primary driver of the extreme volatility of the last 10 days. On Wednesday morning the BOJ capitulated and declared that they will not raise rates into turmoil. Since they created the turmoil, it’s not exactly clear what that means. The one thing we know is that Japan is in a bind, rates are near zero and inflation is a problem. One way or another, rates eventually have to rise. The questions are can they pull that off without more turmoil and when will they attempt to do that?

The Bloom is Off the AI Rose

This is still a very significant economic and political technology race, but the irrational, speculative investment surge is probably over. Questions about the near-term return on investment are popping up all over. It’s less and less about the hype, it increasingly about the results, which we would expect to be mixed at best. Not everybody can win this competitive battle.

Jobs and Q2 Earnings Create a Growth Scare

The weak July jobs data coincided with the recent market disruption, but it was unlikely the primary cause. Nonetheless, the employment trend is clearly down, and unemployment up. The Fed can no longer push hard on inflation without also worrying about the state of the labor market and the state of the economy. That means that the first rate cut is essentially baked in for September. However, the cautious guidance in second quarter earnings reports, especially for consumer driven companies, like McDonalds, Disney, Airbnb, Hilton, Monster Beverage and Lyft, along with rising credit card and loan delinquencies are causing a growth scare. The difficulties being experienced now are not especially intense, but markets are beginning to question the overwhelming confidence in the soft-landing scenario. Does this morph into recession? It could, but that is not baked in.

Geopolitical Tensions

With all the other issues on the front burner, geopolitical tensions have been on the back burner, but that could change quickly if Iran turns up the heat on Israel. Nothing has happened yet, which indicates that diplomacy may be working. That would be a welcome outcome for markets. If diplomacy does not prevail, the U.S. military will likely be taking a more direct role in the Middle East once again. War keeps an economy going, but the initial shock is not well received by markets.

Trump? Harris?

To start, I want to make sure readers understand that this is not a political commentary, it is an economic commentary. We are not taking sides.

Markets rallied hard when it briefly looked like an easy Trump win. Our guess is that the rally was basis of a red wave, (i.e., a GOP House, Senate and Presidency). Things are significantly less clear now. A red wave or a blue wave could continue the large fiscal stimulus to the economy. While that might keep GDP growing for a few years, the additional deficit spending pulls our long-term fiscal problems further forward. Our preference would be for a split government that is effectively gridlocked and theoretically less able to be spendthrifts. Whoever wins, it will be interesting to see if the bond market begins to exert some pressure to deal with the national debt.

What Does It Mean for Markets?

For now, we’d guess the party is over. After a big run, the markets are overdue for a breather. The path of least resistance appears to be consolidation – some swings up and down with little real progress in either direction – until the items above are resolved one way or another.

Have a great week!

What We’re Reading

No sign of U.S. recession in freight demand, CEO of shipping giant Maersk says

Fed’s Barkin: There’s a narrow path, risks are on table for both sides (3 min video)

This week proved markets aren’t bouncing without good news (4 min video)

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?The views expressed in this commentary are subject to change based on the market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.

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