Investors with short-term memories have held the belief that stocks only go up. That certainly has been the case for most of 2024. The Bull Market kept rising in the face of so many challenges; Namely multi-decade high inflation, slowing growth, wars both hot and cold, and the prospects of a divided and potentially contested Presidential election. When you stop and think about it, the first-half rally is truly remarkable. Despite only a small number of stocks leading the charge, the Stock Market, as measured by the S&P 500, kept going higher and higher. Until it didn’t.
This week brought sharp declines. It could be called a Tech-wreck. The areas that have done the best in 2024 generally did the worst. The S&P is down 4% from its all-time highs. The Tech-heavy NAS is down 9%. Even Japan’s Nikkei fell 6% this week. It’s a basic reminder: The Stock Market takes the escalator up and the elevator down. The S&P 500 headed into Friday down for the sixth time in seven sessions. That’s new. Friday saw big gains, erasing some of the losses. The Blue Chip Dow did the best.
I concluded our Summer Newsletter, written at the end of June, with these words:
“This is already the best start to an election year ever. The big question, can it last? We expect a very bumpy road to November. A broadening out of Market leadership would go a long way to smoothing out those bumps. The concentration in just a handful of stocks leading the overall Stock Market can’t last forever. Trees don’t grow to the sky. A healthy correction with a rotation into cheaper areas that haven’t participated would put a stronger foundation under the Market. We think it happens over the Summer and into Fall.”
Those words were written late in the evening on June 27th, a couple of hours after that Presidential debate. The winds have definitely changed. The road to the White House has a new match-up. The AI craze has leaked some air. And America’s Economy is slowing, though Q2 GDP growth did come in at a faster clip than expected. Inflation is slowing too, but prices remain high. And those wars are still present with no signs of ceasing.
As we have stated time and again, for years: It’s Earnings that drive stock prices. More than anything else over time, corporate profits have been the biggest driver of the Stock Market. We are now in the thick of Q2 Earnings Season, where we can focus on facts. Corporate America is submitting its report cards.
Just over 40% of the S&P 500 companies have reported. Expectations were already high. So far, the blended growth for Q2 earnings growth is running at +6.5% rate. So far, it’s short of expectations. The Street estimated 8.8% growth back in June. Of course, earnings growth is quite top heavy. The 6 largest stocks in the S&P 500 are expected to deliver 30% earnings growth compared to last year. The other 494 companies are expected to report a combined 5% rate of growth. AI has been the theme.
The Market is a discounting mechanism. It is forward looking, constantly pricing in anticipated outcomes. Historically, 77% of S&P companies beat Street estimates, by an average of 8%. The AI trade has dominated the rally since late 2022. There’s been an obscene amount of spending on this secular growth theme. Now, investors are increasingly demanding those hefty investments in innovative Tech will generate a return. They want to see proof that companies are profiting or have visibility for profits nearly 2 years after ChatGPT hit the scene.
First up for those Magnificent 7 stocks (Microsoft, Apple, Nvidia, Amazon, Google, Meta and Tesla) were Alphabet (parent company of Google) and Tesla. That said, Elon Musk’s car company, which is more like a renewable energy company, which he calls an AI company, has sort of lost the Mag 7 status in 2024. It’s no longer top 7 in the S&P, but it sure does have a strong following on the Street. Google reported a strong Q2. It was a double-beat with both revenues and earnings beating the Street. Alphabet’s cloud revenues were the driver, surpassing $10 Billion for the first time. That’s AI at work. But there was also a slowdown in YouTube advertising revenues. That’s the US Economy there. This slowdown, paired with increased AI spending, will lower profitability a bit, which sent the stock lower. It was a sell-the-news event as Google was already up over 30% on the year going into earnings. A lot of good was already priced in.
Tesla on the other hand flat out missed. The company’s profit shrunk by over 40% compared to last year as car sales declined in consecutive quarters for the first time ever. Competition from other electric vehicle manufacturers, particularly in China, have placed the pressure. Tesla is losing market share. Looking throughout the Bay Area as a sample, anyone who’s going to get a Tesla pretty much has one already. These reports took the wind out of the swift AI sail. Google didn’t report any revolutionary profits from its new suite of products and Elon Musk continues to kick his robotaxi vision down the road.
A sell-off ensued. The S&P saw its biggest decline since December of 2022. The Tech-heavy Nasdaq fell over 3%, marking its worst daily performance since October of 2022. That hadn’t happened in 400 trading days. It’s been over 350 days since the S&P fell 2%. That streak ended this week too.
But just as the AI craze began to unwind, money has flowed back into areas that have not performed like Tech in 2024. There are companies that are executing effectively in this environment. The Coca-Cola Company is one of them. Coke Zero volume sales grew 20% compared to a year ago. This is an important point. Coke revenue is not just rising due to price increases. The company continues to sell more Cokes because demand is there. But price increases have been taking a toll in America of late, and Coke saw a little of that as Q2 concluded. Strength overseas has The Coca-Cola Company raising estimates for the rest of the year. The stock hit a fresh, all-time high this week.
Economic-growth concerns are very much in play this Earnings Season. Visa and UPS delivered more evidence of the economic slowdown. Visa missed its revenue expectations as it experienced reduced consumer spending. The company highlighted a slowdown in July spending trends with US volume growth decelerating to +4% in July from +5% in June. Validating this trend was UPS, which missed on both revenues and earnings siting its domestic package delivery as the drag. It’s been a theme for a while now; Americans are buying less stuff.
Former Fed official Dudley caught headlines this week when he said that waiting to cut interest rates unnecessarily increases recession risks and it might already be too late to fend off a recession. The stronger than expected Q2 GDP report shows America’s Economy is still in solid shape. But it’s clearly slowing. Importantly, so has inflation. The annualized core PCE (Personal Consumption Expenditure) report came in line at 2.5% for June. This is the Fed’s preferred inflation measurement. It remains at the lowest level since March of 2021. Treasuries saw a modest rally after the print as the data provided more evidence of the disinflationary trend.
Treasuries have been rallying while the yield curve has steepened. The front-end has fallen while the back-end has climbed ever-so-slightly. The 2 vs 10-year spread is now the least inverted since July of 2022. It’s looking increasingly likely that a rate cut finally comes in September. In fact, the Market is assigning a rare 100% probability of that outcome. It actually thinks there’s a 12% chance the Fed cuts by ½ a percent instead of 1/4. The 2 year treasury yield is sniffing that out. And a rate cut at next week’s meeting cannot be ruled out, though it’s pricing just a 5% chance of a July cut.
Back to the Market:
Volatility has picked up big time. After an extended period of low volatility and rising stock prices, it came to an end. The Market got punched in the mouth. The excesses built up from the AI craze made it vulnerable. It was only a matter of time. So is this a consolidation or the beginning of a correction. A consolidation tends to drift and meander, showing little urgency. A correction tends to be distinct and deliberate in its affairs and object. That object is to lose you money and shake the foundation of investor confidence. Buy low and sell high is supposed to be the way but the reality for investors has been buy high and sell low. Fear of missing out takes over. It ultimately takes investors over the cliff.
Corrections are healthy. They do just that: Correct the excesses. It’s like a fastball under the chin of a batter who got too close to the plate. They get too comfortable and complacent. That’s what the Tech trade has done this year. It got people overly excited. A single area of strength can’t last forever. Broader participation is much more healthy. That’s what’s happening now. It finally pays to be diversified. Rotation has come out of Tech into many other areas that weren’t extended or expensive. That’s a good thing. The Market found areas with the least amount of resistance as it’s known to do. Would you believe that Utilities are now up more than Tech on the year? There’s even been rotation within Tech. Semiconductor dominance has been rotating into beaten up Software stocks. It would be healthy for this all to continue. We think it does.
It’s an Olympic year. It’s a time when the world comes together. The Olympics are about healthy competition with good sportsmanship. We sure could use more of this on Planet Earth. Unfortunately, we will be reminded about the tense times in which we live. The 2024 Paris Olympics are set to kick off today, with the opening ceremony taking place under a backdrop of heavy security. The French rail system has already received threats. Bad actors strategically look for events like this to send messages and act bad.
There will be a return for Corporate America to showcase its products and services to the Billions watching. American sponsors cut back during the Beijing Winter Olympics in 2022, in protest of human rights issues and authoritarian control. The United States government boycotted the event by barring diplomatic personnel. This had companies scale back their Olympic-themed commercials.
Hopefully these Paris games will spark greatness, inspiration and a global bond. Cheaters cheat. Bad actors act bad. That’s always going to be the case. But there is far more good out there. Let’s shine a light on the good. I’m writing this from the Junior Olympics of Water Polo, held at Stanford University this week. Teams from across the United States are competing for the Gold medal. Remember the Olympic motto: Citius – Altius – Fortius These words mean Faster – Higher – Stronger. I just love competition.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
