Jason's World

Stock markets rallied this week on solid economic, earnings and inflation data, with a brief pause on Thursday when fears lingered of higher interest rates due to 10-year treasury yields reaching 4% and the possible impact of Japan’s loosening of YCC on US Treasury yields. GDP growth for the second quarter remained solid at 2.4%, way above Wall Street estimates of 2%, bolstered by business investment. PCE, the Fed’s preferred inflation gauge, continue to decline, declining from 3.8% in May to 3% in June. Expectations for earnings this quarter have gradually improved.

Despite inflation coming in lower than expected for three straight inflation reports, the Fed has remained a hawkish tone, as Chairman Jerome Powell sees solid economic and job market growth as continuing barriers to bringing inflation down. Mr. Powell has maintained a skeptical tone about the notion that the fight against inflation is nearing its end.

Yet, this has not stopped the markets from pricing in further economic prosperity and an end to rate hikes after the July meeting. Despite the Fed saying repeatedly that more hikes may be necessary, markets are still forecasting no more hikes for the remainder of the year, although they have been pricing in a less aggressive pivot than they did before. 

Eventually, the hubris of the market may come to a head: because of how the top line number in the inflation report is calculated, even if inflation occurs at a slow rate throughout the rest of the year, the top line number will continue to hover at an elevated rate, which, combined with the strength of the economy will further embolden the Fed to raise rates and probably keep them high for longer.

Earnings season thus far has proven to be a pleasant surprise as most large tech stocks thus far have posted positive surprises. Microsoft, Google and Meta all beat earnings. This had a reinvigorating effect on the tech rally, which was held back in part by Tesla. AI plays roared back to life, with Palantir rising 10% on Friday alone and 12% last week, following Wedbush’s initiation of coverage of the stock at an initial $25 price target, indicating a 36% upside. Nvidia rallied more than 5% last week after falling 2.6% the week before. 

Microsoft’s counterintuitive drop post-earnings reflect the company’s more tempered predictions about its AI rollout. With expectations for AI as high as they are, markets appear to have zero tolerance for even a whiff of bad news. Microsoft’s performance shows how due to these expectations, development of AI has been, for now, a leading metric that investors base their expectations of a company on, and this metric has become more important than revenue growth, earnings growth, and even the status of other non-AI related services.