Weekly Market Commentary

July 22, 2024

The Markets

The rate cut stars are aligning.

For the last year, borrowing costs in the United States have remained relatively high as the U.S. Federal Reserve (Fed) waited for economic data to show that inflation was on track to reach the Fed’s two percent target. Now, we may finally be on the cusp of lower rates.

“The Fed’s preferred inflation gauge has eased to 2.6 [percent], not far off its 2 [percent] target, and the once overheated labor market has cooled to pre-pandemic levels. The rebalancing has been accompanied by moderation in consumer spending, as high prices and borrowing costs tamp demand and thus price pressures,” reported Victoria Cavaliere of Bloomberg.

Last week, Fed Chair Jerome Powell told the Economic Club of Washington D.C., “…if you wait until inflation gets all the way down to 2 [percent], you probably waited too long…Our test has been that we wanted to have greater confidence that inflation was moving sustainably down toward our 2 percent target. What increases that confidence is more good inflation data and, lately here, we have been getting some of that.”

Few anticipate the Fed will lower the federal funds rate at its July meeting, but the outlook for September is good. The probability of a September rate cut was above 90 percent last week, according to the CME FedWatch.

Changing rate expectations disrupted stock markets, last week. Investors moved from big technology firms into smaller companies that tend to perform better when rates are lower. Rita Nazareth of Bloomberg explained that the market experienced, “a ‘rotation’ that saw investors trimming positions on this year’s winners in favor of laggards. Underpinning that trade were bets the 2024 rally would broaden out of megacaps as the Federal Reserve cuts rates.”

By the end of the week, the Standard & Poor’s 500 Index was down about 2.0 percent and the Nasdaq Composite had fallen about 3.7 percent. The Dow Jones Industrial Average fared better, finishing the week in positive territory, reported Alex Harring and Jesse Pound of CNBC. Yields on U.S. Treasuries were mixed over the week.

S&P 500, Dow Jones Global ex-US, Gold, Bloomberg Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods. Sources: Yahoo! Finance; MarketWatch; djindexes.com; U.S. Treasury; London Bullion Market Association. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.

MICROCHIP COMPANIES STUMBLED OVER GOVERNMENT POLICY. In general, one aim of governments in democratic countries is to implement policies that promote solid and sustainable economic growth. Sometimes, a policy change—or the possibility of one—will ripple through financial markets. Last week, we saw two examples of this as companies that have benefited from enthusiasm around artificial intelligence saw their share prices drop sharply when it appeared that U.S. government policy might change.

1.   Stricter limits could be imposed on some exports to China. In one case, a potential change in government policy caused the share price of a Dutch company to drop, reported Adam Clark of Barron’s. The company produces lithography machines that are necessary for semiconductor manufacturing. The company’s solid second quarter earnings report was overshadowed by news that President Biden may impose new restrictions on exports to China. Clark reported that the administration:

“…is considering more severe trade restrictions on exports to China if companies…continue selling chip-making machinery to the country. While the [lithography machinery] company is already restricted from selling its most advanced machines to Chinese customers, [the company] still generated 49% of its revenue from China in the second quarter, as buyers looked to stock up on older machinery.”

2.   The United States’ relationship with Taiwan may change. In an interview with Bloomberg Businessweek, presidential candidate Donald Trump was asked about the United States’ relationship with Taiwan. He answered, “They did take about 100 [percent] of our chip business. I think, Taiwan should pay us for defense.”

After the remarks became public, the share price of Taiwan’s largest company—the world's largest maker of advanced chips—tumbled, reported George Glover of Barron’s. The share price fell even though the company had beaten quarterly estimates and lifted 2024 revenue projections, reported Jane Lanhee Lee of Bloomberg.

Other chip companies’ stocks moved lower, too, on concerns that a change in U.S. policy could result in new supply chain disruptions. “China’s ruling Communist Party has vowed to ‘reunify’ with Taiwan and has refused to rule out using military force to take back control of the country,” reported Glover.

It can be dismaying when the value of a stock or stock market index moves lower. However, falling share prices sometimes have silver linings. They sometimes create opportunities to invest in companies with solid fundamentals at attractive prices.

Weekly Focus – Think About It

“It's not what you look at that matters, it's what you see.”

―Henry David Thoreau, author