Animal Spirits – Is the Market Ahead of the Fundamentals?

Most people prefer to think of markets as efficient rather than random. Markets are certainly efficient in the sense that new news, or fundamental information, is quickly reflected in stock prices. But there are times when rational, fundamental thought seems to disappear, and markets are moved by ‘animal spirits.’

John Maynard Keynes, in his 1936 book The General Theory of Employment, Interest and Money, wrote:

“Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits – of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”

July was one of those periods, although the speculation toned down a bit as the month closed. AI continues to get most of the news focus, but in terms of stock performance, that has become a mixed bag (see story below). What really worked for most of July was speculative stocks. The two charts below are descriptive of the recent market action. The top chart is the performance of the Goldman Sachs basket of most shorted stocks in July, and the second chart is the performance of the Goldman basket of meme stocks.

Animal spirits were alive and well through most of July. The charts show these two groups moving pretty much straight up through the first three weeks of July before giving much of the move back in the last week of the month. It is impossible to predict when such a run of euphoria will end, but the last week put a serious dent in it. Capping off the week was a very ugly jobs report. July jobs rose by 73K, far short of the 104K that was expected. Making matters worse, the May and June jobs numbers had some serious downward revisions. The May jobs number was revised from 125K to just 19K, and June was revised from 147K to only 14K. Suddenly, the muddled case for rate cuts appears surprisingly clear. If these downward revisions had been reported on time, we feel quite sure the Fed would have cut rates this week. The stock market response to the weak jobs report was a sharp sell-off on Friday, pulling the market out of overbought territory. This reversal of the recent speculative binge cautions against buyers being too aggressive for the time being.

Are We Down to the Magnificent 3?

In general, large-cap tech names continue to pace the large indexes, which is far from surprising in a more speculative environment. But unlike previous years, the trend this year has not been the Magnificent 7 moving in tandem. In fact, it has been just the Magnificent 3 – NVIDIA, Microsoft, and Meta – that have outpaced the S&P 500 index (black line), while Amazon, Alphabet, Apple, and Tesla have lagged the index.

Microsoft and Meta led off tech earnings this week with blowout quarters, which pushed Meta up some 11% and Microsoft up some 4% on July 31, but that wasn’t enough to keep the S&P or NASDAQ indexes in positive territory for the day. Amazon and Apple earnings followed, with Apple also hitting the mark, but Amazon disappointed when AWS (Amazon Web Services), which has been considered the market leader, clearly lost market share to Meta and Microsoft, whose web service revenue grew significantly faster than AWS in the second quarter. That should keep four of the Magnificent 7 stocks underperforming year to date for some time to come.

There is a natural inclination to think of these stocks almost as one because they have moved in tandem for so long, but nothing lasts forever. These are very competitive companies fighting it out for AI leadership and, in the end, it is likely there will be some winners and some losers in this small group. This is an important lesson. An interesting factoid that came across our desk this week was that out of the top ten stocks in the S&P 500 at the end of 1999, only two are currently trading higher than they were 25 years ago!

Have a great week!

What We’re Reading

• U.S. added just 73,000 jobs in July and numbers for prior months were revised much lower

• Trump fires commissioner of labor statistics after weaker-than-expected jobs figures slam markets

• Fed governors Bowman, Waller explain their dissents, say waiting to cut rates threatens economy

• Chinese exports to U.S. could decrease by $485 billion by 2027: Tariff simulator

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All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

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.

Past performance is no guarantee of future returns.

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By: Adam