Don’t Jump to Conclusions

Friday’s IT blackout was another great lesson from the school of ‘You Never Know What’s Going to Happen Next’. Surprises happen all the time, but despite that fact, there are a lot of assumptions about the future embedded in the market today. Some of the big ones are:

• • • The economy is headed for a soft landing.
    • Trump will be the next President.
    • The growth of AI will be strong and smooth.

We caution against jumping to any of these conclusions.

The Economy Is Headed for a Soft Landing

Many in the media and on Wall Street are effectively encouraging the Fed to take a victory lap for having slayed the inflation dragon without significant harm to economy. It is a little early for that. They haven’t even made the first rate cut yet.

What has been amply demonstrated over the last 100 years or so is that Fed policy changes are effective, but with a lag, and most recently, with a more significant lag than usual. This has always been the key challenge for the Fed. By the time they see the desired changes in the data, which are also lagged, it is very difficult to ascertain the proper time for action. Typically, by the time the Fed acts, the economy is beginning to tip into recession, and the lagged effect of rate cuts effectively allows the economy to roll intro a recession, before the benefits of those rate cuts take hold.

The idea of a victory lap BEFORE the first rate cut is more than a little presumptuous. We won’t know if they made the right decision or the wrong decision until well after the first rate cut is made. The only thing we know right now is that after a long period of strength, the labor market is finally weakening. That allows rate cuts to be made, but is not an assurance that the timing is right.

This week, initial unemployment claims, rebounded to 243,000 from 223,000 last week. On a not seasonally adjusted basis initial claims spiked to 279,000. Looking at the data by state, Texas led the way, which suggests that the effects of Hurricane Beryl may be influencing this data. But in any event, higher unemployment claims are now the trend. Continuing unemployment claims are also trending higher. This week continuing claims rose again to 1.87 million, a level last seen in late 2021.

To put those numbers into some perspective, the US Labor force is about 168 million, so every 0.1% increase in the unemployment rate is another 168,000 unemployed. If unemployment rises by a half percent from here (to 4.6%), that is another 1 million unemployed. That should be enough to produce a hard landing. That’s not a prediction, but we’ve already moved from a low of 3.5% unemployment to 4.1%. Getting to 4.6%, doesn’t sound so far off anymore.

Trump Will Be the Next President

Love him or hate him, it is hard to ignore him. The assassination attempt appears to have made him almost unbeatable and the “Trump Trade” has already begun. But wait, let’s not jump to conclusions. We don’t even know who he’s running against! In our mind, the Biden candidacy was doomed after the debate. The only question was whether he would step aside or be pushed aside. He didn’t step aside, so the push has now begun. If Democrats are smart and pick a sold centrist candidate, they could have a real shot in November. A critical question for the Democrats is if Biden campaign funds can be moved to support a new candidate. The bottom line is that the election is not set in stone. We suspect a lot is going to happen in the remaining 107 days before the election. As Yogi Berra said “It ain’t over, til it’s over”.

The Growth of AI Will be Strong and Smooth

ASML Holdings (ASML), the first AI tech leader to report second quarter earnings, beat expectations but forward guidance was not raised. That was not well received. Then on Thursday Taiwan Semiconductor (TSM) earnings beat expectations and the guidance was modestly higher. The initial reaction was positive, but Biden Administration comments about restricting chip sales to China put a damper on that.

Microsoft (MSFT) and Alphabet (GOOG) report earnings on Tuesday next week. The big questions are whether these companies will continue to accelerate their AI development (i.e. buy increasing quantities of AI chips), or whether concerns about earning a return on their massive investment will hold them back a bit. The bar is set very high for this earnings period. The massive AI rise we have enjoyed for over a year is already a bit bumpy and could get a lot worse if these earnings reports disappoint even a little bit.

The setup here is reminiscent of the end of the tech bubble. Not because tech is a disaster, but because the high concentration of tech stocks in the S&P 500 could produce a declining index, while most of the stocks in the S&P 500 are actually rising! High concentrations in indexes can often produce counterintuitive results.

Have a great week!

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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.

Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that the future performance of any specific investment or investment strategy will be profitable.

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By: Adam