Investment Strategy
Triple take: What did we learn from last week?
Stocks saw big swings last week and bonds rallied after a catalyst filled week. Ten-year U.S. Treasury yields dropped 20 basis points (bps), and the S&P 500 dropped below its 50-day moving average. Nvidia had its best single-day performance since February, but still ended the week in the red.
Large caps (S&P 500 -2.1%), small caps (Solactive 2000 -6.3%) and growth (NASDAQ 100 -3.1%) all sold off in the past week, and the VIX (a standard measure of equity market volatility) reached its highest level since 2023.
In rates, it was a milestone for the 10-year, which dropped below 4% for the first time since February. Futures markets now fully price in three 25-basis-point rate cuts in 2024, with a slight possibility for more. Economic data showed increasing jobless claims, and a slowdown in manufacturing activity, suggesting continued cooling in the economy.
Across the pond, the Bank of England became the latest central bank to join the rate-cutting party. Of the 37 central banks we track, 22 of them are now cutting policy rates.
There are plenty of potential reasons for newfound market volatility:
- Emerging narrative that the Federal Reserve is “behind the curve,” given weaker labor market and manufacturing numbers
- Month-end positioning turbulence
- Middle East tensions
- U.S. presidential election uncertainty
- Earnings reports
- And others
In today’s note, we try to look through the noise to assess what we learned about the backdrop last week.
The three things we learned from last week
The Fed left interest rates on hold...for now. The Fed has been “on hold” for a year, but we think rate cuts are on deck for September. Since the Fed’s last hike on July 26, 2023, the S&P 500 has returned over 22% (the second-highest return during a holding pattern since 1970).
Check in: 1 year since the Fed went "on hold"
S&P 500 return between last hike & first cut. # months between last hike & first cut
Sources: Bloomberg Finance L.P., NBER, Haver Analytics. Data as of July 31, 2024. *Note: Ongoing Fed pause as of July 31, 2023 to present.
The Fed has held rates steady for good reason. This time last year, the economy was still running hot, inflation was over double the 2% target, and investors feared it could reignite. Now, inflation is close to the Fed’s target and the labor market has cooled considerably. Said differently, growth is cooling but not cool, and inflation is no longer threatening. In Fed Chair Powell’s own words “the reduction of the policy rate could be on the table as soon as September.”
Source: Bloomberg Finance L.P., Bureau of Labor Statistics, Bureau of Economic Analysis. Data as of August 1, 2024.
A September rate cut is now fully priced, and traders even suggest a slight probability of a cut greater than 25 bps. No matter when or how many times the Fed cuts, this is as good as it gets for cash.
When the Fed starts cutting rates, cash yields will drop quickly. Many parts of core fixed income (including municipal bonds and investment grade corporates) are on par or outyielding cash. Investors can better position their portfolios by extending duration and locking in higher yields for longer. In fact, in all but one cutting cycle in the last 54 years, core bonds have outperformed cash. We believe investors should lock in elevated yields while they last.
Bonds tend to outperform when the Fed stops hiking
U.S. core bonds and cash return from the final Fed hike to the first Fed cut
Source: J.P. Morgan, Bloomberg Finance L.P., Haver Analytics, Ibbotson, from Tim Andres & Ben Bakkum. U.S core bonds represented by 50% Bloomberg U.S. Corporate Aggregate Bond Index and 50% Bloomberg U.S. Government Aggregate Bond Index. Data as of December 2019.
AI spending rolls on. Four companies in the “Magnificent 7” reported second-quarter results last week. The theme across all the reports is that the race to build an industry-leading position in AI is accelerating. Of the four-largest “hyperscalers” (Meta, Microsoft, Alphabet and Amazon) that have reported, all increased their capital expenditure plans. In fact, the four hyperscalers—those most involved in cloud computing—combined will spend more than $200 billion in capex this year. Most of which will be concentrated in the AI buildout.
Hyperscalers continue to boost capex plans
Reported U.S. capex by calendar year, $ billions
Source: Bloomberg Finance L.P. 2004 - 2023 capex is as reported by specified companies, while 2024 represents Bloomberg consensus estimates. Data as of July 31, 2024.
Microsoft spent an eye-popping $19 billion in cash capital expenditures during the quarter. That is equivalent to what the company used to spend in an entire year just five years ago.
It’s not just the buildout. AI is already showing its efficiencies. Meta platforms raised guidance for 3Q revenues to $38.5–$41 billion (versus analyst expectations of $39 billion), citing strong growth in advertising. The company says it has been using AI to improve the way advertisements find interested users, adding efficiency to the business.
AI has become a key long-term driver of growth. For now, the first round of winners are closely linked to semiconductor manufacturing and cloud computing. With companies continuing to highlight elevated AI interest and capex during this quarter’s earnings calls, we think these tailwinds can continue to support growth in the sector going forward. Additionally, the AI infrastructure buildout theme continues, which is a promising sign for the semiconductor supply chain exposed to the AI build. Over the coming years, the benefits will further broaden across sectors and industries.
Geopolitics continues to dominate headlines. Our Mid-Year Outlook, A Strong Economy in a Fragile World, highlighted the need to prepare for continued conflict. Last week was a reminder of that, with the largest Russian prisoner exchange with the West in decades, the increased risk of wider escalations in the Middle East, and the continued election turmoil in Venezuela. Despite this, oil actually still traded lower last week. Markets will likely continue to be wary of further conflict, but we do not believe these risks will derail our overall view. Diversification can help mitigate geopolitical risk for most investors.
If investors can take a bit of solace from a volatile week, it’s that fixed income admirably performed its traditional role. The U.S. Aggregate Bond Index rose +1.3% despite the volatility in stock markets. The return of fixed income as a buffer to portfolios should help investors stick with their long-term plans.
As always your J.P. Morgan team is here to help.
All market and economic data as of August 2024 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
The VIX Index is a financial benchmark designed to be an up-to-the-minute market estimate of the expected 500® Index, and is calculated by using the midpoint of real-time S&P 500 Index (SPX) option bid/ask quotes.
The Solactive United States 2000 Index intends to track the performance of the largest 1001 to 3000 companies from the United States stock market. Constituents are selected based on company market capitalization and weighted by free float market capitalization. The index is calculated as a price return index in USD and reconstituted quarterly.
The NASDAQ-100 Index is a modified capitalization-weighted index of the 100 largest and most active non-financial domestic and international issues listed on the NASDAQ. No security can have more than a 24% weighting. The index was developed with a base value of 125 as of February 1, 1985. Prior to December 21,1998 the Nasdaq 100 was a cap-weighted index.
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Our thoughts on the Fed’s recent news, AI spending and geopolitics.
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