The Dow's shaky week: Will Fed rate jitters spark bout of summertime blues?

By William Watts

Investors appear more sensitive to rate-cut timing as earnings season winds down

Nvidia Corp. was supposed to ride to the stock market's rescue this past week. Instead, it rode alone to a record finish after blowout earnings, while stock-market indexes stalled.

Investors struggled to shake off minutes of the Federal Reserve's April 30-May 1 meeting, released Wednesday, that reminded them that policymakers aren't yet comfortable with cutting interest rates soon and, if needed, would be willing to start hiking again.

Investors get a three-day break, with U.S. market closed Monday for the Memorial Day holiday. Nervous types may worry over whether a renewed focus on when or whether rate cuts will arrive along with lofty valuations could set the stage for some summertime blues.

Stocks stalled on Wednesday. And while Nvidia shares (NVDA) soared Thursday to a first-ever close above $1,000, the S&P 500 SPX and Nasdaq COMP logged another round of small losses, while the Dow Jones Industrial Average DJIA slumped over 600 points for its worst day in over a year.

Read: Nvidia's stock surge at odds with the S&P 500 - to a degree not seen in 8 years

The softer tone arrived as investors appeared to shift their focus back to the rate path.

"While during the heart of the earnings season, it appeared that stocks had become more disconnected from short-term interest rate moves, as earnings slowed down the sensitivity to the forecasts for a Fed rate cut has loomed larger," said Louis Navellier, founder and chairman of Navellier & Associates, in a Friday note.

Thursday saw a purchasing managers index reading that showed an acceleration in activity in the services sector and a pickup in overall activity, ending a series of soft readings. The PMI data reinforced jitters about the Fed's ability to deliver a September rate cut.

Economists at Goldman Sachs on Friday pushed back their expectations for the first Fed rate cut of the cycle to September from July. The new Goldman forecast is in line with market expectations, which according to the CME FedWatch tool show a 54% chance of a cut in September, versus only a 12% chance in July.

That compares to earlier in the week, when investors had priced in a roughly 80% probability of a rate hike by September, noted Tom Essaye, founder of Sevens Report Research, in a Friday note.

There's been real movement in rate expectations, he said, and that led to higher Treasury yields and weaker stocks. But it's important to note that its investor perceptions that have changed, not the Fed.

"Once again, we've seen investors stampede from one end of the Fedspectrum to the other," he wrote, noting that investors in late April were talking themselves into rate hikes. Fed Chair Jerome Powell poured cold water on that prospect at his May 1 news conference, prompting investors to reverse the gamut, pricing in a nearly guaranteed September rate cut.

"So, it's not that the Wednesday and Thursday events were hawkish. They weren't. It's that the market (again) got too dovish in its expectations and the data from Wednesday and Thursday simply corrected thattoo-dovish opinion," he said.

Granted, the S&P 500 SPX remains just 0.3% off its record close set on Tuesday, while the Nasdaq Composite COMP ended Friday at a record. The Dow Jones Industrial Average DJIA, despite Wednesday's rout, remains 2.3% below its record finish after ending above the 40,000 milestone for the first time ever on May 17.

But investors may wonder what's next for a rally that saw only a modest April pullback and that some contend may still be overdue for a more meaningful correction given lofty valuations.

The S&P 500's price-to-earnings ratio based on the next 12-months earnings per share stands at 21.4, a 30.3% premium to its average since 2005, according CFRA Research.

In fact, when Fed rate worries are out of the picture, valuations appear to be the only thing stock-market investors worry about, said Steven Ricchiuto, chief economist at Mizuho Americas, in a Wednesday note.

He noted, however, that this year's 11%-plus rise in the S&P 500 matches the 11% to 12% rise in bottom-up earnings expectations for the full year. That's kept valuations from getting stretched much further after last year's market rally.

"Although valuation considerations appear to be weighing on all but a handful of stocks, as long as the market-weight index keeps grinding higher, equity fund inflows will keep the market skewed to the upside, assuring dips will be seen as an opportunity to add to positions," he wrote.

See: Investors eager to 'buy the dip' in stocks and bonds. But the logic differs, economist says

-William Watts

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05-25-24 0800ET

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