Summer Sector Shifts: A Guide To Navigating Changes

The recent sell-off in the NASDAQ last Wednesday, triggered by disappointing earnings announcements from Google and Tesla, led to a flight to quality in the market. Although Google managed to beat analysts’ forecasts for revenue and earnings, its YouTube revenues were seen as a disappointment, causing investors to sell off their shares. These sudden sell-offs in the NASDAQ tend to reverse themselves and eventually settle down, leading to more market volatility in the coming days. However, there is positive news ahead as the Federal Reserve is scheduled to meet this week, and the likelihood of a key rate cut is increasing.

Our focus is on identifying fundamentally superior growth stocks that we believe are on the cusp of announcing better-than-expected sales and earnings for the second quarter, accompanied by positive guidance. Analysts are projecting a 9.3% increase in second-quarter earnings for the S&P 500, which would be the strongest comparison in over two years. The overall stock market is also showing signs of improvement as there has been a shift towards Russell 2000 stocks since mid-July. This rotation indicates anticipation of multiple key interest rate cuts by the Federal Reserve, which would benefit domestic stocks as compared to the multinational companies dominating the S&P 500. These expected rate cuts from the Fed will provide a much-needed boost to the stock market and the economy.

Here are the key market news updates and their implications:

– The most significant news this week centers around the Federal Open Market Committee (FOMC) meeting scheduled for July 31st. The decline in the 2-year Treasury yield, from 5.046% on April 30th to 4.385% on July 26th, has increased pressure on the Fed to cut key interest rates. It is almost certain that the FOMC statement will signal a key interest rate cut on September 18th. The dot plot survey of FOMC members will also be closely watched, as it is expected to signal another key interest rate cut on November 7th, just days after the Presidential election. With the Federal Reserve finally taking steps to join other central banks in cutting key interest rates, this move will provide the necessary boost for the stock market to continue its rally.

– Last week, former New York Fed President Bill Dudley published a compelling Bloomberg Opinion article titled “I Changed My Mind. The Fed Needs to Cut Rates Now.” This week, another former Fed official, Alan Blinder, expressed his opinion in The Wall Street Journal, stating, “The Fed Should Cut Interest Rates This Week.” Blinder argues that money is currently tight, with inflation ranging from 2.5% to 3%. He points out that the current federal-funds rate of 5.25% to 5.5% results in real interest rates of around 2.5% to 3% after adjusting for inflation. Blinder interestingly adds that the 12-month PCE inflation rate has been stagnant or falling since September of last year.

– Another reason for the Federal Reserve to cut key interest rates this week is the growing distress in the commercial real estate sector. According to MSCI, foreclosed and seized office buildings, apartments, and other commercial properties reached $20.5 billion in the second quarter, the highest level since 2015 and a 13% increase from the first quarter. This situation has put commercial property investors, such as Blackstone, under closer scrutiny.

– It is evident that Donald Trump’s adoption of cryptocurrencies is part of his outreach to Silicon Valley. During the Bitcoin 2024 conference in Nashville, Trump announced his intention to fire SEC Chairman Gary Gensler and appoint crypto-friendly regulators. He emphasized his goal to make the United States the global crypto capital and the Bitcoin superpower. Trump also stated that regulations would be written by individuals who support the industry, rather than those who oppose it. Furthermore, he proposed the creation of a crypto industry presidential advisory council, a stablecoin framework, and a reduction in enforcement measures.

– Silicon Valley’s warming up to Donald Trump can also be attributed to Peter Thiel, a former mentor and employer of J.D. Vance, advocating for Vance to serve as Vice President. Many Silicon Valley figures, like Thiel, are now enthusiastic about Vance’s involvement in the GOP ticket and his advisory role to Trump. The concern surrounding the Magnificent 7 stocks, which have operated legal monopolies under the Biden and previous administrations, revolves around their ability to sustain these monopolies. Cracks in their foundations, such as Google’s disappointing YouTube performance or Tesla’s lackluster guidance, can lead to profit-taking in these stocks.

– In another instance of disappointing results, McDonald’s announced its first quarterly sales decline since 2020. Specifically, same-store sales for McDonald’s declined by 1% in the second quarter. This decline is not surprising, as French Fry supplier Lamb Weston also reported disappointing sales to restaurants and consumers. There are now increasing signs of consumer distress, particularly among the bottom 20% of consumers who are grappling with inflation and financial difficulties. McDonald’s sales decline serves as a clear signal of consumer distress, which may encourage the Federal Reserve to expedite key interest rate cuts.

Overall, the market is experiencing a reversion to the mean, but the impact of this week’s earnings reports will determine whether this trend continues or if it represents a buying opportunity for big tech. By the end of the week, we will have the financial results for all but NVIDIA among the Magnificent 7 stocks, which have a significant influence on market value and earnings. Similar pullbacks in the tech sector have occurred in the past, only to see a subsequent surge to new all-time highs. While a repeat of this cycle leading up to the election would not be surprising, a broader-based rally would be more favorable.