Equity markets closed out last week with some gusto following Powell’s Jackson Hole speech on Friday morning (more below).  For the week, the Nasdaq Composite and S&P 500 gained +1.4%, with each trading comfortably above all their major moving averages.  Breadth readings have improved considerably over the last two weeks, particularly on Friday, where advancers led decliners by almost 8-to-1 on the NYSE on the back of higher volume – a bullish sign.  The S&P 500 is now within 1% of a new all-time high, but the S&P 500 equal-weight and the NYSE benchmark are already there. 

The two big events on the calendar this week will be the PCE price deflators coming out at the end of the week and Nvidia’s earnings report after the close on Wednesday.  On the latter, profits are expected to more than double +140% from a year earlier, with sales up an eyepopping +110% to $28.73 billion.  This would mark the fifth consecutive quarter of triple-digit gains on both fronts, but this is already reflected in a stock that is up 10x in the last two years (from a $280 billion market cap to north of $3 trillion) – what it guides about the future will be what investors will be keying in on.   

As for Fed Chair Powell’s comments on Friday, he was emphatic that 1) the time to start cutting interest rates is upon us, 2) the labor market, not inflation, will be more of a determinant of the pace, and 3) upside risks to the unemployment rate trump upside risks to the inflation rate.  Below are some statements from the speech that confirm Powell and the FOMC consensus have now fully made the pivot to kicking off a cutting cycle:

• “The cooling in the labor market conditions is unmistakable.”

• “It seems unlikely that the labor market will be a source of elevated inflationary pressures anytime soon.”

• “We do not seek or welcome further cooling in labor market conditions.”

• “The time has come for policy to adjust.  The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”

• “We will do everything we can to support a strong labor market as we make further progress toward price stability.”

So, what are the market implications? 

For stocks, it’s a combination of goldilocks and nirvana.  The Fed is set to deliver rate cuts into an economy growing at a pace of between +2% to +3% and looks to be on a glide path towards a soft landing.  History shows that in the year following Fed rate cuts, the S&P 500 is up +18% on average when the economy does not slip into a recession.  From a fundamental perspective, this makes sense; corporate earnings would continue to grow (consensus is at $263/share for the S&P 500 over the next twelve months), and those earnings get the benefit of being discounted at a lower interest rate, which provides an upward shift to the present value of those future cash flows. 

However, it’s not all puppy dogs and rainbows.  Equity valuations are already high, with the S&P 500 trading at a forward P/E multiple of 21x, a razor-thin margin of safety if ‘today’s soft-landing turns into ‘tomorrow’s’ recession.  If a recession were to materialize, the lower discount rates on the back of Fed rate cuts would not be enough to offset the earnings degradation in the corporate world.  History shows that in this environment, even with aggressive monetary easing, the stock market typically tumbles more than 25% to the fundamental lows, which are typically 12-14 months after the rate-cutting cycle starts.   

Not to mention, we are moving into the most negative seasonal part of the year, with the S&P 500 experiencing at least a -4% slide during the Fall of each of the last three years.  One other thing of note is seeing Warren Buffet taking profits and raising his cash position to its highest level ever at Berkshire Hathaway.  Look, none of our situations are similar to Warren’s, so just because he is doing something doesn’t mean we should all follow in lockstep, but it is a data point worth considering.

As for bonds and interest rates, market-based odds of a cut on September 18th are 100%—with a 25 basis point cut seen as a 60% likelihood and a 50 basis point cut at 40% (this was less than 30% odds before Powell’s speech). Markets have started to price in different policy paths for some of the major central banks, and these interest rate differentials are impacting global currencies.  Futures markets are discounting three cuts for the ECB, two cuts by the BoE by yearend, and the BoJ leaning towards more hikes compared to the Fed expected to deliver four reductions by December.  This is a major driver of the weakness being exhibited by the U.S. dollar, which is on a five-week losing streak and hitting a thirteen-month low.   

Bottom line, markets have done a lot of legwork towards pricing in a rate-cutting cycle that will start in September and continue with over 200 basis points of cuts until the end of 2025 (see table below).

I’m of the view that stocks, bonds, and gold are all priced reasonably well for this outcome.  As a result, I hold all of them as core pieces in client portfolios, but don’t see any of them as good opportunities to deploy idle capital into at the moment.  Yes, I’ll continue to hold them (we all benefit over time from being long assets) while making some tweaks along the way, but I will await a catalyst that causes markets to shift their thinking with forward pricing.  That catalyst could be election results, incoming data, a geopolitical event… who knows, but right here, right now, if you hold assets, are prudently diversified, and prepared to adjust as we go forward – I’d say you are in pretty good shape.  The one area priced for a different outcome than stocks, bonds, and gold is commodities, and I’d argue they are priced more for a recession than a ‘soft’ or ‘no’ landing scenario.  Tactically, assuming incoming data continues to hold up, I’d be looking for any seasonal and/or election weakness this fall as an opportunity to position for performance chase rally into year-end.  Suppose equities are still up +10-15% heading into the last two months of the year. In that case, I can see a lot of professional money managers scrambling to put on risk in order to catch up to the averages in the interest of preserving their careers.      

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