Stock Market Shaky: Fed Decision Looms

Fed Decision Looms: Stock Market on Shaky Ground!

With earnings season in full swing now and the May Federal Reserve meeting upon us, an already fragile mega-cap stock market hangs in the balance. Gauging the state of the economy and markets is more challenging than ever, but there are unmistakable clues if you know how to read them.

First of all, the market is as efficient and forward-looking as it’s ever been. A.I. and algorithms control mega-cap stock movements now, and a company’s future outlook is infinitely more important than any actual verifiable results from the recent past.

In other words, the market doesn’t react to quarterly earnings results anymore. It focuses on what companies expect for the current quarter and the remainder of the year instead. This helps explain why Tesla missed earnings expectations but the stock went up 12% and Meta Platforms beat earnings forecasts but the stock went down 12%.

Intel is another example from the earnings season we’re in right now. The company grew its 1Q2024 revenue by 9% year-over-year and beat Wall Street’s consensus earnings-per-share estimate. Again, the market is extremely forward-looking now, so Intel stock dropped more than 10% because the company’s current quarter revenue guidance called for $12.5 billion to $13.5 billion while analysts expect $13.7 billion.

You might conclude that investors are confused and uncertain, and that’s definitely the case. The gauge of general sentiment toward large-cap stocks has swung from greed to fear and then back to greed just within the past few weeks.

Directionless and rudderless, stock traders are watching every “Magnificent Seven” earnings report as if it’s make-or-break for the market. This is a knock-on effect of a mega-cap market that’s been propped up by a small handful of gigantic technology firms while the majority of S&P 500 businesses struggle.

A highly concentrated large-cap market isn’t the only thing propping up the house of cards. There’s also the exchange-traded fund (ETF) effect in play. Whether it’s gigantic institutional investors like BlackRock or local family offices, the large-scale traders are piling into high-yielding bonds and funds with heavy allocation in “Mag-7” mega-cap technology stocks.

Think about it: these stock market funds track the S&P 500 and NASDAQ, which aren’t equal-weighted. They’re weighted by market cap, so gigantic Mag-7 tech businesses like Nvidia, Meta Platforms, Alphabet, and Microsoft have outsized influence on the direction of the funds.

Many people with company-chosen funds in their 401(k) accounts don’t even realize how concentrated their retirement holdings are. They also have no idea how fragile those index funds are because it would only take one bad Mag-7 earnings report to put their retirement account deep into the red.

Also notice in the chart shown above that these funds have barely any representation in the commodities sector at all. They’re heavily in bonds because interest rates happen to be elevated right now, and they’re in stocks because the fund managers feel like they have no alternative.

There is an alternative, and it’s a very attractive one. Getting into the most crowded trades typically doesn’t end well, though mega-cap technology stocks could continue to move higher for a while. Just be aware that these are highly risk-on assets, and just one adverse word from Federal Reserve Chairman Jerome Powell could immediately drop those stocks.

That’s why the upcoming Fed meeting is make-or-break for these overconcentrated index tracking funds. At the beginning of this year, the ultra-efficient market priced in the assumption of six or seven interest rate cuts in 2024. Now, investors fear that there will only be two rate cuts at the most this year.

The problem is that the most recently reported economic data doesn’t support cutting interest rates anytime soon. Inflation is ticking up, not down, and the Fed has scarcely any incentive to cut interest rates at the upcoming FOMC meeting or the next meeting in June.

At this point, the market is pricing in a 45% probability of the first rate cut being in September. While the likelihood of an interest rate cut in May is basically zero, nervous large-cap investors will analyze every word out of Powell’s mouth looking for clues as to the Fed’s intentions for the rest of 2024.

They don’t have to be nervous, though, if they’re looking at the big picture. Check that first chart shown above again. Funds are extremely underweight on commodity holdings. They’ve completely abandoned gold and silver in favor of bonds and mega-cap stocks.

You can choose to jump into the most crowded trade in recent memory and hope that Big Tech stocks eke out more gains this year or you can diversify properly with carefully selected, deeply out of favor commodity assets. Then, you won’t have to stay up at night worrying about what the Fed said because with hard assets that bear no counterparty risk, you’ll be in great shape regardless of the outcome.