Market Update

Stocks saw big swings this week and bonds rallied after a catalyst filled week. 10-year U.S. Treasury yields dropped 20 basis points, and the S&P 500 dropped below its 50-day moving average. Nvidia had its best single day performance since February but is still on track to end the week in the red.

Large caps (S&P 500 -1.4%), small caps (Solactive 2000 -2.8%), and growth (Nasdaq 100 -2.4%) all sold off yesterday and the VIX (a standard measure of equity market volatility) reached its highest level since 2023.

In rates, 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. The economic data showed the highest unemployment rate since 2021, 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

In today’s note, we try to look through the noise to assess what we learned about the backdrop this week.

The three things we learned this 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).

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 Jerome Powell’s own words “the reduction of the policy rate could be on the table as soon as September”. 

A September rate cut is now fully priced, and traders even suggest a slight probability of a cut greater than 25 basis points. No matter when or how many times the Fed cuts, we believe 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. 

AI spending rolls on. Four companies in the “Magnificent 7” reported second quarter results this 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 concentrated in the AI buildout.

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 it’s efficiencies. Meta platforms raised guidance for 3Q 2024 revenues to $38.5-$41 billion (versus analyst expectations of $39 billion) citing strong growth in advertising. The company says its 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 continue to dominate headlines. Our mid-year outlook, A strong economy in a fragile world, highlighted the need to prepare for continued conflict. This week was a reminder of that with the largest Russian prisoner exchange with the West in decades, rising risk of wider escalations in the Middle East, and continued election turmoil in Venezuela. Despite this, oil is actually trading lower than where it started the 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 one piece of solace from a volatile week, it is that fixed income performed its traditional role admirably. 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 advisor is here to help.

All market and economic data as of 08/02/2024 are sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

DISCLOSURES

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 Chicago Board Option Exchange (CBOE) Volatility Index (VIX), is a real-time index that represents the market’s expectations for the relative strength of near-term price changes of the S&P 500 Index.

The information presented is not intended to be making value judgments on the preferred outcome of any government decision or political election.

Index definitions:

The Russell 3000 Index is a capitalization-weighted stock market index that seeks to be a benchmark of the entire U.S. stock market. It measures the performance of the largest 3,000 U.S. companies representing approximately 96% of the investable U.S. equity market.

The S&P 500 Equal Weight Index is the equal-weight version of the widely-used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight of the index total at each quarterly rebalance.

The Bloomberg U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).

The S&P 500 Equal Weighted Index is the equal-weight version of the widely-used S&P 500. The index includes the same constituents as the capitalization weighted S&P 500, but each company in the S&P 500 EWI is allocated a fixed weight – or 0.2% of the index total at each quarterly rebalance.

The Magnificent Seven stocks are a group of influential companies in the U.S. stock market: Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA, and Tesla.

The Magnificent 7 Index is an equal-dollar weighted equity benchmark consisting of a fixed basket of 7 widely-traded companies (Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta, Tesla) classified in the United States and representing the Communications, Consumer Discretionary and Technology sectors as defined by Bloomberg Industry Classification System (BICS).

The S&P Midcap 400 Index is a capitalization-weighted index which measures the performance of the mid-range sector of the U.S. stock market.

The S&P 500 index is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

Bonds are subject to interest rate risk, credit, call, liquidity and default risk of the issuer. Bond prices generally fall when interest rates rise.

The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to "stock market risk" meaning that stock prices in general may decline over short or extended periods of time.

Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.

The Bloomberg Eco Surprise Index shows the degree to which economic analysts under- or over-estimate the trends in the business cycle. The surprise element is defined as the percentage difference between analyst forecasts and the published value of economic data releases. 

The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.

The NASDAQ 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the NASDAQ stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.

The Russell 2000 Index measures small company stock market performance. The index does not include fees or expenses.

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 views, opinions, estimates and strategies expressed herein constitutes the author's judgment based on current market conditions and are subject to change without notice, and may differ from those expressed by other areas of J.P. Morgan. This information in no way constitutes J.P. Morgan Research and should not be treated as such. You should carefully consider your needs and objectives before making any decisions. For additional guidance on how this information should be applied to your situation, you should consult your advisor.

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