9-17-24: The Rally That Nobody Saw Coming

by Bryan Perry

September 17, 2024

Investors and traders alike are in a state of awe at last week’s torrid rally for equities that had mega-cap AI-centric stocks once again leading the charge higher. Earlier this month, it was thought that there was a “new paradigm shift” in the AI narrative, as if this generational technological transformation somehow had peaked in terms of the stocks pricing in all future capital investment, revenues, and potential profits.

This skepticism was quickly debunked, and funds flowed back into the AI trade again as CEOs of the leading AI companies reinforced the secular spending cycle and widespread applications that are still in their nascent state of development. As a case in point, it was reported that Elon Musk’s xAI – a company he launched in 2023 – had brought a massive new training cluster of chips online, claiming that it represented “the most powerful AI training system in the world.” Dubbed Colossus, the system was built in Memphis, using 100,000 chips from Nvidia, specifically its H100 GPUs. Musk said the cluster was built in 122 days and would “double in size” in a few months as more GPUs are added.

Also, Oracle reported its Q2 results last week, and its Chairman Larry Ellison claimed there was the potential to build 2,000 data centers globally from the 168 it currently operates. These data centers can span three football fields, while others are built to suit smaller sizes. Headlines such as these are now reinvigorating the AI FOMO trade, as reflected in the recovery in Vanguard’s Mega Cap Growth ETF:

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Beyond this revived love affair with the AI theme, another catalyst for the rally was the notion of the Fed possibly front-loading rate cuts by taking the current 5.25%-5.50% Fed Funds down by a half-point to 4.75%-5.00%. As of last Friday, the bond futures market was showing a 50% probability of a 50-basis point cut at this week’s FOMC meeting. This is up from 30% a week ago, and 25% a month ago.

This shift marks a rapid about-face for traders who earlier last week had almost completely discounted the possibility of a large rate cut in the wake of hotter-than-forecast consumer-price data and signs the labor market remains robust. The trigger for the revision was a Wall Street Journal report on Thursday that Fed policy makers were considering whether to reduce rates by a quarter point or opt for half-point cut.

The chief U.S economist at JPMorgan Chase & Co. Friday reiterated its call for a half-point cut, leading to a volume surge in Fed funds futures that would benefit from that outcome, but JPMorgan is the lone large Wall Street bank forecasting a half-point rather than a quarter-point cut.

Beyond this revived love affair with the AI theme, another catalyst for the rally was the notion of the Fed possibly front-loading rate cuts by taking the current 5.25%-5.50% Fed Funds down by a half-point to 4.75%-5.00%. As of last Friday, the bond futures market was showing a 50% probability of a 50-basis point cut at this week’s FOMC meeting. This is up from 30% a week ago, and 25% a month ago.

This shift marks a rapid about-face for traders who earlier last week had almost completely discounted the possibility of a large rate cut in the wake of hotter-than-forecast consumer-price data and signs the labor market remains robust. The trigger for the revision was a Wall Street Journal report on Thursday that Fed policy makers were considering whether to reduce rates by a quarter point or opt for half-point cut.

The chief U.S economist at JPMorgan Chase & Co. Friday reiterated its call for a half-point cut, leading to a volume surge in Fed funds futures that would benefit from that outcome, but JPMorgan is the lone large Wall Street bank forecasting a half-point rather than a quarter-point cut.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

This might be a September rally to remember on Wall Street, as history is not on the side of September delivering many market rallies. And even though the pace of inflation has declined to around 2.5% per year, that doesn’t reverse the damage done to the majority of American families. The Consumer Price Index (CPI) has increased significantly over the past three years. From 2021 to 2024, the cumulative price increases in the CPI total more than 21%, which represents a big drag on most families’ budgets.

There is also a string of staggering jobs revisions, bringing attention to whether the Labor Department data can be trusted. There is also more empirical evidence of delinquencies on consumer debt on the rise. Ally Financial Corp.’s stock was crushed after the consumer lender said delinquencies in its retail car-loan business were up more than expected as people continue to struggle with higher costs.

“Over the course of the quarter, our credit challenges have intensified,” said Ally Chief Financial Officer Russ Hutchinson at the Barclays Global Financial Services Conference in New York on Monday. “Our borrower is struggling with high inflation and cost of living, and now, more recently, a weakening employment picture.” Combine this revelation with the prospect of slimmer Net Interest Margin (NIM) for banks, and it might explain why Warren Buffet is dumping his Bank of America position.

The low-income wage earner is on the ropes, as lending practices have been looser these past three years than most would admit, CoVid payouts have been largely exhausted and consumer credit card debt is at an all-time high with millions of consumers maxed out, so maybe the Fed is finally getting some internal religion and doesn’t want to see the 65% of Americans living paycheck to paycheck, and the 47% of Americans that don’t pay any income tax experience a collective tsunami-sized financial meltdown.

That wave seems to be forming out on the horizon, so why wait until it hits the coastline? There seems to be little disagreement that the upper middle-class, more affluent consumers and workers are doing pretty well, enjoying superior asset appreciation from home ownership and stock market gains, but the other much larger swatch of the population is showing evidence of increasing financial strain.

The Fed needs to provide some relief right away and the bond market seems to sense newfound urgency. Most folks are hardworking and are not looking for a handout, but in these times where inflation has pushed prices of everything higher from three years ago, they sure could use a break in interest rates.

Navellier & Associates owns Nvidia Corp (NVDA), and a few accounts own Oracle (ORCL), in managed accounts.  We do not own Bank of America (BAC), or Ally Financial.  Bryan Perry does not own Nvidia Corp (NVDA), Oracle (ORCL), Bank of America (BAC), or Ally Financial personally.