Wall Street Frontline ｜Jay Woods on Fed Policy and Q2 Earnings of Tech Giants

Welcome to “Wall Street Frontline”.

As of the week ending August 2, major US tech companies, including Microsoft, Apple, Amazon, Meta, and Intel, released their second-quarter earnings reports. Amazon and Intel became the focus of the market, with their stocks plunging significantly. Amazon's stock plummeted over 9% on Friday due to sales falling short of expectations. Intel's stock tumbled 26% after issuing a grim earnings forecast and announcing a 15% workforce reduction, marking its worst single-day drop since 1974. Nvidia and Tesla also saw their stock prices drop more than 20% from recent highs, entering bear market territory.

The Nasdaq 100 Index experienced a violent rotation among large tech stocks, wiping out over $2 trillion in market value in just over three weeks. On August 2, the index closed down 2.4%, bringing its total decline from the record high on July 10 to over 10%, meeting the definition of a technical correction.

Throughout this year, concerns over high valuations, AI-driven gains, and market concentration in tech stocks have been prominent. With recent disappointing earnings from several high-profile companies, investors have been taking profits and shifting their focus to previously underperforming sectors, such as utilities, which have shown strong performance over the past two trading days.

On July 31st, Eastern Time, the Federal Reserve concluded its two-day monetary policy meeting and announced that it would maintain interest rates at the 5.25% to 5.5% level. The market widely predicts that the Federal Reserve will start cutting rates in September. In June, the U.S. inflation rate fell below 3%, but the job market showed signs of strain. In July, non-farm payrolls increased by 114,000, below the revised 179,000 in June and the Dow Jones forecast of 185,000. The unemployment rate rose to 4.3% in July, the highest since October 2021. This means the unemployment rate has triggered the Sahm Rule.

The Sahm Rule, popularized by economist Claudia Sahm, states that if the average unemployment rate over the past three months rises by 0.5 percentage points or more above the lowest three-month average in the previous year, the economy is in a recession. Over the past three months, the unemployment rate has averaged 4.13%, which is 0.53 percentage points above the three-month average low of 3.60% over the past year.

In this episode of “Wall Street Frontline”, we invited Jay Woods, Chief global strategist at Freedom Capital Markets to discuss tech companies’ earnings and Fed’s most recent monetary decision.

Wall Street Frontline:Meta, Apple, and several other "Magnificent 7" companies released their financial earnings reports. Which key metrics and data should investors focus on? And how do these earnings reports affect the market?

Jay Woods:These earnings reports certainly impact the market. These stocks are among the largest by weight in the S&P 500 and lead their respective industries, so we monitor them closely. Key metrics to focus on include capital expenditures (CapEx), especially on AI-related research. It’s important to see if this spending positively impacts their bottom line. We want to see these companies exceed analyst expectations and provide strong guidance. However, there are concerns about their AI development expenditures and the future impact on their financials.

Wall Street Frontline:Given the significance of AI on stock performance, as seen with NVIDIA and AMD this week, how do you foresee AI influencing the market in the second half of 2024?

Jay Woods:AI remains a crucial growth industry. While AI-related stocks had a tremendous run in the first half of the year, there has been some pullback recently. It's essential to monitor each company's earnings and their continued investment in AI technology, such as NVIDIA chips. Although these stocks might not see explosive growth in the short term, I believe they are consolidating and stabilizing, which is healthy for a long-term uptrend.

Wall Street Frontline: Another significant factor affecting the market is the Federal Reserve's monetary policy. They have just announced that rates will remain unchanged for July. What message do you think this sends to the market?

Jay Woods:Many hoped for a clearer signal about a potential rate cut. While Jay Powell hinted at a possible cut in September, his message was somewhat subdued. He doesn't provide as much information as some would like and can be perceived as being a bit late in his decisions. Many thought the economic data supported a cut in July. However, Powell has set the stage for a potential cut in September. This time, the focus shifted from inflationary concerns to the labor market. The labor market is softening, and there are trends indicating a slowdown. If it slows too quickly, we might talk about a recession, but we’re not there yet. If unemployment numbers come in higher than expected, there will be concerns that the cut didn’t happen soon enough. The balance between low unemployment and low inflation is tricky, and people expected a more dovish tone from Powell. He is likely still preparing for a September cut, but the market wanted more assurance.

Wall Street Frontline:Right now, the market consensus is that they're expecting a rate cut in September. Given this expectation and the recent earnings reports, do you anticipate increased market volatility in the coming weeks?

Jay Woods:We are definitely going to see increased volatility. Historically, August and September are the two worst-performing months of the year. Over the last 20 years, we've had 10 periods where the market was up and 10 where it was down during these months. In fact, August-September has been down for three consecutive years. There are seasonal headwinds, and it being an election year adds to the unpredictability. While the election cycle might not dramatically impact the overall market, daily volatility will be influenced by geopolitical and political headlines, as well as earnings reports. Given the historical headwinds in August and September, I think volatility is here to stay. We just had our first down day in the S&P 500 of 2% or more in over 350 sessions, the longest streak since 2007. Increased volatility is good for traders who thrive on it, but it can be unsettling for long-term investors. The next two months might be rough, but I believe we will be fine by the end of the year.

Wall Street Frontline:Which sectors do you think will be affected the most by the election?

Jay Woods:The technology sector will be significantly impacted, particularly with the Biden administration's favorable stance towards the chip sector through the CHIPS Act, which provided a boost when it was introduced. While many think the energy sector benefits from Trump, an unexpected boost came to Elon Musk and EVs during his administration. Musk and Trump seem to have formed a good relationship over the last few years.

Wall Street Frontline:It seems like Elon Musk is supporting Trump right now from his Twitter, right?

Jay Woods:Yes, ironically, despite being rivals with Trump's Truth Social. It's interesting to watch. As I follow the equity market, I look for stocks that continue to perform well. However, it's still too early to make a definitive judgment. With a significant amount of time before the election, defense stocks are particularly noteworthy. They are likely to do well under both candidates, but a Republican administration would likely bolster this sector even more. For instance, the defense ETF ITA recently hit new all-time highs. Additionally, the financial sector is expected to benefit from a Republican administration, which could facilitate more M&A activity. These sectors currently appear to be the most impacted.

Wall Street Frontline:What is the current sentiment among traders on the floor of NYSE regarding the overall market direction, especially considering the earnings reports and Fed's policy?

Jay Woods:First, we focus on the Fed policy as it drives the market. The beginning of July saw a significant market rotation with the Russell up 11%. Recently, the Russell and NASDAQ 100 had nearly equal year-to-date gains, showing great rotation. However, that rotation seems to have ended, and now we focus on individual earnings growth. Stocks that perform well tend to stay flat or rise slightly, but those that miss expectations are punished. It's all about earnings now, with a close watch on the Fed in September.

Wall Street Frontline:Are there any specific trends or patterns you have observed in trading activities leading up to recently?

Jay Woods:Yes, it goes back to rotation. Investors took profits in some leading stocks from the first half of the year, such as technology, communications, discretionary and financials. NVIDIA, for example, saw a 20% drop twice this year, in March and more recently, despite being up over 100% year-to-date.

Wall Street Frontline: Why NVIDIA's share price always comes back?

Jay Woods:Well, they seem to always come back. I say that, and then there's a chance they might not. The trends are strong, and momentum is still there for NVIDIA and other tech names. Right now, the market signals a need to stay on the sidelines a bit, with increased intraday volatility. Investors rotated out of some winners, looking for opportunities in small caps, which are up almost 10% year-to-date. Rotation is crucial for a secular bull market, as it shows money moving within the market rather than leaving it. Currently, we're experiencing a sell-off across the board, but this is part of the liquidity search for more profitable sectors.