Good morning,
Recall last week’s setup: inflation versus earnings. Unfortunately, inflation won. But what followed the hotter-than-expected CPI report was a surprising departure from the script.
The dominant theme across equity markets was a sharp selloff in AI-related technology. The Nasdaq 100 fell 5.5%, while the Philadelphia Semiconductor Index (SOX) plunged 11.4%. It was a difficult week for much of the broader market as well. The S&P 500 declined 1.94%, the Nasdaq Composite lost 2.4%, and the Russell 2000 dropped 3.0%. International markets were mixed, with Developed Markets (EAFE) gaining 1.4%, while Emerging Markets fell 5.14%.
Last week’s hotter-than-expected inflation report initially pushed Treasury yields to new highs, reinforcing the market’s conviction that inflation would remain stubbornly elevated and interest rates would continue climbing. Investors had become heavily positioned for precisely that outcome.
And then the script was torn up.
As concerns surrounding the AI trade intensified and fears of slowing economic growth crept into the conversation, U.S. Treasuries abruptly reversed course and staged a notable rally, reclaiming their traditional safe-haven status. Add to that what markets interpreted as dovish comments from Fed Chair Warsh on Friday, and the 10-year Treasury yield fell 17 basis points on the week, erasing the past month’s rise in yields.
By Friday’s close, the probability of a Fed rate hike at next week’s FOMC meeting (October 28) had fallen to just 15%.
Looking Ahead
This week’s dominant event for equities will be a slate of mega-cap technology earnings reports, providing the first meaningful test of the AI investment narrative following last week’s rout in semiconductor stocks.
The stakes are unusually high.
Over the next two weeks, companies representing approximately 54% of the S&P 500’s market capitalization will report earnings. Meanwhile, markets are assigning an 85% probability that the Fed holds rates steady next week, and the midterm elections will be behind us in just over two weeks.
Consider the setup: Treasury yields have retreated, the Fed appears increasingly likely to remain on hold, earnings season is approaching its peak, and a major source of political uncertainty is about to be resolved.
If a year-end rally is coming, we should be standing on its threshold this morning.
Conversely, if equities fail to respond favorably to this combination of developments, we may need to consider whether markets are approaching a more consequential inflection point.
Either way, the next two weeks promise to be among the most important of the year.
Be well,
Mike