Dow's Shaky Week: Fed Rate Jitters to Trigger Summertime Blues?

Nvidia Corp. was anticipated to bolster the stock market this past week, but instead, it surged to new heights alone following impressive earnings, while the overall stock market lagged.

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Investors were unsettled by the Federal Reserve’s meeting minutes from April 30-May 1, released on Wednesday, which indicated that policymakers were not yet ready to lower interest rates and might consider raising them if necessary.

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With the U.S. market closed on Monday for Memorial Day, investors get a three-day break. However, there is concern that renewed speculation about rate cuts, combined with high valuations, could trigger a summer downturn.

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On Wednesday, stocks stagnated. Although Nvidia shares (NVDA) jumped 2.57% on Thursday to close above $1,000 for the first time, the S&P 500 (SPX) and Nasdaq (COMP) recorded slight losses, while the Dow Jones Industrial Average (DJIA) plummeted over 600 points, marking its worst day in over a year.

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This shift in market sentiment occurred as investors refocused on the trajectory of interest rates.

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“During the peak of the earnings season, it seemed that stocks were less influenced by short-term interest rate changes. As earnings reports dwindled, the anticipation of a Fed rate cut became more significant,” noted Louis Navellier, founder and chairman of Navellier & Associates, in a Friday commentary.

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Thursday’s release of the purchasing managers index showed increased activity in the services sector and a general uptick, breaking a trend of weaker readings. This PMI data heightened concerns about the Fed's ability to implement a rate cut by September.

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On Friday, economists at Goldman Sachs revised their expectations for the first Fed rate cut of this cycle, moving it from July to September. This new forecast aligns with market expectations, as indicated by the CME FedWatch tool, which shows a 54% chance of a cut in September, compared to a mere 12% chance in July.

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Earlier in the week, investors had priced in roughly an 80% probability of a rate hike by September, observed Tom Essaye, founder of Sevens Report Research, in his Friday analysis.

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Significant shifts in rate expectations have occurred, leading to higher Treasury yields and weaker stocks. Essaye emphasized that it’s investor perceptions, not the Fed’s stance, that have changed.

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“Investors have once again swung from one extreme of Fed expectations to the other,” he wrote, highlighting how investors in late April were anticipating rate hikes, only to be reassured by Fed Chair Jerome Powell on May 1 that hikes were unlikely, prompting a reversal in expectations to a nearly certain September rate cut.

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“So, the events of Wednesday and Thursday were not hawkish. The market had become overly dovish in its expectations, and the data from those days corrected that excessively dovish view,” he explained.

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Despite the recent turbulence, the S&P 500 (SPX) is just 0.3% below its record close set on Tuesday, while the Nasdaq Composite (COMP) finished Friday at a record high. The Dow Jones Industrial Average (DJIA), despite Wednesday’s drop, is only 2.3% below its record close, having surpassed the 40,000 mark for the first time on May 17.

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Investors are now contemplating the future of a rally that experienced only a modest pullback in April. Some argue that a more substantial correction may be overdue given the high valuations.

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The S&P 500’s price-to-earnings ratio for the next 12 months stands at 21.4, a 30.3% premium to its average since 2005, according to CFRA Research.

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When Fed rate concerns are not at the forefront, valuations seem to be the primary worry for stock-market investors, said Steven Ricchiuto, chief economist at Mizuho Americas, in a Wednesday note.

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Ricchiuto pointed out that this year’s over 11% rise in the S&P 500 matches the 11% to 12% rise in bottom-up earnings expectations for the full year, which has prevented valuations from becoming excessively stretched following last year’s market rally.

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“Although valuation concerns are affecting most stocks, as long as the market-weighted index continues to rise, equity fund inflows will likely keep the market tilted upwards, with dips seen as buying opportunities,” he wrote.

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