Fed Awaits Better Inflation Data, Treasury Yields Continue To Decline

gesrey The Fed’s Federal Open Market Committee (FOMC) statement on Wednesday acknowledged “modest further progress” on inflation. That was the good news. The bad news is that the Fed did not lower its inflation forecast based on the Personal Consumption Expenditure (PCE) index and it raised its unemployment forecast to 4.1%. In his best Fed-speak, Fed Chairman Jerome Powell said, “We’ll need to see more good data to bolster our confidence that inflation is moving sustainably toward 2%.” The biggest news was the update of the Fed’s “dot plot” by the FOMC members, where eight members expected two rate cuts this year, seven forecast just one rate cut in 2024 and four said that there would be no rate cuts this year, so the median of these three diverging opinions yielded only one key interest rate cut to occur this year, perhaps on September 18th or immediately after the November Presidential election. The only good news is the “dot plot” forecasted four key interest rate cuts in 2025. Overall, I am grossly disappointed in the Fed, since their previous “dot plot” forecasted three key interest rates cuts this year. In the meantime, Treasury yields continued to decline in the wake of the better-than-expected CPI and PPI. The bond vigilantes are now in charge and controlling Treasury yields. As I have repeatedly said, the Fed cannot fight market rates, so if the Treasury yields go lower, the Fed may be forced to cut rates sooner. Since our Fed is now lagging Europe in cutting key interest rates, “carry trades” are expected to increase. That’s where foreigners put money in the U.S. dollar seeking higher yields in a strong currency. If these carry trades approach a trillion dollars, they could actually drive Treasury yields significantly lower and encourage the Fed to cut interest rate sooner than they would otherwise cut them, forcing the Fed’s hand. The Coming Move in Selected Small-Cap Stocks Our friends at Bespoke have a great feature called “Chart of the Day,” and they presented a pair of charts with the title “It’s the Market Cap, Stupid” that broke the performance of the S&P 500 into deciles. For both the second-quarter and year-to-date performance, the top decile (the largest-capitalization stocks) in the S&P 500 rose 2% and 15.3%, respectively. Conversely, the bottom decile (the smallest-capitalization stocks in the S&P 500) declined 10.3% (so far in the second quarter) and 7.3% (year-to-date), respectively. (Bespoke Investment Group) Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary. Interestingly, despite this Bespoke report, our small- to mid-capitalization stocks performed exceptionally well in May and so far in June. Due to the annual Russell realignment, as well as quarter-end window dressing, I expect that my small- to mid-cap stocks will continue to perform well in the upcoming weeks. Over the next two weeks, Russell will refine its proposed changes to their indices. Small- and mid-cap stocks added to the Russell indices on June 24 are typically the biggest winners. After this annual Russell realignment, quarter-end window dressing is expected to boost many of our fundamentally superior stocks as many institutional investors make their portfolio look “extra pretty” in their quarter-end reviews. As for the best of the big-cap stocks, Nvidia (NVDA), in the wake of its 10-for-1 stock split, is expected to pass Microsoft (MSFT) in total market capitalization to become the largest public company. In the upcoming months, I expect Nvidia to blow through $4 trillion in market capitalization and eventually hit $5 trillion in market capitalization next year, when it announces the successor to its Blackwell chips that it is now rolling out. The recent news that the Justice Department and Federal Trade Commission have struck a deal over how to proceed with antitrust investigations into Nvidia, Microsoft and OpenAI are not expected to derail the AI revolution, and The Wall Street Journal said these investigations “may ultimately come to nothing.” The simple fact of the matter is that since Nvidia spent over $2 billion to develop its next-generation generative AI chips, competing with Nvidia has become increasingly futile. In fact, all the other AI chips under development are increasingly low-tech chip solutions, not the deep learning, generative AI chips that Nvidia makes. As a result, Nvidia is leading the entire stock market and, as Bloomberg TV recently said, the Magnificent Seven in the S&P 500 has become “the Magnificent One, and 499 other stocks.” As for those other 499 stocks, pardon me for talking like a “math geek” for a minute, but if you ignore Nvidia and look at those other 499 stocks in the S&P 500, they are increasingly impacted by “mean reversion” trading algorithms that Citadel implements after each earnings announcement season ends. These algorithms hit overbought stocks that trade based on a non-linear neural algorithm that becomes unwound as volatility increases. Former algorithmic traders that I have questioned reluctantly hint that these mean reversion algorithms typically last 10-12 trading days, depending on how volatility increases. For the record, I am a “linear” math guy, since my quantitative and fundamental analysis is done on a trailing 52-week basis, although we also run quantitative rankings on a 270-day, 120-day, 90-day, 60-day and 30-day basis. The neural algorithm folks like to brag that they are not burdened by any fixed time cycle and that their neural algorithms “naturally adapt.” I do not mean to burden you with too much math jargon, but in the end, these mean reversion neural algorithms just hit overbought stocks as they back and fill and digest their recent gains. Conversely, these mean reversion neural algorithms can be used to artificially “pump up” oversold stocks. As trading volume dries up, however, these mean reversion neural algorithms typically run for cover, since without trading volume, no algorithm can keep working. So that is your crash course in algorithm trading. The key point to remember is that the stock market tends to be efficiently traded during each quarterly announcement season. But after earnings season winds down, these algorithmic games begin and markets become much less efficient as overbought winning stocks are hit with profit-taking and oversold stocks firm up as adaptive trading algorithms run wild. In short, there are four months each year when stocks are efficiently traded (in earnings announcement seasons) and there are eight months of inefficient trading, when adaptive trading algorithms run wild! But if you hold on through the two-month gap between earnings, you should be rewarded during earnings season! Navellier & Associates owns Nvidia Corp. (NVDA), Microsoft (MSFT), and a few accounts own Tesla (TSLA) per client request in managed accounts. Louis Navellier and his family own Nvidia Corp. (NVDA) and Microsoft (MSFT) via a Navellier managed account, and Nvidia Corp. (NVDA) in a personal account. He does not own Tesla (TSLA) personally. All content above represents the opinion of Louis Navellier of Navellier & Associates, Inc. Disclaimer: Please click here for important disclosures located in the “About” section of the Navellier & Associates profile that accompany this article. Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients. Original Post Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.