@theMarket: Trump's War Powers Oil & Bond Yields Higher

Oil spiked higher this week, regaining $90 a barrel as the dollar rose and U.S. Treasury bonds sold off. It is not hard to guess what the stock market did as a result. 

 

Down.

 

I'm sure you are just as tired as I am watching this Kabuki show unfold in the Middle East. Not only is the Straits of Hormuz shut in, but now Iran's proxy, the Houthis, have opened a second front along the Red Sea. They have already attacked two Saudi oil tankers and have vowed to close that oil avenue off from any further shipment of oil from Saudi Arabia.

 

Brent crude is up more than 40 percent in three weeks. Readers only need to fill up at the pump this week to realize the cost of this ongoing travesty. The Ten-year U.S. Treasury bond is now yielding 4.67 percent. Traders are dumping U.S. Treasuries as well as stocks in anticipation that by August the inflation data will be rebounding substantially. That would put an interest rate hike back on the table by September by the Federal Reserve Bank.

 

It is a tangled web this administration has woven. There were reports on Friday that Pakistan, with support from China, was seeking to revive negotiations between the two adversaries. That dropped oil prices by 5 percent to around $88 a barrel. Hope springs eternal I guess when  dealing with this war.

 

Oh, in case I forget, the president has just slapped a whole host of new tariffs (10-12 percent) on world trade, manufacturing a new excuse (forced labor in 80 countries) as justification. This adds yet another layer of price increases consumers will be receiving in the months ahead since we now know you and I are paying most of these tariff costs.

 

All the goals of this administration's economic policies, touted by U.S. Treasury Secretary Scott Bessent — reduce budget deficits, boost growth and increase energy production — have remained pipe dreams. Instead, interest rates are reaching new highs, spending and deficits are off the charts, and oil, rather than declining, is skyrocketing.

 

The AI trade has faltered as well. The recurring worry that the large mega-cap tech companies are spending too much money plagues the markets. The fate of this area hinges on the outlook for 2027 capital expenditures growth from the hyperscalers like Google, Meta, Amazon, and Microsoft. Currently, Wall Street analysts are expecting capex to grow by 28 percent next year. That's up from 23 percent two weeks ago and before Google's second quarter earnings announcement on Wednesday night.

 

Google once again raised its estimate of how much more it is planning to spend on AI this year, from $190 billion to a range of $195 billion to $205 billion. The stock cratered on the news despite a blockbuster revenue growth of $119.8 billion, up 24 percent from a year earlier. And what Google is doing, its competitors will do too. By the end of the earnings period, we could see that number increase to 37 percent.

 

Given that all these companies have whittled down their cash due to this monumental spending, investors expect that the only way to increase spending further will be for these companies to sell more stock and raise debt, thereby diluting existing holders. Even if they succeed, there is still no guarantee anytime soon that these companies will see the kind of payoff that is necessary to the bottom line given the amount of money involved.

 

Tesla was another dud. Auto sales are falling, and capex in all his tomorrow ventures, including AI, is exploding higher. Combined with the 50 percent decline in the price of SpaceX, Elon Musk is keeping a low profile lately.

 

Regular readers know that I entered the July-August period rather cautiously. I believe we are in a normal mid-summer consolidation in a mid-term election year. It appears as if Donald Trump is working overtime to ensure Democrats win that contest. That adds even more uncertainty to an equation already burdened by the possibility of a "massive attack" in Iran and therefore further spikes in energy prices. So far, second-quarter earnings have been on target for the most part. Next week, Microsoft, Meta, Apple and Amazon report on Wednesday and Thursday. Their announcements will largely dictate which way technology goes in the short term.

 

I see two possible outcomes for the markets over the remainder of the summer. Both would bring with them high volatility. The first is that we chop around here. Since technology is leading this pullback, I see it trading in a range of a little above and below 680 as reflected in the main Technology ETF (QQQ).

 

The S&P 500 Index, supported by the rotation I have discussed previously (that is out of tech and into sectors like healthcare, utilities, industrials, etc.), could remain at this 7,400 level. Once again, you could still see 50-point swings weekly or even daily in the index.

 

If, on the other hand, Trump allows his emotions to play out with few in the White House willing to talk him down, a sudden escalation in the war might occur. Oil prices spike much higher as a result. In that case, the first stop on the S&P would be 7,300 (testing a double bottom). If that fails to hold, we are looking at 7,200 (cycle lows). Technology would have an even bigger decline.