@theMarket: Oversold Tech Rebounds in Relief Rally

Late in the week after a further drubbing, the technology sector staged a rebound from a deeply oversold position. How long it lasts and how far it will go is debatable. In the meantime, long-dated yields in the bond world continue to rise.

 

You can blame the Fed for the continued backup in interest rates. Kevin Warsh's second FOMC meeting has come and gone with a big nothing done when it came to interest rate policy. He argued that the financial markets are doing the heavy lifting right now, and that is all right with him.

 

I could have entitled this column "Bond Vigilantes Ride Again" because that is exactly what the Fed chair is counting on. Readers haven't heard me mention these fixed income traders recently. This is the name markets give those who buy and sell bonds based on their forecasts for economic growth, inflation and geopolitics. Under the last Fed chair, Jerome Powell, the central bank bent over backward to inform the markets of what it was thinking and doing before it did it.

 

Those days are over. Chairman Warsh is determined to pull back on communication. Instead, he prefers to keep his cards close and watch how markets digest the ongoing data. Right now, the vigilantes are convinced that, thanks to the Iran war, tariffs, and government spending, inflation, after a month or two of reprieve, is set to rise again.

 

If that's the verdict, why then did the Fed not simply raise interest rates at this meeting? For one thing, if the once-again spike in oil prices is fueling higher inflation expectations, how would raising interest rates change that? It wouldn't, nor would higher rates reduce the impact of Trump tariffs. Those are supply issues. In inflationary times, the Fed is focused on reducing demand for money by making borrowing costs higher via hikes in interest rates.

 

Remember, too, the Fed's bailiwick is the Fed funds rate, that is a short-term debt instrument. Raising that rate might impact the yields on short-term borrowing costs. It has little impact on longer-term maturities where all the corporate, mortgage, and auto loans occur. That's where the private sector comes in.

 

By the end of the FOMC Q&A session, the markets were left with uncertainty. There was no hint at a September hike, no guidance on what the FOMC members are thinking, only the assurance that inflation was too high. If you think about it, the Fed has been on hold for five meetings in a row and yet bond yields have risen substantially without them.

 

Markets were miffed with the outcome. While Warsh asserted the Fed's commitment in pursuing its 2 percent inflation target, he repeatedly declined to connect that commitment to any concrete action. As a result, traders took the indexes down hard and bond yields higher. To be fair, some of the sell-off at the end of the day on Wednesday was due to one fund manager who was forced to liquidate his holdings in many AI stocks after suffering steep losses over the last few weeks.

 

On the macroeconomic front, the first reading of second quarter GDP growth came in at 1.5 percent below the forecast of 2 percent. Weak, yes, but with the questionable accuracy of government data, traders ignored the result, preferring to wait for further revisions. The Fed's favorite inflation index, the Personal Consumer Expenditures Index (PCE) for June, was cooler. That was thanks to the decline in oil prices, but with oil back up, investors ignored that data point, expecting higher numbers this month and next.

 

Second-quarter earnings continue to separate the wheat from the chaff. Microsoft gave an upside surprise, while Meta did the opposite. Apple disappointed. Amazon gained 15 percent on its results. I did warn that investors would become more discriminating based on individual company results. That is what is happening.

 

As I counseled readers last week, August should see further volatility in the markets. We are already seeing that. Wednesday, the S&P 500 Index fell almost 1.5 percent; Thursday it gained back more than that. Friday it failed to follow through to the upside. While the week was volatile, the index ended essentially flat. The same could be said for the Nasdaq, although volatility was more than twice that of the other indexes.

 

Last week I wrote that I was watching two levels: "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." The low this week was 7,313. From there it bounced, and we are once again back above 7,400.

 

I also explained there was a second alternative. "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." We did that as well. All in one week!