by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is closely analyzing Nvidia’s latest earnings report to assess its implications for the future. In sports news, the New York Giants honored rookie wide receiver Malik Nabers by unretiring the iconic No. 1 jersey. Today’s Comment will explore the broader significance of Nvidia’s earnings for the Magnificent 7, delve into why policymakers are having cold feet heading into the monetary easing cycle, and offer a discussion about the ongoing chip war between China and the West. As always, we’ll conclude with a roundup of key international and domestic data releases.

 AI Hype Fades: Nvidia’s disappointing results will likely intensify pressure on AI-related companies to demonstrate profitability.

• Despite exceeding analyst expectations with second-quarter revenue of $30 billion compared to the projected $28.7 billion, the US chipmaker’s stock price declined. Investors sought a more substantial earnings beat and were disappointed by the company’s subpar outlook. While the company has expressed confidence in its Blackwell processor, a next-generation AI chip, production delays due to design issues have raised concerns. Despite these challenges, the company expects revenue to increase to $32.5 billion in the current quarter, surpassing analyst estimates of $31.9 billion.
• Nvidia’s underwhelming earnings could foreshadow broader challenges within the Magnificent 7. This cohort of tech giants has been a major catalyst for the S&P 500’s gains this year, but recent signs suggest a potential slowdown. Investors are growing wary of tech companies’ abilities to sustain their current valuations, especially given their significantly higher price-to-earnings ratios as compared to the broader large-cap market. These concerns have become more pronounced as companies like Microsoft, Amazon, and Google have vowed to plow more money into AI, despite a lack of concrete results.

• Today’s results could further fuel a shift in investor sentiment, driving a rotation toward new market leaders. While other sectors may benefit from this change, large cap stocks are unlikely to be completely overlooked. The emergence of a new market leader will hinge on the economic trajectory over the coming months. As signs of a potential slowdown emerge and the Federal Reserve prepares to ease monetary policy, interest rate-sensitive sectors like Financials and Real Estate may experience a resurgence. However, market volatility is expected to be elevated as investors cope with the uncertainty.

Not So Fast: While many Federal Reserve officials have struck a dovish tone, there are still some holdouts who aren’t entirely convinced about the need for a rate cut in September.

• Atlanta Fed President Raphael Bostic on Wednesday expressed skepticism about the need for an immediate interest rate cut at the upcoming Federal Reserve meeting. During an interview, he noted that while inflation has exceeded his expectations and unemployment has risen more rapidly than anticipated, he still wants more conclusive data before fully supporting lowering rates in September. Over the next two weeks, the Federal Reserve will have two inflation reports for Personal Consumption Expenditure (PCE) and another for the Consumer Price Index (CPI) as well as another jobs report to analyze before its upcoming meeting.
• Bostic is not alone in expressing concerns that inflation may resurface if central banks become complacent. Bank of England Governor Andrew Bailey has tempered expectations for another rate cut at the central bank’s next meeting, due to concerns of a reacceleration in inflation. Despite the recent decline in inflation data, the Bank of England anticipates a higher inflation rate at year’s end. In South America, Brazil was one of the first major economies to implement rate cuts but is now considering an interest rate hike to address an unexpected resurgence in inflation.

• The PCE is not anticipated to accelerate significantly as some of its components were showing signs of moderation in the Producer Price Index (PPI), but the August CPI report could introduce uncertainty to the Fed’s aims for a rate cut. Historically, prices tend to rise during the fall months. This should not be a problem as long as the month-to-month figures remain relatively in line with last year’s increase of 0.2%. If inflation rises about that amount, it could call into question the path of future interest rate cuts.

The Fight Over Chips: Western nations have shown no signs of backing down in the face of China’s threats over export controls.

• The Netherlands delivered a major setback to China’s semiconductor aspirations on Thursday by denying ASML license renewals for servicing its advanced ultraviolet lithography equipment within the country. This move effectively curtails China’s access to the cutting-edge technology essential for developing domestic chip manufacturing capabilities. ASML’s lithography machines are indispensable for producing high-performance chips and China has no way of replacing them. The move comes as China prepares to limit export of key materials needed for chip production.
• The Netherlands’ decision aligns with the US-led effort to impose unilateral restrictions on chip exports to China. Japan and South Korea, while expressing reservations, have also complied with US requests to limit exports that could bolster Beijing’s ambitions of developing a domestic chip industry. Behind the scenes, US officials have employed the threat of invoking the Foreign Direct Product Rule against countries that fail to comply. This rule would enable the US to restrict the flow of exports containing even the smallest amount of US technology.

• Denying China access to chipmaking technology is unlikely to prevent the country from eventually developing its own industry. However, it does provide the West with a strategic advantage by incentivizing firms to invest more in the materials needed for chip production. This aligns with the West’s broader goal of reducing reliance on Chinese commodities. The escalating competition between the West and China is likely to persist for the foreseeable future as both sides seek to establish dominance in the clean energy and chipmaking sectors as a means of asserting global influence.

In Other News: As anticipated, Brazilian President Lula da Silva has selected his political ally Gabriel Galipolo to lead the country’s central bank. This choice is likely to temper expectations of a rate hike at the central bank’s upcoming meeting in September. Russia is finding it difficult to retake land captured by Ukraine in a sign of growing uncertainty about the direction of war. The California AI bill has garnered significant attention as lawmakers seek to establish safeguards for the development of new AI technologies.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Anticipation is high for Nvidia’s upcoming earnings report as markets hope for another strong performance. In sports news, NCAA football is considering eliminating the spring transfer window. Today’s Comment will explore the reasons behind rising confidence but declining job expectations. We will then delve into the ongoing clash between governments and social media companies and analyze Argentina President Javier Milei’s policy adjustments. Additionally, this report offers a comprehensive roundup of international and domestic news releases.

Sentiment Improves Despite Job Concerns: Consumer optimism increased in August, even as concerns about employment grew.

• Consumer sentiment reached a six-month high in August as households reported increased confidence in both business conditions and the overall economy. The Conference Board Consumer Confidence Index climbed from a revised 101.9 to 103.3, driven by gains in both the Expectations and Present Situation indexes. The Expectations Index, which remained above 80 for the second consecutive month, rose from 81.1 to 82.5, its highest level since August 2023. Meanwhile, the Present Situation Index improved from 133.1 to 134.4.
• Despite the broader market’s positive tone, concerns persisted about the labor market. The report indicated a decline in respondents expressing optimism about job availability and an increase in those finding jobs more challenging to secure. This weaker outlook reflects a broader concern that firms are beginning to slow hiring as the economy shows signs of losing momentum. This sentiment aligns with the Federal Reserve’s increased focus on its employment mandate. In July, the employment rate surged to its highest level since October 2021, while job openings showed signs of deceleration.

• The rise in consumer confidence is another indication that earlier-month recession fears may have been exaggerated. This bodes well for the equity market, bolstering the chances of a soft landing, especially given recent signals from numerous Fed officials favoring a September rate cut. However, it also suggests that a substantial rate cut may be less likely, given the economy’s relative stability. Nevertheless, the upcoming jobs report will likely be pivotal in determining the size of the rate cut, as another surge could reinforce the notion that the Fed is behind the curve.

Social Media Takes the Stage: Social media companies and governments are increasingly at odds over the definition of free speech.

• In a letter to the House Judiciary Committee, Meta CEO Mark Zuckerberg accused the Biden administration of pressuring the company to limit content related to the COVID-19 pandemic. Zuckerberg argued that such restrictions were inconsistent with Meta’s content standards and vowed to resist any future attempts to influence the platform’s policies. In response, the White House defended its actions, asserting that its requests for tech companies to curtail misinformation were aimed at protecting public health during the outbreak.
• His comments come amid a growing public outcry over the role of social media in disseminating divisive content. Earlier this month, Elon Musk, CEO of X (formerly Twitter), faced criticism from the UK government for suggesting that the country was on the brink of civil war. This shift coincides with the aging of the US social media audience, hindering the platforms’ abilities to increase advertising revenue. Despite being perceived as a platform for younger users, Meta’s median user age is between 30 and 39, with less than a quarter of its user base under 24.

• The ongoing debate about social media content has significant implications for the Communications sector. Many of these companies rely heavily on online advertising as a solid revenue source. Over the past few years, Meta and Alphabet have been major drivers of growth within the Communications sector. While these firms are likely to benefit from the upcoming election season, subsequent regulatory efforts could weigh on the overall sector as lawmakers seek to curtail the power of these tech giants.

 Argentina: While he has had some victories, Argentine President Javier Milei is increasingly making more concessions as he looks to revive the economy.

• Since taking office, Milei and his administration have implemented a series of policy adjustments. On Tuesday, the Argentine government announced a reduction in tariffs aimed at combating inflation. Milei’s decision to lower the import tax from 17.5% to 7.5% represents a reversal from his initial post-election increase. Additionally, he has softened his stance on China, shifting from campaign rhetoric that labeled Chinese party leaders as “assassins” to a recognition of the importance of Chinese investment and trade for Argentina’s future.
• Milei’s policy pivot comes amidst Argentina’s struggle to achieve economic growth, despite implementing painful austerity measures. Since taking office, Milei has enacted significant cuts to real pensions and public sector wages, while freezing public infrastructure projects. These measures have strengthened the government’s financial position, resulting in five consecutive budget surpluses and a faster-than-expected deceleration in inflation. However, the economy entered a recession in the first quarter, with economic activity in all but one sector posting annual declines in June.

• Despite being early in his first term, the president has demonstrated the challenges faced by those perceived as extremists in attempting to deviate significantly from their predecessors’ policies. While presidents play a crucial role in setting agendas, they often inherit situations that necessitate compromise. Therefore, it’s essential to consider the broader political landscape when assessing the potential impact of a new leader on the market. That said, Argentina’s long-term outlook is looking better since Milei has implemented some of his reforms.

In Other News: The US has affirmed its commitment to defend Israel if attacked by Iran, underscoring the ongoing threat of conflict in the region. In domestic politics, Democratic presidential candidate Kamala Harris and her running mate, Tim Walz, are scheduled for their first CNN interview, which aims to provide voters with deeper insights into their candidacies. Meanwhile, Mexican President Andrés Manuel López Obrador has suspended relations with the US and Canadian embassies in response to disagreements over his judicial reform plans.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is eagerly awaiting earnings reports from several chip companies. In sports news, Dallas Cowboys’ wide receiver CeeDee Lamb has signed a new multi-year contract. Today’s Comment analyzes the influence of the Fed on equities, the impact of China’s trade restrictions on the West, and why Germany’s economy appears to be in the gutter. As always, the report concludes with international and domestic data releases.

Smaller is Better? A highly anticipated Fed pivot has helped boost smaller companies, but there are still many unknowns.

• Investors will closely watch the Fed for the next few weeks as it prepares to cut rates in September. While Fed officials have signaled a 25-basis-point cut at the next meeting, they have been less committed to future policy moves. On Monday, San Francisco Fed President Mary Daly advocated for rate cuts, while Richmond Fed President Thomas Barkin acknowledged inflation risks but saw no harm in a modest rate reduction. Their comments build on Fed Chair Powell’s remarks at Jackson Hole on Friday, indicating a shift in the central bank’s focus from inflation to safeguarding the labor market.
• Since the Jackson Hole speech, investors have adopted a more risk-tolerant stance. On Monday, the S&P small-cap and mid-cap indexes rose as high as 2.2% and 2.6%, respectively. This robust performance reflects a shift in investor preference toward factors like profitability and dividends, which have outperformed traditional metrics like size and momentum. Historically, smaller firms have offered higher dividend yields than those of their larger counterparts. Additionally, declining borrowing costs will enhance profitability for small-cap firms, which are more likely to hold floating-rate debt.

• Smaller companies have outperformed larger tech stocks, which have experienced a slight pullback despite year-to-date gains. Investors searching for undervalued opportunities have led to a shift away from mega-caps, whose stock prices have outpaced earnings growth. AI-related companies have been particularly vulnerable to this sell-off as skepticism mounts about their growth potential, given their strong performance over the last two years. Earnings from chip companies will release this week, and those, especially Nvidia’s, will be a crucial test of tech’s resilience in the current market.

Chip Wars: Beijing has imposed trade restrictions on critical minerals needed for chip production as trade tensions continue to escalate with the West.

• China’s recent aggressive trade policies have started to worry firms with limited alternatives. Last year’s export controls on gallium and germanium, both crucial for semiconductor manufacturing, have led to a surge in prices for the commodities as other countries have been forced to make up the gap. The move comes as Beijing signals that it is willing to retaliate if its companies are targeted. In two weeks, China is poised to further restrict antimony, a vital component in defense technology, such as infrared missiles, night-vision equipment, and even nuclear weapons.
• The West has struggled to counter China’s strategic advantage in critical minerals. China dominates global production of gallium (over 80%), germanium (60%), and antimony (48%), while Western countries, hampered by stringent regulations, have found it difficult to develop competitive domestic industries. So far, companies have relied on existing stockpiles to maintain production. However, there are concerns about how long this can continue. Companies like Intel have continued to rely on gallium to make breakthroughs in semiconductor efficiency, even as prices have more than doubled.

• China’s market dominance is primarily due to its ability to undercut competitors’ prices. By restricting the supply of resources to the rest of the world, China is likely to spur greater competition from other countries that were previously unable to compete. Since the restrictions were implemented, there have been increased discoveries of these resources in Utah and Montana. Moreover, governments are likely to leverage these restrictions as a justification for increased support of key industries as they seek to reduce their reliance on China in the future.

Germany’s Industrial Crisis: There are growing concerns that industrial capacity in Europe’s second largest economy will not be able to recover in the coming months.

• The German economy contracted by 0.1% in the second quarter of the year, which was primarily driven by a 2.2% decline in capital spending and a modest 0.2% drop in consumer spending. Waning consumer confidence, which was fueled by concerns about job security and a struggling manufacturing sector, contributed to these declines. The GfK Consumer Climate indicator registered a five-month low, reflecting these concerns. Meanwhile, factory output has declined for three consecutive months, raising fears of a prolonged manufacturing downturn.
• The negative report marks a setback as Germany struggles to regain its economic footing after a disappointing 2023. Despite an initial 0.2% growth in the first quarter, the overall economic activity remains relatively unchanged from the previous year. The country’s flagging industrial sector has been the primary drag on growth, with German output declining steadily since its 2017 peak. Rising competition from China and the United States, coupled with difficulties in securing cheap Russian gas, has contributed significantly to this industrial downturn.

• A significant risk to the German economy is the ongoing green energy transition. Although the government has committed to clean technology, public resistance to the associated costs has been substantial. The current economic downturn could exacerbate populist sentiment, especially as the country also confronts rising concerns about illegal immigration. Consequently, we anticipate a potential shift toward easing some of the more stringent regulations on fossil fuels in the coming years. This could help mitigate further declines in Germany’s factory output.

In Other News: Canada announced that it will impose a 100% tariff on Chinese cars and a 25% tariff on Chinese steel in a sign that the West is working together to isolate China. A pivotal Mexican congressional committee sanctioned Mexican President Andrés Manuel López Obrador’s restructuring of the judiciary in a move likely to incite a potential impasse with the United States and Canada regarding the existing trade arrangement. French President Emmanuel Macron ruled out the possibility of a left wing coalition as he looks to form a government with moderate politicians.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is still anxiously awaiting clues on the Federal Reserve’s next move. In sports news, Hideki Matsuyama continued his impressive run at the BMW Championship with a remarkable 73-yard putt for his third consecutive birdie. Today’s Comment will discuss our views on interest rate expectations and long-term bond rates, the persistent threat that unions pose to controlling inflation, and our early impressions of the two leading presidential candidates. As always, our report includes an overview of domestic and international news.

After the Fed Cuts: While investors eagerly await Powell’s speech for hints about the Federal Reserve’s September moves, we contend that monetary policy’s sway over the market is waning.

• Before his speech, several Federal Reserve officials have been working to temper market expectations. On Thursday, Boston Fed President Susan Collins and Philadelphia Fed President Patrick Harker both indicated a willingness to consider rate cuts at the Fed’s upcoming meeting but advocated for a cautious approach. However, there is noticeable hesitation about easing policy. Kansas City Fed President Jeffrey Schmid expressed that he would like to see more data before endorsing a rate cut, a sentiment shared by Fed Governor Michelle Bowman.
• Historically, Fed expectations have been a strong predictor of long-term interest rates. However, this year, the correlation between these two factors has become less pronounced. This divergence is likely attributable to concerns that the Fed may not be as aggressive in cutting rates as it has been in past cycles. The FOMC’s latest economic projections indicate that members anticipate the long-run rate to reach 2.8%, which is above the 20-year average by 100 basis points. This suggests that the market may be looking past the first rate cut.

• While the market may be looking to Powell’s Jackson Hole speech for signals of a potential 50 basis point rate cut at the September FOMC meeting, we believe such a move is unlikely. Even if we are mistaken, we would expect the effect on long-term rates to be minimal because the market has likely already priced in most of the expected rate cuts for the coming year, leaving little room for further declines. Consequently, other factors such as the widening fiscal deficit, aging demographics, and economic growth are more likely to influence long-term rates in the coming months.

Supply Chain Mayhem: The threat of disruptions to shipments has increased as Canadian railway workers continue their strike and US East and Gulf Coast port workers consider similar actions.

• North American supply chains will likely cope with twin strikes. In Canada, the government has intervened in the ongoing rail strike. The labor board has been ordered to end the shutdown that has halted freight traffic for the past two days. Two railway unions went on strike following failed contract negotiations with Canadian National Railway and Canadian Pacific Kansas City regarding railway schedules, safety, and time management. Meanwhile, US port workers are also threatening a strike in October. Negotiations have stalled over the use of automation for processing trucks without human labor.
• The threat of strikes arrives at a politically charged moment. Since the pandemic, unions have experienced a resurgence, with the percentage of US workers belonging to unions reaching its highest point since the mid-1960s. The shift in sentiment has occurred as union leaders have been able to leverage a shortage of labor supply to demand higher wages for workers. Over the past four years, worker compensation has risen at the fastest pace since the early 2000s, though recent data suggests a slowdown.

• Unit labor costs are arguably the most reliable indicators of long-term inflation. As marginal production costs rise, firms are more likely to pass these costs on to consumers. Consequently, the resurgence of labor unions could hinder the Federal Reserve’s efforts to achieve its 2% inflation target. As the chart above demonstrates, worker compensation has been a primary driver of core PCE services, a key inflation metric closely watched by the Fed. While rising productivity has thus far helped offset increased wage bills, a reversal of this trend could significantly complicate inflation control efforts.

First Impressions: With the major parties having officially selected their presidential nominees, it’s time to summarize their key ideas.

• The Republican presidential candidate, Donald Trump, a supply-sider with a populist edge, advocates for expanding domestic production through deregulation and incentives to bring manufacturing back to the US. He has pledged to lower taxes and eliminate restrictions on energy production. In contrast, the Democratic nominee, Kamala Harris, a traditional Keynesian, supports using subsidies and regulation to achieve her policy goals. She has endorsed price controls on medication, rent, and food and has proposed grants for first-time homebuyers.
• While the president plays a key role, the primary arena for policy battles is Congress. In recent decades, rising partisanship has hindered both parties’ ability to pass legislation as groups have become increasingly focused on obstructing the other rather than passing laws. A prime example of this is the reliance on continuing resolutions, which avoid government shutdowns but fail to address the deficit. Although controlling both houses of Congress increases the chances of passing legislation, it has also made it easier for fringe groups to derail the process.

• The betting odds indicate a closely contested election. On PredictIt, Kamala Harris holds a slight lead of 55% to 48%, while Polymarket shows Donald Trump ahead at 51% to 47%. However, bettors are leaning toward a split in Congress. Polymarket suggests a 72% chance that Republicans will regain the Senate, while Democrats have a 62% chance of regaining the House. With plenty of time before Election Day, these odds are subject to change. That said, if they hold, both candidates will face challenges in fulfilling their campaign pledges.

In Other News: Hamas rejected the latest ceasefire agreement over demand to have troops in Gaza. The rejection is a reminder of how hard it will be for the two sides to end the conflict within a short time. An oil tanker was attacked in the Red Sea, another indication of the threat that geopolitical tensions pose to supply chains. Separately, RFK Jr. is widely expected to step down from presidential contention and is rumored to be endorsing President Trump in exchange for a potential role in his administration, possibly as the head of the National Institutes of Health or as Spy Chief.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The stock market is currently grappling with the potential for interest rate cuts, fueled by the recent downward revisions to BLS payroll data and dovish commentary from Federal Reserve officials. In sports news, Cincinnati Reds first baseman and 2010 NL MVP Joey Votto has announced his retirement at the age of 40. Today’s Comment delves into the recent Federal Reserve meeting minutes, explores the escalating tensions between the West and China in the race for clean energy dominance, offers a comprehensive update on Mexico, and discusses the increase in US concern about China’s nuclear capabilities. As always, our report concludes with a concise overview of key domestic and international data releases.

Doves Take the Wheel: Expectation of a rate cut in September appear locked in after it was revealed that some policymakers were willing to cut in July.

• The Federal Open Market Committee (FOMC) released the minutes from its July 30-31 meeting, which highlighted the growing shift in Fed officials’ focus away from its inflation mandate and toward employment. Nonfarm payroll data and the unemployment rate have exhibited signs of increasing and raised red flags for the committee. Additionally, FOMC members expressed optimism that inflation is likely to continue its downward trend. Despite a unanimous vote to maintain interest rates, several members expressed an openness to supporting a decision to cut interest rates by 25 basis points.
• While the recent triggering of the Sahm Rule has fueled expectations for a substantial interest rate cut at the Fed’s upcoming meeting, we maintain a cautious outlook. Although the rule (which measures the three-month moving average of the unemployment rate against its 12-month minimum) has surpassed its recession threshold of 0.5%, the spike could be transitory. The early July passage of Hurricane Beryl through the southern states likely contributed to a temporary surge in job losses.

• The Federal Reserve’s decision on interest rate cuts will likely be influenced by the August employment and Consumer Price Index (CPI) reports. While the July Personal Consumption Expenditure (PCE) data may offer some insights, its impact is expected to be relatively minor. If these figures continue to support the notion of a cooling labor market and inflation, the Fed is likely to implement a 25-bps rate cut in September. A larger, more substantial cut would likely only be considered if there is another unexpected surge in the unemployment rate.

The Great Split: While it appears that demand for EVs have waned, the geopolitical war over dominance in the space has started to heat up.

• The West is actively working to prevent China from dominating the clean energy sector. Next month, the EU plans to impose tariffs as high as 36% on Chinese-made electric vehicles, including Tesla, due to unfair competition concerns. This move is intended to protect its struggling industrial sector by preventing China from dumping its artificially cheap plug-in vehicles in Europe. The production of electric vehicles in the West has faced challenges due to limited consumer demand. Recently, Ford scrapped plans to build a fully electric SUV.
• Despite weak demand, the West has continued efforts to bridge the technological gap with China. Earlier this week, the Department of Defense approved a $20 million grant to fund a cobalt sulfate refinery in Canada, a mineral that is a critical precursor for battery production. Meanwhile, the EU secured a deal with Serbia to allow lithium mining last month. These moves align with both regions’ plans to expand their renewable energy capacity. US battery production is expected to increase from 257 to 1000 gigawatts hours over the next decade, while Europe aims to become battery cell self-sufficient by 2026.

• The battle for clean energy dominance is likely to intensify over the coming years. The Inflation Reduction Act, designed to incentivize clean energy projects, has strategically targeted Republican districts to counter conservative efforts to undermine its goals. Meanwhile, Europe’s ability to wean itself off imported fossil fuels from hostile powers like Russia hinges on the successful development of its renewable energy resources. While China will likely dominate the space for now, we expect the West to push through plans for renewable energy despite the political headwinds.

The New Mexico: Growing concerns surround the country’s direction as Claudia Sheinbaum prepares to become president.

• Mexican judicial officials staged a strike on Wednesday in protest of controversial reforms aimed at overhauling the country’s court system. The proposed system would elect judges, including those in the high court, through popular vote. This initiative, championed by outgoing President Andrés Manuel López Obrador (AMLO), is intended to combat corruption and impunity within the judiciary. However, it has been widely criticized as a tactic to replace judges who oppose his agenda with those who will support it. The push has led to concerns about the lacking balance of powers within the government.
• The push to reform the country’s judicial system could further tarnish Mexico’s reputation as a nearshoring hub for companies seeking proximity to the US supply chain. During the AMLO presidency, the judiciary served as a valuable check on the president’s overreach. For instance, earlier this year, the Supreme Court struck down a law that would have favored state-owned power companies over private ones. The proposed reforms could pave the way for more policies that would increase the costs of doing business in Mexico for foreign investors.

• With AMLO’s Morena party securing a supermajority, a sweeping overhaul of the judicial system appears inevitable. The market has already reacted, leading to a sharp sell-off in the country’s currency, with the Mexican peso (MXN) dropping 10% against the dollar since the election. Meanwhile, Mexican equities have also suffered. This trend could shift after the US election if the next American president pushes for changes to the USMCA. As a result, we believe the situation in Mexico remains fluid.

United States-China-Russia: According to the New York Times, President Biden in March approved a highly classified nuclear strategic plan, the “Nuclear Employment Guidance,” that prioritizes China ahead of Russia for the first time. It also directs preparation for a coordinated joint nuclear attack from China, Russia, and North Korea. The new plan is consistent with fears that China’s nuclear arsenal will match or exceed the deployed US arsenal within 10 years.

• The rapid growth in China’s strategic nuclear arsenal will likely reinforce the US’s emerging bipartisan support for nuclear modernization and rising defense budgets.
• More broadly, it will probably also contribute to further tensions between the Chinese bloc and the West.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is awaiting more guidance from Fed officials as it looks for a better understanding of the path of policy rates. In sports news, Jets QB Aaron Rodgers is being pushed to his limits in training camp as he prepares for a grueling comeback attempt after an injury ended his previous season. Today’s Comment will explore the reasons behind the market’s recent broadening, analyze the implications of payroll revisions for the Fed’s upcoming rate decision, and examine why investors are growing nervous about central bank independence in Brazil. As always, our report will include a comprehensive roundup of key international and domestic data releases.

The Great Rebalancing: While mega-cap companies struggle to recover from the July sell-off, smaller firms are leading the market rally.

• The S&P 500 is poised for a new high this week as market uncertainty stemming from Fed rate cuts and recession worry diminishes. This surge seems to reflect strong second-quarter 2024 earnings. Over 80% of companies surpassed earnings expectations, with the overall index outperforming estimates by 13.6% compared to the anticipated 8.3%. A strong guidance also played a role as companies were relatively upbeat about future growth despite growing concerns of a looming economic slowdown.
• Surprisingly, this market rally has not been driven by the tech giants that typically dominate the S&P 500. While the Magnificent 7 Index, which once led the S&P 500’s gains, is now 8% below its early July peak, the overall S&P 500 has remained relatively unchanged during the same period. In contrast, the S&P 500 Equal Weight Index, which eliminates market cap bias, has reached an all-time high. Although the mega-tech companies have regained some ground, there are signs of a potential shift in market leadership.

• This shift in market leadership is likely to be gradual and uncertain over the next few months. The upcoming election, unclear monetary policy, and economic strength will likely weigh heavily on investor sentiment. As a result, investors may be reluctant to abandon their previous winning trades in the Magnificent 7, especially given their strong performance over the past two years. This will be particularly true if Nvidia reports another strong earnings result next week. However, we are increasingly confident that the dominance of tech stocks may be nearing its end.

Gloomy Payrolls: Bureau of Labor Statistics (BLS) revisions are expected to show that the economy added less jobs than originally estimated, which is likely to place additional pressure on the Fed.

• Market expectations suggest that benchmark revisions will unveil a significant overestimation of job growth in the prior report, ranging from 400,000 to 600,000 positions. These revisions arrive amid growing criticism that the Federal Reserve may have neglected its maximum employment mandate in its singular focus on taming inflation. While the anticipated downward adjustment to job numbers is unlikely to reshape the overall economic outlook, it could exacerbate worries about a more rapid labor market cooldown than policymakers realized in its previous rate decision meetings.
• The pandemic likely contributed to the BLS’s difficulty in accurately determining the number of job openings in recent years. Government stimulus and increased free time encouraged many people to start their own businesses, complicating the Fed’s efforts to track hiring trends. Additionally, many of these new companies struggled to stay open in the years following the pandemic, making it challenging to assess their impact on the job market. This likely caused delays in the BLS’s data collection, forcing surveyors to rely on educated guesses while awaiting more accurate information.

• The revisions could influence how the Fed adjusts policy rates. A larger-than-expected drop might push the central bank to take a more aggressive stance to safeguard the labor market. On the other hand, a milder revision could encourage caution, with officials gradually easing policy restrictions to prevent inflation from reaccelerating. Additionally, the upcoming jobs data will be pivotal in shaping the Fed’s September decisions. While we expect the Fed to limit rate cuts to 25 bps, a surprise rise in unemployment above 4.5% could prompt stronger measures to prevent further labor market deterioration.

Brazil: While the central bank has mentioned that it will not hesitate to raise interest rates to control inflation, it appears that Brazilian President Lula da Silva has other plans.

• On Tuesday, Brazil’s central bank chief, Roberto Campos Neto, appeared to downplay the possibility of raising interest rates in a newspaper interview. Specifically, he stated that he was not committed to raising interest rates and remained optimistic about inflation falling below the country’s 3% target. His comments led to a sharp decline in the Brazilian real (BRL), as investors interpreted them as signaling a lack of urgency from policymakers to address rising inflation, which had increased from 3.7% in April to 4.5% in July.
• The Central Bank of Brazil, while officially independent since 2021, has struggled to maintain its autonomy amidst political pressure to adopt more expansionary monetary policies. This pressure has been particularly evident in calls for lower interest rates to stimulate economic growth from the Brazilian president. Last week, Lula attempted to deflect criticism of his involvement in monetary policy decisions by asserting that the next central bank head he appoints will need to demonstrate courage when deciding to lower or hike interest rates.

• In the coming weeks, Lula is widely expected to choose Gabriel Galipolo as his pick to take over the central bank. The central bank faces internal tension as Galipolo, set to take full control in 2025, has views more closely aligned with Lula’s economic team. While Galipolo has also pushed for rate hikes, there are concerns about his loyalty. That said, the leadership announcement could spark division within the central bank and could complicate efforts to shift policy in any one direction. As a result, the September meeting will be a crucial indicator of the bank’s future direction.

In Other News: A federal judge has halted the Biden administration’s attempt to ban noncompete clauses, underscoring the challenges that presidents face in advancing their agendas within a highly partisan government. Meanwhile, China has countered the EU’s crackdown on EV imports by launching an investigation into European dairy products, further highlighting the escalating trade tensions between China and the West. Ford is scrapping plans for a fully electric SUV due to cost concerns, in another sign that the EV market is starting to cool.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with a potentially groundbreaking deal in which a Canadian firm is seeking to buy the Japanese company that owns the 7-Eleven chain of convenience stores. If successful, the deal would be the biggest-ever foreign takeover of a Japanese firm. We next review several other international and US developments with the potential to affect the financial markets today, including an interest-rate cut by Sweden’s central bank and a proposal by Vice President Harris to hike the US’s maximum corporate income-tax rate to 28%.

Japan: Seven & i Holdings, the Japanese firm that owns 7-Eleven, has announced it is considering a friendly takeover offer from Canadian retailer Alimentation Couche-Tard, which has a controlling stake in the Circle-K chain. Any deal would face US antitrust scrutiny, of course. Nonetheless, if a transaction is concluded, it would be the biggest-ever foreign takeover of a Japanese company.

• If a deal can be concluded, it would also signal that Japan has made further progress in dismantling its prior protective, inflexible business culture and regulatory approach.
• To date, the progress on that front has already helped make Japan a darling of stock investors in recent years. If the proposed Seven & i deal is successful, it could unlock even more value in Japanese stocks.

Australia: The minutes of the Reserve Bank of Australia’s latest policy meeting, which were released today, showed that the central bank has ruled out any interest-rate cuts in the near term due to continued price pressures. With the Bank of Japan starting to hike rates and the RBA holding them steady, that makes the two Asia-Pacific central banks the most important holdouts against the broader trend toward rate cuts in major developed economies.

China: The Shanghai and Shenzhen stock markets yesterday said they have cut the amount of data they will provide on foreign inflows into onshore shares, apparently to reduce the influence of foreign capital flows on the domestic markets. The move, which was likely made under pressure from Beijing, is another example of government intrusion into China’s private markets, which we think is one reason for China’s recent slowdown in economic growth.

Israel-Hamas Conflict: Hamas and Palestinian Islamic Jihad said they were responsible for an attempted suicide bombing in Tel Aviv yesterday. The bomb detonated early, killing the attacker and slightly injuring just one bystander. Nevertheless, as Israel continues pummeling Gaza to destroy its Hamas-led government, the attack may signal that the Palestinians are shifting tactics back to the frequent suicide bombings that rocked Israel in the early 2000s. If successful, such tactics could leave Israel with prolonged security issues, even if Hamas is routed in Gaza.

Sweden: Citing “somewhat” weaker economic growth and roughly on-target consumer price inflation, the Riksbank today cut its benchmark short-term interest rate by 25 basis points to 3.50%. The central bank also signaled it will probably cut rates two or three more times before the end of the year if the inflation outlook doesn’t worsen again. The move reflects the broad trend toward lower interest rates in key economies around the world (excluding Japan and Australia, as mentioned above).

Canada: Ahead of a railroad strike that could be launched as soon as Thursday, global shipping giant A. P. Moller-Maersk said it will stop taking orders for Canada-bound cargoes that would have to be transferred to rail transport. More broadly, the threatened strike could significantly disrupt the operations of companies across North America, given how intertwined the US and Canadian economies are.

US Tax Policy: As the Democratic Party opened its national convention in Chicago yesterday, Vice President Harris’s campaign office said she now endorses hiking the maximum corporate income tax rate to 28% from today’s 21%. The proposal sharpens the contrast between Harris and Republican nominee Donald Trump, who has proposed cutting the rate to 15%.

US Dollar: The greenback weakened against a key basket of currencies again today, leaving the widely followed US Dollar Index down 4.1% from its most recent high in May and basically right where it was at the start of the year.

• The index is still historically high after the dollar’s long bull market that began more than a decade ago, but it has been stuck in a range between about 106 and 100 since the beginning of 2023.
• If the prospect of falling US interest rates now pushes the index below 100, it could potentially signal a longer-term downtrend for the greenback.
• Any potential bear market in the greenback would likely be positive for international stocks going forward.

(Source: Wall Street Journal)

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