Summary
- The good news is the Federal Reserve (Fed) has all but promised to deliver three rate cuts in 2024 even if inflation remains slow to drop.
- The bad news is this was already priced into the market. With the 2Y Treasury yield still trading above 4.5%, there is little visibility now on whether or when further cuts might be coming.
- Micron Technologies stock soared 20% and Accenture tanked 10% on upbeat and downbeat earnings reports, respectively.
- This highlights the yawning gap between companies producing hardware to build out AI infrastructure and those that hope to capitalize on that capacity with software and AI apps.
- Only 15 companies report this week. Cruise operator Carnival Corp. is the headliner with a key report on whether demand for cruise experiences is softening. Cintas Corp. and Paychex will provide useful colour on how busy and optimistic industrial America is.
Market Implications
- We expect equities to trade in a narrow range and perhaps grind higher for now.
What We Learned Last Week
The Fed Delivers
The Fed certainly knows how to keep markets off-balance. Usually, it dampens down hopes and expectations. However, last week it threw a change-up and all but assured markets that three rate cuts are in the cards for 2024.
This was largely priced in, with the 2Y Treasury yield recently trading near 4.5-4.7%. But the uncertainty band has tightened, with the VIX index of equity volatility dropping to 13% after trading in the 14-15% for the past two months.
What does that mean for equities? We think that largely depends on what drives the coming rate cuts. Falling inflation? A slowing economy? Or some combination of election year politics and ‘it is time’?
In the first two cases, initial rate cuts will most likely lead to expectations of further rate cuts. In the last case, we expect rates will be on hold around 4.5% until either inflation eases, the economy slows, or the election outcome justifies further cuts.
Currently, the 2Y Treasury yield clearly signals little likelihood of further rate cuts based on what we know now. It traded in a narrow range after the Fed meeting and did not go below 4.5% (Chart 1).
We expect equities to remain in a tight trading range, perhaps with a bias to grind higher until we get some indication that rate cuts could go further. Equities are a market weight hold for now.
‘Please, Sir, Can I Have Some More Hardware?’
Earnings reports last week provided two new data points confirming out thesis that the AI trade today is mostly about hardware rather than software.
After struggling for the past 1.5 years to cope with soft demand for commodity memory chips, Micron Technologies (MU) announced it is now a full-fledged participant in the AI hardware goldrush. It is now manufacturing high bandwidth memory (HBM) chips that are particularly desirable for AI applications. Its 2024 production is already sold out and much of 2025 production is already spoken for on massive demand from data centers building out capacity for AI processing. MU also posted a large beat on revenue and earnings and offered a two-year outlook well above expectations. Its stock jumped nearly 20% (Chart 2).
Meanwhile, professional services and software vendor Accenture (ACN) missed on revenue and earnings and offered an outlook below analyst projections. ACN has talked up emerging opportunities in AI-related services, but clearly it will take time for those to be realized. ACN stock dropped a sharp 11%.
Bottom line – everyone knows AI is the next big thing. But until the processing capacity is in place, the AI boom will be tilted heavily towards hardware producers rather than software and app developers.
The Week Ahead
Only 15 companies in our Russell 1000 universe report in a holiday-shortened week. The most interesting report will likely be cruise operator Carnival Corp. (CCL). Many consumer-oriented companies have been reporting soft outlooks due to cautious consumers and an uncertain macro-outlook. So far cruise operators have bucked that trend, reporting solid bookings well into 2024.
Cintas Corp. (CTAS), which provides uniforms and safety equipment to industrial companies, will also provide useful colour on how busy industrial America is. And payroll processer Paychex Inc. (PAYX) will highlight whether smaller companies can upgrade their payroll and HR systems.
The media will also likely have some fun chronicling the latest from that ultimate COVID-19 pandemic meme stock GameStop (GME).
Meanwhile, investors will be focusing more on economic data on housing, 4Q GDP, and PCE inflation.
Coming earnings reports:
Tuesday
- GameStop Corp. (GME)
- McCormick & Co. (MCK)
Wednesday
- Carnival Corp. (CCL)
- Cintas Corp. (CTAS)
- Paychex Inc. (PAYX)
