The week ahead: digesting Jackson Hole, waiting for payrolls and Nvidia loses its shine

What a difference a day makes. Analyst chatter prior to the Jackson Hole symposium had been about soft landings and the ability of the global financial system to withstand higher interest rates, as the rally in stock markets in 2023 was proving. However, after Fed chair Jerome Powell’s keynote speech on Friday, the talk has turned to hard landings. Bond giant Pimco has said that markets are too optimistic about the global economy, and they are now expecting a recession due to ongoing interest rate increases. The question now is whether this pessimism is justified and what markets will do next.

 Of course, whenever a fund manager speaks it’s always worth interrogating what they have to say. Pimco – the largest active bond fund manager in the world – is obviously going to try and talk down stocks, to attract more people to bonds, which tend to outperform when the economy is in trouble. Added to this, stocks managed to rally on Friday, even though Jerome Powell warned that it was too early to declare the fight against inflation over and said that the Fed would not hesitate to raise interest rates in future if it was warranted. However, there is no doubt that cracks in market sentiment are appearing.

When investors punish good earnings reports

The first sign of a shift in the winds as we move towards Autumn, is the market reaction to Q2 earnings season. Out of the 84% of companies listed on the S&P 500 who have reported earnings for the second quarter, 79% have reported EPS above expectations, which is above both the 5 and 10-year averages. Added to this, earnings beats have exceeded expectations by an average of 7.2%, which is below the 5-year average, but above the 10-year average. With earnings beating 10-year averages, one would expect the market reaction to be positive, however, this is not the case. Instead, companies that have reported positive earnings surprises, have seen their share prices fall by an average of 0.5% over the two days after their earnings release. This is a much worse reaction than usual, and if this stands then it would be the largest average decline in share prices on the back of positive earnings surprises since Q2 2011. As FactSet point out, after EV maker Tesla reported earnings above analyst estimates, its share price tumbled more than 10.5% between July 17-21. The reason why this is happening is not, at first sight, apparent. For example, earnings guidance from S&P 500 companies is no more negative than usual and out of the companies that reported Q2 earnings who also gave future guidance on their earnings, 49 out of 79 issued negative guidance, which is between the 5 and 10-year averages. Instead, it suggests that sentiment could be sapping from financial markets, and it is also a sign that the end of a tightening cycle is tougher for financial markets than the middle of it.

Rate cuts could be elusive

Sentiment is unlikely to pick up after the Jackson Hole symposium. Although 10-year Treasury yields have fallen in the past week, down from 4.3% to 4.23%, 10-year Treasury yields remain elevated. Added to this, the decline in 10-year yields is largely due to a repricing of near-term interest rate expectations. There is now a 54% chance of rates rising again in the US between now and the end of 2023, up from 32% a week earlier. Likewise, expectations have receded that rates will fall in the coming year, there is now only a 62% chance that rates will fall by June 2024, down from an 83% probability last week. Thus, as we get into the last days of summer, the sands are shifting, and this could impact market sentiment as we move into September.

As David Smith mention in the Sunday Times this week, one theme we may all be digesting as we move into the Autumn is weather inflation targets for the world’s largest central banks should move higher from 2%, to, say, 3%. This is unlikely to happen in the near term as raising the inflation target now would dent the credibility of central bankers as they try to fight inflation, it would also increase the government’s debt load and would erase 30 years of trying to bring the inflation target down. The UK’s inflation targets in the 1990s was between 1-4%! The ONS has mentioned that the underlying trend for all inflation across the UK economy since 2002 was 2.75% - which is closer to 3%. Thus, a 3% inflation target could be coming, but not right now.

What to watch this week

Looking ahead, the market will be watching some key data as we enter September, an historically stormy month for equities. US non-farm payrolls are released for August on Friday, along with PCE data for the US on Thursday. If both come in hotter than expected, then it could revive concerns about inflation, like those raised by global central bankers at the Jackson Hole symposium. The focus will mostly be on the US in the coming week; however, it is also worth watching German CPI to see if the rise in oil and gas prices adds upward pressure to its CPI reading.

Nvidia’s puzzling decision

Elsewhere, we will be watching how Nvidia’s stock price performs this week, after it took the market by surprise and announced a $25bn share buyback. This comes after its stock price tripled this year and it announced another stellar quarter of earnings. Its share price rose to a fresh record at one point on Thursday, before paring its gains and it closed down more than 2% on Friday. Added to this, the share buyback comes at an interesting time. Usually, companies announce a share buyback when its stock price is cheap, however, Nvidia’s forward P/E ratio is far from cheap at more than 46x earnings. Without the forward adjustment It is over 100 x earnings. Thus, Nvidia has made its stock more expensive, and thus less attractive to the broader market. This decision is puzzling, and one that could weigh on the stock price as we move through September.