This is one of the biggest weeks of the season. More than 150 S&P 500 companies report, four of the Mag 7 are among them, and the Fed meets alongside a fresh PCE inflation reading. The Mag 7 earnings matter, but they take second place to the FOMC meeting.
A Fed meeting with no clear answer
Markets put a 40% chance on a rate hike and a 60% chance on no move. That is unusual. By the week of a meeting, traders normally feel almost certain what the Fed will do. This time the outcome is a real unknown, and markets dislike unknowns. Anything uncertain tends to weigh on prices.
For years the outcome was basically pre-announced. Using the Fed Watch tool, the odds sat near 98% one way before meetings. That old system had a flaw: if new information in the final week made the Fed want to change course, it was boxed in. Officials felt handcuffed and could not disrupt a market that had already priced 98% one way. Under the new approach, the Fed can weigh data right up until it pulls the lever. That is a good thing, though only by a small margin, and it will take a lot of getting used to. We are not comfortable walking into a meeting without knowing the decision.
Is the new, uncertain setup healthier for markets long term? Yes, but barely. Markets like certainty, so the trade-off is more volatility.
My base case is no hike. The Fed chair looks competent. Hiking against inflation driven by a single-factor supply shock is not historically the right move; inaction is the better choice. Crude oil falling five or six dollars today gives him room to take a breath and hold. Oddly, the hike odds did not drop despite that oil move, so the market seems to be hedging against a possibility I doubt will happen. I don't think they tighten at all this cycle. The odds held firm near 38% through the weekend.
The rotation and extreme concentration
A rotation out of the Mag 7 has run since May. Back then the Mag 7 made up 35% of the S&P 500's market value; now it is about 31%. Rotations and broadenings are healthy, but in the short term they get clumsy and messy. Even so, the Nasdaq falling while the S&P holds is a good sign. Given how extreme the concentration is, this unwinding is unlikely to happen without some damage to the downside.
For perspective, before this period the most market value the top seven U.S. stocks ever held was 26%, reached in 1980 and again in 2001. In 2001 it ended badly. The peak this cycle was 35%, and we sit at 31% now, so there is room for disruption over the next couple of months, and it will happen.
Alphabet: the canary in the coal mine
Alphabet reported a great quarter: cloud revenue up 82%, total revenue up 20%, strong numbers. The market expected higher capex spending, yet the stock was punished anyway. The disconnect comes from mania. In any AI-style mania, prices rise until they don't. The fundamental story has not changed; what changed is that pricing and positioning got extreme.
I think Alphabet probably was the canary in the coal mine marking the beginning of the end of the all-things-AI trade. I would not slide all my chips onto that, but it points to the market saying: after three years, at some point it is put up or shut up, not just spend. And they have spent heavily. Larry Page reportedly said he would rather go bankrupt than lose the AI race, an all-in stance. I don't like that kind of talk. I hold a large, heavily hedged position in Google and don't want to hear my biggest single position described as heading for bankruptcy. Mania by definition is insane, and we don't want our CEOs swept up in it. We want calm heads.
Tone now moves stocks more than numbers
Earnings reactions have come to hinge on the tone of management and CEO commentary far more than anything in the actual financial statements. It is now about how well media-trained management is. That is a strange time to live in. Still, I want CEOs to express caution. IBM lost 25% in a single day. Established names like Micron and AMD ran up something like 300% in six to eight weeks. Those are crazy conditions. IBM's caution went too far and the market did not reward it, but tempering expectations is the right approach for CEOs now.
Where the broadening goes next
If Alphabet did start the dominoes, the next phase moves away from the makers of the "picks and shovels" that build AI, which are already bid up. The question becomes: who uses AI inside their own sector to become more productive and efficient? About two months ago we called for the broadening to flow into healthcare and banks, and so far that has worked. Healthcare has been the top pick. Coming Mag 7 earnings this week will show whether Alphabet was the first domino to fall.
