Two Pain Points: $100 Oil and a 5% 10-Year Yield
Crude near $100 and the 10-year Treasury yield at 5% have converged, and both hurt stocks. Equities have been under pressure for the last couple of weeks. Higher oil cuts consumer buying power and puts a shadow over the consumer. Retail sales data comes tomorrow.
High yields also create competition for stocks. They squash future earnings expectations and lower the value of discounted cash flows that come back over time. The mix has shifted sector flows: money has gone into energy, healthcare, and financials, with little going into tech lately. That hurt the large tech names and pressured the whole market.
Global Yields Rising, Central Banks Hiking
Yields are climbing worldwide, hitting levels in Asia and Europe not seen since the late 1990s and early 2000s. Drivers: the persistent Middle East conflict and new attacks, fewer buffers than earlier this year, China raising its oil imports again, and rising inflation pressures.
Last week the ECB raised rates; Christine Lagarde called a hike a "no-brainer." This week the Fed and the Bank of Japan are likely to raise rates, and both may speed up the pace. The BOJ has moved about twice a year and markets now expect a quarterly pace.
Markets have mostly shrugged off higher rates because earnings keep getting revised higher. If the pace of the AI buildout slows, earnings estimates are at risk.
The ECB is done, the Fed is expected to hike tomorrow, and a BOJ hike looks baked in. The Bank of England was the only outlier, but markets are now pricing multiple BOE hikes into 2027, which moved the bond market.
Tech Splits: Chips Versus Software
The semiconductor-versus-software spread hit a record 11.3%. Tech can no longer be treated as one block. Software and chips have been moving against each other. Software and the hyperscalers rallied on the idea of a slowdown in chip demand, or at least weaker chip and memory pricing power - which is likely why chips were hit hard.
Tech has not led for a while, though there are pockets of strength inside it. The indexes have not dropped much, but the churn below the surface has been deep. It was a violent, aggressive rotation.
Europe as a Diversifier
Europe is a possible way to diversify away from the AI trade. Its index has only a 10% weight in tech. Economic data has surprised to the upside, earnings have been revised higher, and earnings grew 24% in the second quarter, with double-digit growth expected in the coming quarters. Europe's banks are in strong shape and lending. Free cash flow is strong; the free cash flow yield in Europe is almost double the US rate. That gives European companies cash for buybacks and dividends, which is less true in the US now because the hyperscalers are spending their cash on the AI buildout.
What Matters at the Fed Meeting
The Fed is the main event. The 25 basis point hike itself is well documented and expected, so it is not the key point. What matters is whether there is dissent: Waller argues these are supply shocks and the Fed should wait them out, while the other side says the trend is moving the wrong way and the Fed should get in front of it now. The other question is how the market prices future hikes - one, two, or three. Right now three hikes are priced through the start of 2027. The dot plot and the meeting language could change that. The feeling is that the "insurance cuts" added to the market over the last few years will now be unwound.
Charles Schwab (SCHW) provided this outlook.
