NVIDIA Soars, but the Market Lags

This week’s article will be slightly abbreviated due to our focus on compiling the latest Quarterly Market Outlook for the year ahead.

Last week was pretty mixed in terms of performance for the broad market. There were two key events that shaped developments: the FOMC minutes and NVDA’s earnings report on Wednesday. Other than those, the market traded in a wait and see pattern and finally settled lower on Friday.

As has been the case over the last few quarters, Nvidia failed to disappoint. It announced earnings and revenue that beat expectations and a 10-1 stock split. While NVDA did soar +10% following its earnings beat, most stocks did not follow. The FOMC minutes revealed little new information, but there was a phrase that apparently created some angst:

“On balance, the staff continued to characterize the system's financial vulnerabilities as notable but raised the assessment of vulnerabilities in asset valuations to elevated, as valuations across a range of markets appeared high relative to risk-adjusted cash flows.”

This sparked a wave of profit taking on Thursday, which was partially reversed on Friday. SPY’s late April rally looks to be running out of steam, but for the moment the bulls remain in charge of the narrative. The 20-DMA crossed above the 50-DMA and the MACD is on a BUY signal short term, offering support right near the current close.

Support climbs to $515 - $524, while upside is unconstrained to $560 (R2, +5.86%).

The MACD signal has returned to more neutral levels, with a possible negative crossover coming up. From a technical perspective, any pullback or consolidation can be used to add equity risk exposure to portfolios as needed. However…

A clash between Growth Expectations and Inflation is coming up

With Q2 Earnings Season mostly wrapped up, there are fairly few catalysts to drive the market for the next couple of months. Since the bear market lows of October ‘22, the market has rallied as a function of valuation expansion, from a P/E ratio of roughly 17.7 to 24.9 currently.

S&P 500 EPS has also recovered somewhat from the Q4’22 lows of 39.61 to 47.79 in Q4’23. However, the valuation expansion was 40%, while the actual earnings growth was only 20.5%. The market is running well ahead of actual results.

Part of the reason why the market continues to rally has to do with expectations of Central Bank support (rate cuts), as the economy and inflation cools. However, EPS Growth expectations and Fed-fueled liquidity due to low inflation are on a head-to-head collision course. Most likely, these two assumptions will become mutually exclusive at one point or another. Something “has to give”.

Apparently, that “something” is the US consumer. Retail sales comprise roughly 40% of Personal Consumption Expenditures (PCE), which is nearly 70% of the GDP calculation. Assessing the trend of Retail Sales helps us understand the much touted “health of the consumer”. While there are many headline stories about the strength of the consumer, retail sales have steadily declined since the first half of 2021. Retail sales tend to lead PCE, suggesting we will see lower inflation and lower economic growth this year.

One of the reasons why consumers are not spending as they used to is tied to their source of income: it’s easy to spend government stimulus paychecks, as was the case in 2021. Later, as interest rates were still fairly low, consumers turned to credit in order to maintain their standard of living.

Now, it seems both of these easy sources of money have run out. Data from the New York Fed suggests there’s little additional debt the average US citizen can afford to take on.

The reduction in spending power will translate into weaker corporate earnings reports, especially for B2C companies. That is why we have pared back exposure to the Consumer Discretionary Sector (XLY) recently.

Several retail companies have recently commented on their customers during their recent earning calls. Their messaging is consistent with the official Retail Sales data: “the consumer is under pressure”.

Our Trading Strategy

The market is being priced for perfection, assuming it will have its cake and eat it too. Eventually, much higher than average EPS growth expectations will conflict with the lower inflation readings necessary to encourage the Fed to cut interest rates. It’s hard to tell right now which will matter more for the market, but it’s clear some growth issues are beginning to appear on the horizon. The market has cheered low inflation data up until now, in a “bad news is good news” type of reaction. Ironically, investors are hoping for a recession in order to get another infusion of monetary accommodation from the Fed.

We need to play this game of musical chairs accordingly. Bulls are clearly in charge of this market across all timeframes. In order to generate positive returns, we need to remain allocated to risk as our process dictates. Dips can be bought. However, there are certain sectors we would avoid, which are more prone to disappointment than others, especially companies directly related to consumers.

Key PCE data, along with Personal Income and Spending will be released on Friday, making this the most important trading day of the week. We are not expecting “hot” readings at this point, but it’s unclear to what extent the market will keep cheering weak economic numbers.

Our Quarterly Market Outlook for Q2 2025 is in the works, and we’ll discuss these issues, as well as key company fundamentals in this comprehensive report to be released soon!

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