Stagflation Ahead? | Seeking Alpha

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The big news this week was the hawkish Fed announcement, which brings up worst-case scenario fear for the market, stagflation (0:50). Moving into AI 2.0, Broadcom as an example (7:00). Home improvement retailers slide; housing in the crosshairs (11:05).

Transcript

Rena Sherbill: Brian Stewart, our fearless Director of News at Seeking Alpha, welcome back to Wall Street Breakfast. Great to have you on.

Brian Stewart: Thanks. Great to be on again.

RS: Here we are, the last show of 2024, we’re heading into the holiday season, we’re heading into the New Year, lots of quiet. Hopefully, everybody is doing something that makes them feel content towards the end of the year and the beginning of a new one.

We had some news this week that also taps into that energy of seeing what 2024 was all about and also giving a sense of what 2025 is about. Perhaps for those that have guessed already, I’m talking about the Fed meeting and what they warned us or highlighted for what may be coming, what likely is coming, less rate cuts in 2025. Give us kind of the highlights of that meeting and how you’re digesting it as a news guy.

BS: Yeah. So the big news this week, like you’re saying, is the Fed announcement. And it wasn’t so much what they did or said in the particular announcement, it’s more kind of the projections for 2025. So they cut rates by 0.25 point, which was widely expected by the time that the decision came around, but their view for 2025 which seems much more hawkish than the market had kind of predicted.

The Fed upgraded its inflation expectations for 2025 and 2026 and also reduced the number of projected cuts that they would do next year. This brings up kind of the worst-case scenario fear for the market, which is stagflation, kind of going back to that situation in the 1970s and 1980s where you had elevated inflation and a stagnant economy. So you’re kind of getting the worst of both worlds.

And the market, the way things are now, I mean, inflation is just over 3% on the core CPI. Interest rates right now, it’s still above 4%. So it’s not exactly the dark days of the late ‘70s. So we’re not really going back to disco divas and leisure suits just yet, but there is a fear of kind of a mini stagflation on the horizon.

RS: What’s your sense of the reasoning behind making that announcement at the year-end?

BS: Well, what’s interesting about sort of the market’s relationship with the Fed recently it’s been bouncing around a lot.

If you go back to late September and look at how markets were viewing the Fed at that point. At that point, they were pricing in a 100% chance that rates would be lower than they are now, and that’s at the end of the January 29th meeting.

So even at that point, there was a 10% chance that there would be a full percentage point lower than the current levels by the end of the January 29th meeting. So a very aggressive cutting spree was sort of priced in at that point. And then if you fast-forward to November 22, so about a month ago at this point, at that point, there was a 37% chance that there would be no rate cuts either in December or January.

So not only not getting the rate cut that we don’t expect to happen in January, but also not getting the one that just happened in December. So if we go from that November 22nd point, markets have been bouncing around a lot in their Fed expectations.

However, the market has not been bouncing around a lot. Therefore, we’ve been able to kind of internalize that debate about the market and keep it separate from the sort of buying and selling that the market has had.

RS: Although we have seen some choppiness in the past couple of days subsequent to this meeting, how do you contextualize that?

BS: One of the interesting points about the market reaction has been – and we talked about this a couple of weeks ago, where there was a bifurcation forming between tech stocks and kind of the blue-chip industrial stocks. And that’s only become more aggressive kind of going into the Fed meeting. After the Fed, all markets were down. So it was kind of everybody was in the same boat at that point.

But going into that, the NASDAQ Composite Index (COMP:IND) had risen about 6% from November 22nd to its close on December 16th, so in sort of the preparation for the Fed meeting. About that same time, the S&P 500 Index (SP500) was up only about 2%, so a third of the increase that the NASDAQ had, but then the Dow Jones Industrial Average Index (DJI) was down about 1%.

And then going into Thursday’s trading, the Dow had declined 10 days in a row, which is the longest losing streak since 1974, and it was down 11 out of 13 days.

So you can see sort of the processing that people are doing. They’re much more willing to kind of see the glass half full for tech stocks, and they’re much more glass half empty for the rest of the market.

RS: Anything you want to add to the conversation about interest rates or how investors should be thinking about this kind of marinating on what 2025 may or may not look like. Anything else to add to this part of the conversation?

BS: Yeah, one interesting aspect to keep in mind, especially as investors kind of weigh the stagflation concerns, interest rates are high now compared to what they’ve been in the last couple of decades, so for the 21st century, basically. But if you take a longer view of interest rates over, say the past 100 years or whatever, they’re actually pretty low.

So during the late ‘90s, during the entire sort of dot-com tech run-up, interest rates were higher than they are now. And that was considered a pretty loose Fed at the time that Fed got criticism after the dot-com bubble burst that they were sort of too encouraging of money was too loose at that time. But for that entire period, it was higher than the rates are now, and it peaked at 6.5% in mid-2000.

And even up till mid-2006, going into the housing crisis and the Fed’s reaction to the financial crisis that happened in 2007, 2008, interest rates were at 5.25%, which is higher. The Fed’s target rate was 5.25%, which is higher than the rate that we currently have. That’s a point of controversy.

And so the rates that we’ve had for the last 20 years or so are sort of the result of the financial crisis number one and then COVID number two. And so it’s been a strange couple of decades. And I know it’s weird to talk about two decades being a strange period.

But I think investors should kind of get used to the fact that we might be higher for longer and even higher forever kind of thing, just because we might be just getting back to a normal rate environment that we had for most of the 20th century.

RS: Given that context in color, where would you say investors should be focused stock-wise? Like what makes the most sense in terms of what stocks may have an advantage over others or what stocks may be signal makers for the interest rate conversation?

BS: The sort of tech industrial split, I think is going to continue. When you talk about the markets, we often talk about fear and greed as being the main drivers. You can also reframe that as optimism versus skepticism.

And so every stock is kind of telling a story and kind of making a prediction about what their future growth might be if conditions are this or that. And investors kind of come to that either with the feeling that they’re going to believe that story or that they’re skeptical of that story.

And I think that the market has proven that it’s much more optimistic about the story tech stocks are telling and much more skeptical about the overall sort of economic picture.

And so I think that we’re moving into the AI market 2.0. I mean, one example of that just over the last week is Broadcom Inc. (AVGO), which is up 20% over the past week, jumped following its earnings. Investors were excited about the custom AI potential that was sort of highlighted in that earnings report.

Meanwhile, at the same time, NVIDIA Corporation (NVDA) was down about 7% for the week. And this wasn’t just sort of an outsized reaction to the Fed. NVIDIA kind of dribbled down 1%, 2% every day during the week. It’s been down 10 out of the last 11 sessions. And so it’s fallen about 11% over that time period.

So I think in that context when you look at Broadcom’s jump and NVIDIA’s sort of drift lower, I think what you’re seeing is kind of a rotation within tech away from the sort of dominant names in the early part of the AI revolution to looking for like, who’s next?

Like if we go with the concept that NVIDIA can’t hold the market share that it’s had going forward in the face of stiff competition, who are going to be the winners as that kind of pulls back to kind of a normalized situation.

RS: And what does Broadcom represent? What is the next-gen of this AI play? What is it that they’re representing?

BS: Well, another kind of interesting point about Broadcom is it’s not like a startup that’s come out of nowhere. I mean, it’s an established company, much like NVIDIA. I mean, NVIDIA has been around forever, and it was just sort of well-situated to take advantage of the picks and shovels kind of investing thesis for AI providing the semiconductors for that.

And so it’s interesting that the AI conversation is still sort of centered on the ways in which established large-cap tech companies can take advantage of AI as opposed to in kind of a previous sort of tech excitement eras, the dot-com or whatever, whereas startups were really the focus of that.

So we’re still looking at investors watching the mature companies for which ones are kind of well-situated and have positioned themselves to take advantage of the boom. And I think going forward, when you look to ‘25, ‘26, keep an eye on the IPO market, keep an eye on whether some of those more kind of aggressive startups start to move into the market.

RS: And what would you say is the kind of turning point that happened that makes the picks and shovels the play right now?

BS: I think it has to do with a lack of visibility on the sort of customer-facing part of it. I mean, if a company like OpenAI ever came public, I think, that would sop up a lot of the money that’s otherwise going to the semiconductors and things like that. There just isn’t a lot of opportunity right now to invest in kind of the direct AI effect, and you’re more investing in the process by which AI is going to be picked up by most companies.

RS: A company that disappointed in that regard this week, speaking of their guidance was Adobe Inc. (ADBE). Care to offer any color on that or thoughts on what’s going on with Adobe and how analysts are taking it?

BS: I think investors should take that as kind of a warning that AI giveth and AI taketh away. You can – if you get a bad earnings report on a company that’s gotten some AI buzz, then there’s room for a big haircut. So you have to be kind of careful with these sorts of volatile moments.

RS: Something that we talked about last week that we had to look forward to this past week was the home stocks. Anything to say there or any kind of messages that they offered investors?

BS: One interesting aspect of the Fed decision and the reaction to the market. One of the big losers in that was the home improvement retailers, so Lowe’s Companies, Inc. (LOW) and The Home Depot, Inc. (HD) were both down about 7% on that news.

And the housing market is sort of in the crosshairs for any kind of high interest rate environment because it makes it hard to buy and sell homes when interest rates are too high.

Next week, there’s not a lot of data coming out. There’s practically no earnings reports and there’s just a kind of a smattering of econ, but among the econ reports that are coming out relate to the housing market.

In the holiday-shortened week, one of the data points that investors will have to chew on is the health of the homebuilding sector.

RS: Anything else to highlight from this past week worth paying attention to?

BS: No, I think people have already kind of turned the page to the holidays. Next week is a holiday, a shortened week, and the week after is a holiday, a shortened week. So there are not a lot of catalysts on the way in the next couple of weeks. The next earnings season doesn’t start until kind of the second half of January.

So the only data that’s on the radar, we got the econ that’s coming in January to kind of look back at December. So that’ll be important in terms of kind of rate setting. But I think the debate around interest rates is going to be ongoing over the next few weeks. We’re probably going to start getting Fed speakers coming out in the near term setting market expectations.

And then the only other thing I would say is warning investors that given the lack of participation in the next couple of weeks and the lack of catalysts that there’s probably not a lot to be learned from market activity over the next couple of weeks. There’s going to be a lot of noise, a lot of money managers sort of setting portfolios to close out the year.

And so I don’t know how much long-term information you’re going to be able to glean from where the market moves day-to-day over the next couple of weeks.

RS: We have some quiet days ahead.

BS: Yeah. That’s nice for everybody.

RS: I think so too. A little repose, a little reflection, some quiet time. Brian, always appreciate your insights. Like I said at the top, we’re off for a couple of weeks. Speaking of quiet periods, very much look forward to talking to you again in 2025. Thank you, everybody, for listening. Happy holidays. Happy New Year.