Going into this morning's inflation report, the divergence in the performance of a handful of tech giants and "the rest" of the stock market was at historic extremes.
The market cap weighted S&P 500 was up almost 19% on the year, driven mostly by performance of the tech giants. The equal-weighted S&P was up only a little over 4%. The Russell 2000 (small caps) was up only 2%.
The divergence made sense in the tightening cycle, particularly as the Fed was relentlessly making verbal threats to bring down jobs and demand.
It makes a lot less sense heading into an easing cycle.
But what if the easing cycle gets derailed by an industrial revolution?
If we look at this chart, it appears that concern emerged in mid May.
This above chart shows how the S&P and the Russell have performed since Jerome Powell signaled the end of the tightening cycle last October.
As you can see, the two indices traded tightly for about six months, on the tailwinds of impending interest rate cuts. But in May, the small cap index started trading south, diverging from the S&P 500. And that was despite an inflation number, reported in mid-May, that was favorable for the rate cut outlook.
What happened? Nvidia earnings.
It wasn't just another triple-digit growth quarter for Nvidia. It was the announcement of a "next wave of growth," powered by "a new chip" that was revealed to be already powering the next iteration of ChatGPT, a version that was said would "change the world" (in the words of Sam Altman).
Would this undo the Fed's efforts to slow the economy, and inflation, and force the Fed back into the inflation fighting stance?
The divergence in the chart suggests that was a consideration.
That brings us to this morning.
The June inflation data reported this morning showed a decline in prices from May to June. And it was the first monthly price decline since May of 2020 (the depths of the pandemic lockdown and deep economic contraction).
The year-over-year change came down to 3%.
Of that 3%, two-thirds of it (2.01 percentage points) was auto insurance and rent (Owner's Equivalent Rent). As we know, and the Fed knows, these numbers are lagging features of an inflationary period, and in the case of rents, it's old data – not reflecting the current rent climate (which is deflationary).
So, as we did in my post-CPI note last month, if we adjust the year-over-year change in the headline CPI number, using the pre-pandemic averages for auto insurance and Owner's Equivalent Rent, headline CPI drops to 2.25%.
With this disinflationary data this morning, as you can see in the far right of the above chart, the divergence of the past six weeks closed sharply today.
Now, remember as inflation falls, and with the effective Fed Funds rate at 5.33%, the Fed's policy gets tighter and tighter. That means more and more pressure on the economy, and on employment.
The result?
As for the economy, Q2 is now tracking just 2% growth – half of where the projections started (the green line in the chart below).
That 2% growth, follows 1.4% growth in Q1. So the economy is running at a sub-2% pace in the first half of 2024. That's below historical trend. And that's with historic multi-trillion dollar fiscal tailwinds.
So as the government has slammed down the accelerator, the Fed has simultaneously slammed on the brakes.
With that, the employment data from last Friday shows a rate of change in the rise of unemployment data that's consistent with past recessions.
So, we've gotten all of the debt associated with hyper-aggressive fiscal stimulus over the past four years. We've absorbed the related historic devaluation of purchasing power of our money. But the Fed has throttled the requisite "bang for our (many) bucks." They have given us a fraction of the growth.
If not growth, what has been the beneficiary of the explosion in money supply over the past four years? The stocks of the tech giants, which has fueled the extreme divergence in the chart below, between the blue line (money supply) and the orange line (S&P futures).
With this above chart in mind, we had bearish technical reversal signals in the tech-heavy Nasdaq futures and S&P futures today.
