Stocks Largely Erase Early Week Losses

Key Takeaways

• S&P 500 Momentum Turns Positive Amid AI Market Corrections
• Upcoming Earnings And Economic Reports Could Spark Market Volatility
• AI Hype Meets Reality As Investors Seek Tangible Earnings Growth

Stocks rallied broadly across all sectors on Thursday. The Nasdaq Composite gained 2.9%. The Russell 2000 jumped 2.4% and Dow Jones Industrial Average added 1.76%. The S&P 500 was also up 2.3% and is now down just 0.5% for the week, despite the massive swings in volatility. Speaking of volatility, the VIX fell nearly 15%, closing just below 24.

One key indicator for markets has turned back to being positive. 54% of stocks in the S&P 500 are trading above their 50-day moving average. That number had fallen as low as 42% on Monday. That suggests short-term momentum has turned positive for most stocks. Granted, I would like to see the number higher, but for now, 54% means the majority of stocks in the S&P have regained positive momentum.

Much of the selling earlier this week was attributed to the unwinding of the so-called carry trade and specifically, the Yen carry trade. The basic premise of how a carry trade works is, traders borrow money in a currency where interest rates are low (or in this case, zero). They then use that money to buy other assets. The idea is sound until interest rates increase. When Japan increased their rates, suddenly borrowing in Yen was no longer free and in order to pay back the borrowed Yen, traders had to first sell the assets they’d accumulated. While I do believe that was a part of the selling and perhaps the proverbial straw that broke the camel’s back, I don’t think that was the only explanation, especially since the Bank of Japan has been signaling for quite some time they intended to raise interest rates. I think there was another factor that compounded the selling and much of it related to AI (Artificial Intelligence).

I have talked at length about the concentration risk in the market. Much of that risk developed as a result of enthusiasm over the potential of AI. Nvidia and Microsoft saw massive runs in their stock prices. Just as recently as a couple months ago when Apple announced their Apple Intelligence, we saw that stock surge. Alphabet, Amazon, Tesla and other stocks all made mention of the significant investment in AI and each time these companies said that, their stock was rewarded. My concern has been how these companies plan to monetize AI and when that question was put to Alphabet at the start of earnings season, AI had its Wyle Coyote moment and realized it had run off the side of the cliff.

While I do think AI has potential to be revolutionary, I thought the same of things like the internet. But as we saw in the 90s, valuations can get out of hand over potential. At the end of the day, stocks are driven by earnings and while potential is great, getting out ahead of yourself over potential can lead to disappointment. Just ask any team that’s drafted a first overall NFL pick.

One of the more interesting aspects of this week is that there wasn’t much in the way of economic data or earnings. That will change over the next couple weeks as a host of household name companies report earnings and important economic reports are released. On the earnings front for next week, Home Depot will report Tuesday. Cisco Systems reports on Wednesday. Then on Thursday, Alibaba, Walmart and Applied Materials all report. I am especially interested in what Home Depot and Walmart have to say with respect to consumer spending. We’ve already heard this week from both Airbnb and Expedia about concerns over moderating levels of consumer spending.

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Turning to economic reports scheduled for next week, on Tuesday we’ll get the latest Producer Price Index which will be followed on Wednesday by the Consumer Price Index. Then on Thursday, Retail Sales come out, followed by Consumer Sentiment on Friday. It was just a short while ago a weak economic report was viewed as a positive development if you were hoping for an interest rate cut. However, as I have said before, interest rate cuts tend to happen when economic conditions are deteriorating. The latest reports we’ve received have been weak, but instead of continued enthusiasm over a rate cut, investors are realizing a weak economy is bad for business. Therefore, the market sensitivity to these upcoming releases could be high.

For today, I am expecting a relatively quiet day. It was a long week by Monday afternoon and I get the sense everyone is tired. I would not be surprised to see a more subdued day. However, with concerns over the economy mounting and a number of consumer dependent companies reporting earnings, we could be back in store for more volatile trading next week. As always, I would stick with your investing plan and long term objectives.

tastytrade, Inc. commentary for educational purposes only. This content is not, nor is intended to be, trading or investment advice or a recommendation that any investment product or strategy is suitable for any person.