Looking to the Futures

The NASDAQ 100 index (NDX) suffered its biggest decline in over one year Wednesday. It sold off through the trading day after earnings from tech bellwethers Alphabet (GOOG, GOOGL, -5%) and Tesla (TSLA, -12%) disappointed traders. The drop represented a steepening of a trend that started two weeks ago 

That trend started in earnest on July 11^th, a day after the index notched its all-time high of 20,690. Since then, it has lost over 8%. The beginning of the selloff coincided with the inflation report, which kicked off a rotation from mega-cap tech to a broader marketplace of smaller names; over the same timeframe, the small-cap Russell 2000 index (RUT) is up over 7%. Monthly inflation unexpectedly fell for the first time since January 2023.

The inflation print for June came in at -0.1% versus expectations of a 0.1% increase. Core CPI was also lower than expected. Those numbers have increased expectations of the Fed cutting rates in September. The CME FedWatch Tool now reflects 100% certainty of a rate cut based on 30-Day Fed Funds futures prices (/ZQ). A month ago, the chart reflected a 2-in-3 chance of a cut. The September probability chart now only reflects uncertainty of the magnitude of the cut, with an 86% chance for 25 basis points and 14% for 50 basis points.

Expectations of a rate cut would tend to provide a lift to small caps and a headwind for large caps for two related reasons. For small caps, they tend to have lower credit ratings on their debt, so financing tends to be more expensive. Also, about 40% of their debt is floating rate, which is often indexed to the Fed Funds rate. For the S&P 500, only 9% of corporate debt is floating rate. Large caps can also have massive cash hoards, where they can earn the risk-free rate on treasuries (IRX:CGI). Berkshire Hathaway (BRK/B) had $189 billion in cash at the end of the first quarter. With interest rates over 5%, that cash would generate over $9 billion a year, enough to purchase ten companies in the Russell 2000 at the median market cap of $900 million.

While well-capitalized large-cap tech stocks have had a rough go of the past two weeks, their ability to weather difficult economic conditions could benefit them relative to smaller firms if the Fed’s “soft landing” gets extended. That looks slightly less likely given Thursday’s economic data. Preliminary GDP topped expectations at 2.8% versus 2.0% expected, while the preliminary price index for gross domestic purchases increased 2.3%, below consensus estimates of a 2.6% increase. Looking at the bigger picture, the NASDAQ-100 is still up about 14% year-to-date while the Russell 2000 is up approximately 11%.

The beginning of the breakdown two weeks ago took the contract below its 9- and 20-day simple moving averages. Wednesday’s decline sent it below the 50-day SMA. The MACD has been negative since the downturn began and is at its lowest level this year. Over that time, the RSI declined from significantly overbought at 79 to 36. A further decline to 30 or below would take it oversold levels and could indicate selling exhaustion.

Friday July 26, 2024

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