Can Tech Stocks Clear the Clouds?

Recently, Federal Reserve Chairman Powell delivered dovish policy signals at Jackson Hole, triggering a rebound in global risk assets. Following the S&P 500 and Nasdaq indices, the Dow Jones Industrial Average reached its first historical high of the year.

Moving forward, markets will focus on the upcoming release of the Fed's preferred inflation indicator - the Personal Consumption Expenditures Price Index. Given that US tariff rates are currently at their highest levels in decades, the future inflation trajectory will significantly impact rate cut prospects and subsequently influence investor risk appetite.

Powell's Stance Softens

Last week's key US economic data primarily centered around Purchasing Managers' Index (PMI) figures, while the market continued monitoring potential changes in the employment landscape.

S&P Global reported that the US August composite PMI preliminary reading reached 55.4, marking a 9-month high. Manufacturing PMI preliminary reading hit 53.3, representing a 39-month peak. The US August S&P Global Services PMI preliminary reading stood at 55.4, a 2-month low.

Regarding labor conditions, following July's disappointing non-farm payrolls, employment market data showed volatility. Initial jobless claims climbed by 11,000 to 235,000 last week, marking the largest increase since late May. Meanwhile, continuing claims rose to 1.972 million, reaching the highest level since November 2021. This preliminarily suggests that layoff risks may be intensifying and adds to signs of labor market weakness. As companies navigate President Trump's protectionist trade policies, the labor market landscape is gradually shifting toward low layoffs and tepid hiring demand.

Facing macroeconomic changes since July, Fed Chairman Powell showed a more accommodative stance in what may be his final Jackson Hole appearance. "In the near term, inflation risks are tilted to the upside while employment risks are tilted to the downside, creating a challenging situation," he further explained. "Given that policy remains in restrictive territory, changes in the baseline outlook and risk balance may necessitate adjustments to our policy stance."

Senior economist Bob Schwartz from Oxford Economics stated that since Powell has prepared markets for a September rate cut, even with the key August employment report still pending, it would be difficult to reverse course. If employment conditions unexpectedly improve, September's rate cut might be hawkish in nature.

According to the CME FedWatch tool, the probability of a 25 basis point rate cut by the Fed in September has risen from around 70% mid-week back to nearly 85%.

Bank of Montreal Chief US Economist Scott Anderson noted: "While some (Federal Open Market Committee) voting members may have already decided on a September rate cut, most are likely still awaiting August employment and inflation reports before making final decisions. We continue to forecast a Fed rate cut in September but lean toward being more cautious than what interest rate futures markets are pricing."

Schwartz explained that despite Powell's hints at rate cuts, this doesn't represent a repeat of last year's 50 basis point reduction. Powell believes the labor market is in balance, and recent weakness doesn't indicate substantial risk, allowing the Fed to "proceed carefully." He further analyzed that unlike other Fed officials, Powell places greater emphasis on the employment mandate, having previously committed not to fall behind the labor market curve. Overall, Powell appears to be paving the way for gradual interest rate normalization.

Can Markets Sustain the Rally?

US stocks experienced initial declines followed by gains last week, with Friday's late session rally, boosted by Powell's speech, recovering all previous losses. The S&P 500 ended its five-day losing streak while the Dow achieved its first closing record this year.

Sector performance showed more gains than losses. Dow Jones market statistics revealed energy as the top performer, gaining 2.8%, with unclear near-term prospects for the Russia-Ukraine conflict pushing oil prices higher. Oil services giant Schlumberger rose over 8% for the week. Real estate followed with a 2.4% gain, while financial and materials sectors each advanced 2.1%, all benefiting from Fed easing expectations. The two declining sectors were technology (-1.6%) and communication services (-0.9%).

Pressure on artificial intelligence-related stocks was the main driver behind last week's market weakness. With indices soaring to historical highs this year, AI trading has been a key market driver. For instance, semiconductor giant Nvidia's stock has risen approximately 30% this year, while AI-focused data and analytics company Palantir has roughly doubled year-to-date. According to LSEG Datastream data, the technology sector's forward 12-month earnings multiple reached around 30 times, the highest level in a year, while tech's share of the S&P 500's overall market capitalization stands at nearly its highest level since 2000.

Notably, recent warning signals include MIT research finding that 95% of companies see no returns on AI investments, and OpenAI CEO Sam Altman's comments that investors might be overly excited about artificial intelligence.

Investors returned to buying tech stocks in late Friday trading, along with small-cap Russell 2000 index and other interest rate-sensitive market segments. Truist Wealth Co-Chief Investment Officer Keith Lerner stated: "Powell conveyed the message the market wanted to hear. That's the bottom line."

In its market outlook, Charles Schwab wrote that Powell's Jackson Hole speech established the foundation for a possible September rate cut, driving market gains. Prior to this, market performance was dragged down by weakness in marquee tech stocks. During the tech selloff, overall market breadth remained relatively stable, indicating investors weren't fleeing the market entirely. Instead, they're seeking new leaders, driving cyclical sectors like industrials, energy, and financials.

The firm believes companies outside the "Magnificent Seven" tech giants are working to catch up. 71% of S&P 500 stocks trade above their 50-day moving averages, while 68% trade above their 200-day moving averages, up 8 percentage points from last week. Given tech stocks' poor performance over the past week, while the Nasdaq lagged, markets appear to have found a new catalyst to drive forward momentum - a "dovish" Federal Reserve. With all major indices' moving averages back above their respective 20-day averages, this provides reason for continued optimism heading into next week.