What Could Possibly Go Wrong with This Market?
The S&P 500 hit several new all-time highs last week and rose each day of last week as the current positive cocktail of stable growth (jobless claims/flash PMIs were solid), improved trade clarity (the U.S./Japan trade deal and anticipation of a similar deal with the EU before the Aug. 1 deadline), legislative clarity (no real drama looming from Washington), solid start to Q2 earnings and rate cut expectations powered stocks modestly higher and the S&P 500 to new highs.
This positive combination has caused investor sentiment to get more bullish. But while there’s undeniably a positive setup for stocks right now, I believe it’s always important to look at the other side of the trade and specifically what could go wrong. So, I have identified four candidates, from most likely to least likely, that could upset the current positive mantra.
What Could Go Wrong Candidate 1: Not-As-Good-As Hoped AI Earnings.AI enthusiasm has been an important (probably the most important) driver of this rally. But AI-related earnings so far, while good, aren’t meeting lofty expectations and since tech is such a big weighting in the S&P 500, underwhelming tech earnings could cause this rally to pause.
Last week, NXPI and GOOGL earnings were “fine,” but neither were as good as expected, while INTC did little to alter the negative perception of that stock that it’s missing the AI revolution. This week, we get earnings from STX (Tues), META & MSFT (Wed) and AAPL & AMZN (Thurs). If those earnings don’t meet lofty expectations, tech could give back some of this torrid rally and the rest of the market could follow. Earnings are the principal reason I remain 25% in bonds in many of my managed accounts.
What Could Go Wrong Candidate 2: Economic growth disappoints.Economic growth recently has pushed back hard against the idea tariffs will cause an economic slowdown and that’s underwriting these high valuations. If this week’s jobs report or ISM Manufacturing PMI, or next week’s ISM Services PMI misses expectations and calls into question economic growth, it will break this currently bullish mantra.
What Could Go Wrong Candidate 3: A September Fed rate cut is put in doubt. Expectations for two rate cuts this year have been a solid contributor to the rally off the April lows. However, if Powell throws cold water on a September hike at this week’s meeting (which he could because there is some evidence of tariff-driven inflation), then Treasury yields will rise and could break this currently bullish mantra.
What Could Go Wrong Candidate 4: Tariffs are higher than expected. The U.S/EU trade deal further reinforces that most tariffs will be around 15% - 20%, but will they stay there given the opaque nature of these trade “deals.” The market is also assuming that 15% tariffs won’t cause an economic slowdown or delay rate hikes. But if Aug. 1 arrives and tariffs are higher than expected (or they keep rising), then that could jeopardize TACO and break this bullish mantra.
Bottom line, the outlook for the market is positive as some trade clarity, solid growth, good earnings and looming rate cuts are fueling a shift from the “intrinsic growth” rally of June (which was led by tech) to a “Trumponomics euphoria”-type market that’s led by cyclical sectors, consumer sectors and YTD laggards (e.g., the Russell 2000). But we must remember that this entire rally is based on the assumption that just because something hasn’t happened yet, it won’t happen at all. While that can be true, it’s not a guarantee. So, we will remain vigilant to what could go wrong with this market, so we’re not blindsided by volatility and don’t give back these strong gains.