US stocks surged on Fed rate cut hopes, plus what to watch from Big Tech earnings

Key Concepts

• Market Performance: Dow, S&P 500, NASDAQ, Russell 2000 all showing gains, with NASDAQ and S&P 500 reaching record highs.
• Inflation Data (CPI): Cooler than expected CPI report fuels optimism for Federal Reserve rate cuts.
• Federal Reserve Policy: Discussion around potential rate cuts, with October being a strong possibility, but also caution about future moves.
• Banking Regulations: Fed proposal to increase transparency in bank stress tests.
• Economic Indicators: CPI, labor market anecdotes (layoffs), consumer sentiment, and private sector data are being analyzed.
• Sector Performance: Tech leading gains, with semiconductors and software showing strength. Energy down for the day but strong for the week.
• AI Investment: Debate on AI bubble vs. justified valuations, with concerns about "mini bubbles" in asset-heavy businesses and debt-funded capex.
• US-Canada Trade Relations: President Trump's threat to end trade talks over an anti-tariff ad, with a potential resolution through pausing the ads.
• Government Shutdown: Impact on federal workers, air traffic controllers, and military pay, as well as data availability for the Fed.
• Big Tech Earnings: Upcoming earnings reports from Microsoft, Alphabet, Meta, Apple, and Amazon are crucial for market sentiment.
• Consumer Spending: Stress on lower-income consumers, while high-end consumers are supported by the wealth effect.
• Candy Industry: Inflation impacting candy makers due to rising cocoa prices and other input costs.
• GLP-1 Medications: Potential impact on food consumption patterns, favoring protein and reducing sugar intake.

Market Performance and Inflation Data

The stock market experienced a strong day, with the Dow up 530 points, the S&P 500 up about 1%, and the NASDAQ up about 1.4%. This bullish price action accelerated following the 8:30 a.m. Eastern CPI report, which came in cooler than expected. This data has sparked optimism that the Federal Reserve will continue its rate-cutting path. The Russell 2000 also performed well, up about 1.4%. The bond market saw some seesaw action, but the 10-year Treasury yield was up one basis point to 4.0%, and the 30-year Treasury yield was up one basis point to 4.58%. The US dollar index was flat.

Sector Performance

Technology was the leading sector for the day and the week, up 1.85%. Financials and utilities were also outperforming the S&P 500. Energy, a leader for the week, was down about 1% for the day. Staples, materials, and consumer discretionary were also down. Within the NASDAQ 100, most components were showing gains. The chip index (SOX) was also set for a record high. Notable movers included Nvidia (up 2.5%), Apple (up over 1.5%), and Google (up almost 3%), while Tesla was a mega-cap decliner, down about 3.6%. IBM was highlighted for its strong earnings-driven performance, up 9% over the past five days. Semiconductor stocks like Micron and AMD were up significantly, with AMD hitting record highs. Oracle was a software outlier, down 2% over five days.

Federal Reserve Stress Test Proposal

The Federal Reserve has proposed an update to its stress test process for large banks, aiming to increase transparency. Currently, the models, methodologies, and specific scenarios used in stress tests are not fully disclosed or open for public comment. Vice Chair of Supervision Michelle Bowman believes this lack of transparency can lead to uncertainty for banks in capital planning and potentially misalign capital requirements with actual risks. The proposal would involve disclosing the stress tests and their design in full detail, with an annual option for public input. These stress tests, mandated after the 2008 financial crisis for banks with $100 billion or more in assets, assess a bank's ability to lend during a severe recession. While changes are not expected to significantly alter capital requirements, former Fed head of supervision Michael Barr warned that it could weaken the tests and the banking system. Comments on the proposal are due by next January.

CPI Inflation Data and Economic Outlook

Matthew Martin, Senior US Economist at Oxford Economics, described the CPI print as "slightly cooler than expected" and a "slam dunk" for a rate cut in October. However, he noted that the Fed is more attentive to downside risks in the labor market and that the CPI data might not be a significant "needle mover." Martin pointed to details that could give the Fed pause, such as potential tariff pass-throughs, rising core goods prices (like furniture and apparel, linked to tariffs and the end of de minimis shipping), and increasing food prices at home.

Tally Leger, Chief Market Strategist at The Wealth Consulting Group, expressed less concern about core goods inflation (1.5%), stating that the bulk of inflation pressures are coming from the services side (around 3.5%). He highlighted disinflation from the housing component, with softening home prices and outright deflation in some energy categories (falling oil prices). Leger believes that softer inflation data, coupled with a slowing labor market, keeps the Fed on track for further interest rate cuts, which is "very good for the stock market through the valuation channel."

Regarding the labor market, Neil Dutta's note highlighted anecdotes of layoffs from companies like Amazon, Nestle, Target, and GM. However, Matthew Martin countered that private sector data and state/local unemployment benefits continue to point towards low layoffs, with any spike being related to the government shutdown. He also noted increasing hiring intentions from small businesses (NFIB) and positive gains in the services sector. Martin believes businesses will feel more confident to retain employees due to loosening financial conditions and reduced uncertainty.

Tally Leger anticipates the Fed will be more cautious, looking for further rate cuts in 2026 but a pause after October. He believes there's still momentum in the economy, particularly from high-income households, and that the Fed will view the economy as strong, not wanting to move too quickly to accommodative monetary policy for fear of inflation reaccelerating.

Investment Opportunities and Sector Recommendations

Tally Leger sees opportunity in the gap between S&P 500 sales and private payroll growth, which he believes is a "basic recipe for margin expansion" and a "massive tailwind for earnings." He recommends buying the dips, expecting the market to end the year on a high note. His preferred sectors include pro-cyclical, economy-sensitive sectors like consumer discretionary and financials, as well as technology. He specifically mentioned Nvidia as a stock with strong earnings power and potential, and that semiconductors and software names are still a good story despite some trimming.

US-Canada Trade Tensions

President Trump threatened to terminate trade talks with Canada over an anti-tariff ad run by the Ontario government. This is the third time he has made such a threat, previously over digital service taxes and the Middle East. The market reaction has been muted due to the repeated nature of these threats. The Ontario premier announced a pause on the ads to allow trade talks to resume, but it remains to be seen if this will satisfy President Trump. The larger deadline for US-Canada trade relations is next summer, when the USMCA agreement is set to be renegotiated, with about 85% of goods traveling between the two countries up for negotiation.

Government Shutdown Impact

The government shutdown is entering its fifth week, with significant consequences for federal workers. Today marks a critical point as bi-weekly electronic funds transfers for government employees are zero. This will affect hundreds of thousands of workers. Air traffic controllers will not receive full paychecks next Tuesday, potentially exacerbating existing delays. Military personnel will also face a full paycheck disruption at the end of the month, a first in American history. The shutdown also limits the availability of crucial economic data for the Federal Reserve, forcing them to rely on estimates and private indicators, making policy decisions more challenging.

Big Tech Earnings and AI Debate

Upcoming earnings reports from Microsoft, Alphabet, Meta, Apple, and Amazon are highly anticipated. Investors are focused on valuations and the AI spending boom.

AI Boom vs. Bubble: Gil Laura of DA Davidson believes there is "no bubble" for the companies reporting next week (Microsoft, Amazon, Google, Meta), as their AI capital expenditures are driven by customer demand and long-term contracts. He notes that some "bubbleicious aspects" might emerge from special purpose vehicles and off-balance sheet funding, particularly debt-funded capex by companies like Oracle, Meta, and OpenAI. However, he considers the core investments by the large tech companies to be "prudent."

Drew Pettit, US Equity Strategist at City, defines a bubble as "irrational pricing of stocks" where fundamentals cannot justify the valuation. He believes that broadly, the AI market is not in a bubble, but acknowledges "pockets on the fringes" where "mini bubbles" might be forming. He states that current valuations are justified by expected future growth, with the market pricing in mid-20s to 30% growth for US AI names over the next three years, aligning with consensus estimates. A "red flag" is that much of the value comes from future growth, not current earnings. However, he notes that these are "very profitable companies with tons of free cash flow," which is driving investment.

Areas of Concern: Pettit identifies "asset heavier businesses" as areas of concern, such as data center buildouts and power generation (especially nuclear), where significant upfront capital and debt funding are required, and future pricing is uncertain. He also points to "early stage companies that are already seeing stock prices and valuations rip" as potential "mini bubbles."

Attractive Entry Points: Pettit suggests attractive entry points in traditional utilities (e.g., Duke Energy), tech enablers like semiconductors (Nvidia, Marvell), and Amazon at the "upfront in the tech value chain." He also mentions smaller cap semis like MKSI, where analysts expect more growth than the market is currently pricing in.

Geographic Trends: Pettit notes that the AI trade is not solely a US phenomenon. He highlights international opportunities in China (Alibaba, Tencent) and outside of China (TSMC, SK Hynix), suggesting geographic breadth in the AI trade.

Circular AI Deal Making: Both Gil Laura and Drew Pettit address concerns about the "circular web of AI deal making," such as Nvidia investing in OpenAI, which then commits to Nvidia's chips. Laura calls this the "unhealthy part of the behavior," funded by debt with high leverage. Pettit, however, is more comfortable in the near-term, noting that the initial funding source is free cash flow from Nvidia and that these companies have stable free cash flows to pivot to growth opportunities. He believes management teams are good stewards of capital.

Ad Market and Search Market: Gil Laura reports that the ad market and search market are doing well. Meta grew 22% last quarter, while Google grew 12%. He expects the gap to narrow as election comps fade, with Meta's growth likely to decelerate and Google's to hold steady. A significant factor to watch is OpenAI, which has not yet launched advertising but is expected to take share from other platforms, primarily Google, in the future.

Apple's iPhone Cycle: Laura believes it's too early to definitively assess the strength of Apple's current iPhone cycle, even after the earnings report. He notes that the product wasn't compelling enough for a large upgrade cycle, but data points suggest otherwise, contributing to the stock's performance. He points out that Apple is the most expensive on earnings among its peers, despite potentially lower growth. Any disappointing news could lead to a pullback.

US-China Trade Tensions: The US-China trade tensions are largely priced in for Nvidia, which has minimal sales to China. For Apple, these tensions add volatility but are also embedded in the stock price. A constructive outcome with China is unlikely, and a "slow process of decoupling" is occurring, with companies like Apple and Nvidia moving production out of China and Asia, respectively.

Consumer Sentiment and Halloween Spending

October consumer sentiment fell to a five-month low, according to Bloomberg. John Bobgardner, Managing Director and Senior Consumer Equity Research Analyst at Mizuho Americas, states that the consumer is "stressed," with lower-income consumers struggling and household financial conditions worsening. Even high-end consumers are emphasizing the wealth effect from the stock market. Absolute debt levels and higher price points are contributing to consumer stress.

Despite this, Americans are expected to spend a record amount on Halloween. However, candy makers like Hershey and Mondelez are facing squeezed margins due to inflation.

Candy Industry Inflation and Company Analysis

The primary driver of inflation in the candy industry has been the raw material, cocoa. Although cocoa prices have fallen 50% year-to-date, they remain more than double the 10-year average due to tight global supply. Other contributing factors include rising dairy prices, sugar, labor, and packaging costs, and potentially tariffs. Companies are navigating this by increasing prices, reducing pack sizes (shrinkflation), and altering ingredients. Chocolate candy prices in the US have risen 40% per pound over the past three years, outpacing wage growth.

Company Recommendations:

• Mondelez (MDLZ): Recommended as an "outperform" (buy) due to greater diversification, with about 40-45% of sales from emerging markets and chocolate comprising only about a third of sales. The company is diversifying into new categories through M&A and benefiting from cost savings and operating leverage.
• Hershey (HSY): Rated "neutral." The company is more concentrated in the US market, facing a tough consumer environment. A new CEO may lead to reinvestment in the business, potentially impacting earnings growth over the next 12-18 months.

GLP-1 Medications and Consumer Habits

GLP-1 medications are having a noticeable impact on consumer food choices. Categories with protein, such as yogurt and cottage cheese, are seeing volume growth, while chocolate, juices, and other high-sugar items are declining. Consumers on GLP-1s report a net positive benefit, leading to calorie reduction and altered shopping patterns.

Post Holdings Investment

Post Holdings (POST) is recommended as a smart move due to its diversified business model, including food service, pet food, and cereal. The company is described as having one of the best management teams, with shrewd capital allocation and a strong M&A strategy. It offers a "natural hedge" where different segments can balance each other. While the cereal category is currently soft, food service is growing well, and the company has exposure to eggs, a trending category.

Upcoming Events and What to Watch

• Tech Earnings: Microsoft, Alphabet, and Meta report on Wednesday, followed by Apple and Amazon on Thursday. Investors will focus on AI spending, cloud infrastructure, iPhone sales (especially in China vs. US), and overall growth.
• Federal Reserve FOMC Meeting: The two-day meeting concludes on Wednesday with an interest rate decision and a press conference from Fed Chair Powell.
• US-China Summit: President Trump and President Xi Jinping will meet on Thursday in South Korea amid ongoing trade tensions.
• Government Shutdown: Continues, impacting data availability and federal worker pay.
• Disney and YouTube TV Distribution Agreement: A new deal is set to expire next week, with potential for Disney networks to be dropped from YouTube TV.

Market Domination Overtime Recap

Jared Blickery provided a weekly recap, highlighting that the Dow was up 1% for the day and 2.2% for the week. The NASDAQ and S&P 500 also showed gains, with the NASDAQ 100 finishing at a record high. The Russell 2000 was up 2.5% for the week. Tech was the top sector for both the day and the week, followed by utilities and financials. Energy, despite being down for the day, was the second-best performing sector for the week. Interest rate-sensitive trades benefited from the easing inflation concerns.

Weekly Sector Performance:

• Top: Tech, Energy, Industrials, Healthcare, Financials
• Bottom: Staples, Utilities

Weekly Index Performance:

• Dow, S&P 500, NASDAQ, and Russell 2000 all finished the week higher.
• Apple and Alphabet reached record highs.
• AMD was up 8.5% for the week, with Lamb Research up 7%.
• Software names like Salesforce, Shopify, Palo Alto, and Crowdstrike also saw significant gains.
• China-related stocks like Alibaba showed strength, with tensions easing.

Conclusion

The market is currently buoyed by cooler-than-expected inflation data, fueling optimism for Federal Reserve rate cuts. While technology and growth stocks are leading the charge, concerns remain about potential "mini bubbles" in certain asset-heavy areas of the AI market and the broader impact of inflation on consumers. Upcoming big tech earnings and the Fed's policy decisions will be crucial in shaping market sentiment in the near term. The ongoing government shutdown and US-China trade tensions add layers of uncertainty.