6-18-24: Powell Needs to Face Reality – and Take Control

by Louis Navellier

June 18, 2024

The Fed’s Federal Open Market Committee (FOMC) statement on Wednesday acknowledged “modest further progress” on inflation. That was the good news. The bad news is that the Fed did not lower its inflation forecast based on the Personal Consumption Expenditure (PCE) index and it raised its unemployment forecast to 4.1%. In his best Fed-speak, Fed Chairman Jerome Powell said, “We’ll need to see more good data to bolster our confidence that inflation is moving sustainably toward 2%.”

The biggest news was the update of the Fed’s “dot plot” by the FOMC members, where eight members expected two rate cuts this year, seven forecast just one rate cut in 2024 and four said that there would be no rate cuts this year, so the median of these three diverging opinions yielded only one key interest rate cut to occur this year, perhaps on September 18^th or immediately after the November Presidential election.

The only good news is the “dot plot” forecasted four key interest rate cuts in 2025. Overall, I am grossly disappointed in the Fed, since their previous “dot plot” forecasted three key interest rates cuts this year.

As I mentioned in Wednesday’s podcast, I am very disappointed in the Fed, including some new FOMC members that are not qualified. In my opinion, Fed Chairman Powell has lost control of the FOMC due to all of the infighting and diverging opinions, so rather than promoting certainty, the Fed is promoting uncertainty. The Fed cannot seem to get a unified message out. As a result, I have lost any confidence in Fed Chairman Powell, and I stand by my podcast statement that he is weak and needs to be replaced.

In the meantime, Treasury yields continued to decline in the wake of the better-than-expected CPI & PPI. The bond vigilantes are now in charge and controlling Treasury yields. As I have repeatedly said, the Fed cannot fight market rates, so if the Treasury yields go lower, the Fed may be forced to cut rates sooner.

Since our Fed is now lagging Europe in cutting key interest rates, “carry trades” are expected to increase. That’s where foreigners put money in the U.S. dollar seeking higher yields in a strong currency. If these carry trades approach a trillion dollars, they could actually drive Treasury yields significantly lower and encourage the Fed to cut interest rate sooner than they would otherwise cut them, forcing the Fed’s hand.

The G7 Meets in Italy – As Europe Lurches Toward World War III

We are inching closer to World War III, now that the U.S. and Britain have provided Ukraine permission to use U.S. and British long-range missiles to strike deeper into Russia, provided they do not strike the Kremlin or the greater Moscow area. Vice President Kamala Harris and National Security Advisor Jake Sullivan attended a peace summit regarding Ukraine in Switzerland. I suspect that a more serious peace deal between Ukraine and Russia will ensue in the upcoming months, since otherwise, the death toll from the fighting will become intolerable. Meanwhile, Ukrainian President Volodymr Zelensky needs to make a peace deal ASAP, since he recently warned Donald Trump that he could be a “loser president” if he imposes a poor peace deal, implying that Ukraine could only survive while Joe Biden remains in office.

There are a couple of notable takeaways from the G7 meeting in Italy. First, Bloomberg reported that the food was wonderful, so welcome to Italy! Second, the G7 agreed to provide Ukraine with a loan of up to $50 billion, backed by frozen Russian assets associated with seized Russian central bank assets. Earlier, France, Germany and Italy had opposed selling those seized Russian central bank assets, so instead, they are just using the profits from those seized assets to loan money to Ukraine. Finally, the G7’s official communique was not very nice to China and criticized Beijing for “enabling” Russia’s war in Ukraine.

Josh Wingrove, a Bloomberg White House Reporter, said that the G7 leaders agreed to express “concerns about China’s persistent industrial targeting and comprehensive non-market policies and practices that are leading to global spillovers, market distortions and harmful overcapacity in a growing range of sectors.”  So much for free trade! The G7 is becoming increasingly isolationist and erecting trade barriers via tariffs.

Speaking of tariffs, when Donald Trump visited Washington DC last week and met with Congressional leaders, he floated the idea of eliminating income taxes and replacing the lost revenue with higher tariffs. I said on CNBC Asia on Thursday that this is a controversial idea and he doesn’t really mean it. However, since Trump is good at getting hits on the internet, I suspect that the rhetoric to replace the federal income tax will resonate with many voters. As a result, the Presidential election is getting much more interesting!

Since Ukraine has lost 35% of its population through emigration, attrition and war deaths, and many of its major cities have been obliterated, all continued fighting does is ensure that its economy cannot recover. That, and the death of an estimated 500,000 Russian soldiers, makes the fighting increasingly futile. There is no way that Ukraine can effectively defeat Russia as Ukraine runs out of soldiers. I fear that Ukraine’s attacks on Russian refineries, export terminals and the Trans-Siberian railroad means that the next big target is the Russian Arctic crude oil pipeline, which could send crude oil prices to over $100 per barrel.

Crude oil prices rose last week after Goldman Sachs analysts said Brent light sweet crude oil should rise to $86 per barrel in the third quarter due to summer fuel demand. Goldman Sachs predicted a trading range of $75 to $90 per barrel for Brent. As Europe and other major economies recover, and as central banks cut key interest rates and global growth recovers, crude oil prices are expected to meander higher. Overall, the strong seasonal demand that drives crude oil higher in the summer appears to be underway.

Obviously distraught at the recent parliamentary elections, French President Emmanuel Macron called a snap parliament election. Exit polls in France gave the Rassemblement National (RN) party 31.4% of the vote, which was more than double the vote to Macron’s Centrist Alliance party (14.6%). The RN party is led by firebrand Marine Le Pen, who picked an exciting young leader, Jordan Bardella, who is only 28 years old and will be harder to demonize by Macron and other opponents. Interestingly, young voters in Europe are leading this conservative wave. As a result, a new French Revolution may be underway!

In the wake of recent EU elections, I fear that the EU is increasingly likely to break up. Specifically, the recent EU parliamentary elections resulted in a definite shift to the right, especially in France and Germany. The new ruling coalitions are expected to be: (1) less willing to implement aggressive climate control actions, (2) less friendly to mass immigration and (3) more skeptical about aiding Ukraine.

As for tariffs, the European Union (EU) announced last week that it formally notified Chinese vehicle manufacturers, including BYD, Geely (which owns Volvo) and SAIC (the MG brand) that it will be imposing tariffs up to 48% on electric vehicles (EVs). Approximately one-fifth of EV sales in Europe were Chinese brands in 2023 and that total is expected to rise to a 25% market share in 2024. So now Chinese EV manufacturers face up to 48% tariffs in the EU and a 100% tariff on EVs sent to the U.S.

China has been expanding its presence in Eastern European countries like the Czech Republic, Hungary and Slovakia. Hungary has invested heavily in battery manufacturing with Chinese partners and even secured a BYD factory. Since the EU is ignoring countries that have big automotive industries, like Germany and Hungary, the ruling elites in Brussels are clearly not listening to its EU members.

And finally, Tesla shareholders on Thursday re-approved Elon Musk’s $48 billion pay package (at the current stock price) as well as a move to reincorporate in Texas from Delaware. The reason Musk wanted to move Tesla’s HQ to Texas is that a Delaware judge previously blocked his generous pay package as excessive. Since Musk made many Tesla shareholders rich in previous years, apparently shareholders have no problem awarding Musk with another generous stock grant. In the meantime, the images of satellite photos of new Tesla’s being stored at manufacturing plants around the world is truly scary. As a result, I suspect Tesla price cuts and/or lease deals may be forthcoming to help move its excess inventory.

The Coming Move in Selected Small-Cap Stocks

Our friends at Bespoke have a great feature called “Chart of the Day” and they presented a pair of charts with the title “It’s the Market Cap, Stupid” that broke the performance of the S&P 500 into deciles. For both the second quarter and year-to-date performance, the top decile (the largest capitalization stocks) in the S&P 500 rose 2% and 15.3%, respectively. Conversely, the bottom decile (the smallest capitalization stocks in the S&P 500) declined 10.3% (so far in second quarter) and 7.3% (year-to-date), respectively.

(Bespoke Investment Group)

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Interestingly, despite this Bespoke report, our small- to mid-capitalization stocks performed exceptionally well in May and so far in June. Due to the annual Russell realignment, as well as quarter-end window dressing, I expect that my small to mid-cap stocks will continue to perform well in the upcoming weeks.

Over the next two weeks, Russell will refine its proposed changes to their indices. Small and mid-cap stocks added to the Russell indices on June 24 are typically the biggest winners. After this annual Russell realignment, quarter-end window dressing is expected to boost many of our fundamentally superior stocks as many institutional investors make their portfolio look “extra pretty” in their quarter-end reviews.

As for the best of the big-cap stocks, Nvidia, in the wake of its 10-for-1 stock split, is expected to pass Microsoft in total market capitalization to become the largest public company. In the upcoming months, I expect Nvidia to blow through $4 trillion in market capitalization and eventually hit $5 trillion in market capitalization next year, when it announces the successor to its Blackwell chips that it is now rolling out.

The recent news that the Justice Department and Federal Trade Commission have struck a deal over how to proceed with antitrust investigations into Nvidia, Microsoft and OpenAI are not expected to derail the AI revolution and The Wall Street Journal said these investigations “may ultimately come to nothing.”

The simple fact of the matter is that since Nvidia spent over $2 billion to develop its next generation generative AI chips, competing with Nvidia has become increasingly futile. In fact, all the other AI chips under development are increasingly low-tech chip solutions, not the deep learning, generative AI chips that Nvidia makes. As a result, Nvidia is leading the entire stock market and, as Bloomberg TV recently said, the Magnificent Seven in the S&P 500 has become “the Magnificent One, and 499 other stocks.”

As for those other 499 stocks, pardon me for talking like a “math geek” for a minute, but if you ignore Nvidia and look at those other 499 stocks in the S&P 500, they are increasingly impacted by “mean reversion” trading algorithms that Citadel implements after each earnings announcement season ends. These algorithms hit overbought stocks that trade based on a non-linear neural algorithm that becomes unwound as volatility increases. Former algorithmic traders that I have questioned reluctantly hint that these mean reversion algorithms typically last 10-12 trading days, depending on how volatility increases.

For the record, I am a “linear” math guy, since my quantitative and fundamental analysis is done on a trailing 52-week basis, although we also run quantitative rankings on a 270-day, 120-day, 90-day, 60-day and 30-day basis. The neural algorithm folks like to brag that they are not burdened by any fixed time cycle and that their neural algorithms “naturally adapt.” I do not mean to burden you with too much math jargon, but in the end, these mean reversion neural algorithms just hit overbought stocks as they back and fill and digest their recent gains. Conversely, these mean reversion neural algorithms can be used to artificially “pump up” oversold stocks. As trading volume dries up, however, these mean reversion neural algorithms typically run for cover, since without trading volume, no algorithm can keep working.

So that is your crash course in algorithm trading. The key point to remember is that the stock market tends to be efficiently traded during each quarterly announcement season. But after earnings season winds down, these algorithmic games begin and markets become much less efficient as overbought winning stocks are hit with profit-taking and oversold stocks firm up as adaptive trading algorithms run wild.

In short, there are four months each year when stocks are efficiently traded (in earnings announcement seasons) and there are eight months of inefficient trading, when adaptive trading algorithms run wild! But if you hold on through the two month gap between earnings, you should be rewarded during earnings season!

Navellier & Associates owns Nvidia Corp (NVDA), Microsoft (MSFT), and a few accounts own Tesla (TSLA), per client request in managed accounts.   Louis Navellier and his family own Nvidia Corp (NVDA), and Microsoft (MSFT), via a Navellier managed account, and Nvidia Corp (NVDA), in a personal account. He does not own Tesla (TSLA), personally.