Adobe Firefly; Jenny Chang-Rodriguez/BI
2024 was supposed to be easy for Wall Street's speculators. There was an improving economic picture, a clear way to trade it, and the chance to take it easy while still racking up profits. Inflation canceled that, and now it's almost certain that Wall Street's summer is canceled, too.
After 2023's glorious stock-market rally, the Street went into this year expecting nirvana — a combination of healthy corporate earnings, strong household consumption, and a final defeat of high inflation. The combination would put the Federal Reserve on a glide path to cut interest rates — a move that would reduce the cost of debt, push stocks higher, and make consumers feel richer.
But inflation proved stickier than expected, and those interest-rate cuts started to fade from view. First, Wall Street pushed back its prediction for the first cut from March to June, then to September — now investors are starting to wonder whether a cut is coming at all.
"This isn't what we were told we were signing up for, that's for damn sure," Justin Simon, a portfolio manager at Jasper Capital, told me. "We were going to get rate cuts, and everything was going to the moon. That's why people bought stocks. Now that seems relatively unlikely."
As the hope for cuts faded, the performance of major stock indexes has become decidedly "meh." The S&P 500 has slipped 0.2% since the beginning of March, when this new reality started to down on Wall Street, while the tech-heavy Nasdaq is down 0.7%. But worse than all that is the potential for higher rates to stick around long enough to change the shape of our economy and, as a result, what companies have been making money in the stock market.
That means Wall Street's fantasies of decamping to the Hamptons for the summer have shattered. No leaving the interns and junior analysts to just run the same trades that worked last year. No set-it-and-forget-it strategies pushing up portfolios. No unquestioningly buying the dip. Inflation's stubbornness has injected the market with uncertainty, which, in turn, drives volatility. Unfortunately, uncertainty and volatility do not come with a $100 lobster cobb salad from Duryea's. They generally come with pain.
When doves cry
Wall Street's expectations of sailing into a smooth summer weren't entirely its fault. While Federal Reserve Chair Jerome Powell tried to strike a cautious tone, the Fed's public projections for interest rates signaled that multiple rate cuts were coming in 2024. To the world of finance, that sounded like a little victory lap over inflation and meant the US would likely stick a soft landing — a Goldilocks scenario in which prices stabilize without slowing down the economy so much that it causes a recession.
But as the new year began, things started to go awry. Inflation data showed that prices were still rising at an uncomfortable pace — the core consumer price index, which strips out volatile categories such as food and energy, rose 3.8% year over year in March. The Fed's preferred measure of inflation, the core personal consumption expenditures index, has also remained stubbornly above the central bank's 2% goal. Economists started to doubt that higher prices were being driven just by corporations opportunistically jacking up prices to pad profit margins — but rather something more enduring. Wall Street really started to worry that its precious cuts weren't coming. JPMorgan CEO Jamie Dimon reminded everyone not to get "lulled into a false sense of security" that a soft landing was coming.
We were going to get rate cuts, and everything was going to the moon. That's why people bought stocks. Now that seems relatively unlikely.
Last week, the Fed admitted in a statement that even though the economy was on solid footing, "in recent months, there has been a lack of further progress toward the Committee's 2% inflation objective." It kept rates at current levels, reiterated its commitment to data dependence, and said it remained "highly attentive to inflation risks." In other words, there's still a chance data is telling us inflation will get worse. Some analysts, including Torsten Slok, the chief economist over at Apollo, see signs that it could turn south.
"Rising energy prices combined with the ongoing rebound in the manufacturing sector increase the likelihood that we could see an increase in goods inflation over the coming months," Slok wrote in a recent email to clients.
A scenario like that could put the Fed in a position where it might not just hold rates at 5% but also consider hiking them. At his press conference on Wednesday, Powell said hiking was "unlikely," but he didn't say it was off the table. He also didn't offer a guess as to where this persistent inflation was coming from and said we'd find out "over time."
In Wall Street's language of probabilities, that means nirvana has become considerably less likely. This isn't to say that the economy is all bad or that there's no hope. GDP for the first quarter came in at 1.6%, lower than economists expected, but the underlying details were more promising. Unemployment is still near historical lows, and wage growth continues. Consumers are still spending that money, too — driving strong retail sales. On the business side, UBS's head of equities, David Lefkowitz, said in a recent note to clients that "corporate fundamentals remain largely solid and intact" and that about 75% of the S&P 500 companies that reported first-quarter earnings had beaten estimates. This is good news, of course … unless it turns out to be bad news. The economy has to actually come in for a landing for it to be a soft one. If the US takes back off, we run the risk of inflation picking up again, which would force the Fed to take more drastic measures to rein in prices. April's job report came in at 175,000 jobs created, weaker than the 238,000 expected, but employment stayed below 4% and wage growth cooled. Wall Street loved that — it was growth, but not too much growth. Goldilocks, the weather on April 25th — "not too cold, not too hot, all you need is a light jacket."
Paradoxically, there are signs that things aren't as hunky-dory as they may appear. McDonald's missed quarterly earnings estimates for the first time in two years as, the company said, its customers were "more discriminating with every dollar they spend." Starbucks saw sales decline for the first time since 2020, in what the company's CEO called a "highly challenging environment" surrounding "pressures consumers face." Over at Pepsi, organic sales fell 2%. What all these companies have in common is that they had been able to extract more money from customers with significant price increases over the past couple of years, and now they can't. Money has tightened, and now they can't push price hikes over sales volume. Expect to see this theme repeat itself all over the market. The bad news is that this means the consumer — the engine of the US economy — is getting tired. The good news is that this means these companies won't be a source of inflation.
"I certainly hope that inflation has peaked," Silas Myers, a cofounder and the CEO of the investment firm Mar Vista Investments, told me. "But we are seeing significant cracks in consumer spending at the lower end. People are trading down products."
All this contradictory information raises a lot of questions for Wall Street. Do we actually need more interest-rate hikes, or can the Fed just wait for things to settle? If we need to keep pushing to lower inflation, just how ugly will things get? What if the inflation pickup is a head fake and, actually, the economy is weakening? Is not cutting interest rates now a mistake? You can see why this tug-of-war will keep Wall Street on its toes and off Georgica Beach.
What works, what doesn't
When rate cuts seemed guaranteed, and Wall Street's betting class was lining up which oceanfront parties to hit this year, it seemed like the market would be easy picking this year. If rates fell, there would surely be more money sloshing around in the stock market, pushing up indexes and likely crowning the same winners as the year before. But as doubt about the economy crept into Wall Street's mind, so, too, did concern about these trades.
Higher rates for longer means business models that used to work might not work anymore. Investors have to be a little more discerning. Bets that companies will develop tech and then figure out how to monetize it after the fact are already being punished compared with bets on disciplined, profit-focused operations. Take the "Magnificent Seven," a group of tech stocks that dominated the market in 2023. The fortunes of these companies — Nvidia, Tesla, Microsoft, Meta, Apple, Amazon, and Alphabet — have diverged as the market got religion about the realities of the artificial-intelligence revolution. After Meta announced bumper earnings last month, investors sent its stock crashing 10% because the House of Zuck said it would spend $35 billion to $40 billion building an AI product this year. Exactly how that investment would be monetized it couldn't say. In a world where money is more expensive, those are the types of questions the market wants answered posthaste. Microsoft and Alphabet, which have already started monetizing their investments, fared much better.
"People are really worried about a hawkish pivot because I think they own all the wrong stuff," Simon said. When a trade is en vogue on Wall Street, you can expect everyone to crowd in, and if the trade reverses, you can expect a stampede to the exit. That ultimately creates market moves so dramatic they can push down indexes and, frankly, wreck a trader's day if they're not paying attention. So it's time to pay attention.
The simplicity that Wall Street hoped for is one of the few options that's no longer on the table.
This new regime doesn't apply just to Wall Street's stock investors. The longer that higher rates in the US stick around, the more our monetary policy diverges from the rest of the world's. In the EU and the UK, inflation is receding, and rate policy looks like it's coming down. In Japan, interest rates are barely above zero. That divergence means major volatility as hot money sloshes around the world looking for the safest haven. As if to emphasize that fact, on the day of Powell's speech, the value of the Japanese yen blasted up against the dollar by 1% in one second — a massive move by currency-trading standards and a vicious reversal given that over the past year, the yen has fallen 11% against the dollar. There is a certain set on Wall Street that does not get to "rosé all day" on Hamptons summer water when currencies trade that way.
The Fed has always said there are "long and variable lags" between when it moves interest rates and when the economy feels those moves. Now the Fed is starting to admit that those lags may be longer and more variable than it thought. The simplicity that Wall Street hoped for is one of the few options that's no longer on the table. Simple — like a cold glass of lemonade on the front porch or a $210 pitcher of Gimme Shelter at Sunset Beach — is what summer is made of. That's why this year, it's canceled.
Linette Lopez is a senior correspondent at Business Insider.