Companies are routinely measured against earnings estimates published by the investment analysts who follow them, and when the company’s actual earnings surpass expectations, the company is often rewarded with a bump to its stock price. That bump is usually magnified if the company’s management team also provides upbeat guidance about its future sales, or earnings, or operations, or whatever. This is commonly referred to as a “beat and raise.”

I’ve always been fascinated by the fact that this language is borrowed directly from the poker parlor floor, but it's still a pretty good analogy: By telegraphing its winning hand, the company on the happy side of a beat-and-raise is effectively upping the ante for the entire table while also throwing down a gauntlet to its competitors – effectively challenging them to call their bluff, match their cards or get left in the dust. And occasionally, a company becomes so big and so representative of the market’s dominant narrative that its results are tracked closely by the whole market.

Today that company is NVIDIA, whose chip designs once made it a roaring success in the video graphics market but more recently has made it a pretty good proxy for how markets are viewing the opportunity presented by artificial intelligence writ large. In recent quarters when NVIDA has beaten and raised earnings, markets have generally responded by moving higher in a broader sense as well. 

Some of that is simply a function of how large the company has grown: Before the launch of ChatGPT brought generative AI to the very front of everyone’s frontal lobe in November 2022, NVDIA’s market cap was a somewhat-modest-by-comparison $359 billion. That was good enough for 13th place in the S&P 500^® Index; respectable for sure, but not really big enough to easily and routinely move the index all by itself. But by the middle of last year, as AI optimism began to capture the market’s full attention, NVIDIA had joined the trillion-dollar club, making it the fifth-largest stock in the index and suddenly giving it enough gravity to move the benchmark by simply throwing its own weight around.

But the tendency of the market to rally alongside NVIDA whenever the company beats-and-raises the quarter has been consistent enough to convince some that there was more going on than just outstanding performance by a single, increasingly large index constituent. More plainly, when NVIDIA has beaten-and-raised in the past, markets seemed to take that as evidence that AI enthusiasm was for real, thereby justifying a broader move higher for the market as a whole as well.

For those of us who lived through the Web 1.0 hype-cycle, this has always been at least a little bit uncomfortable. After all, a broad market advance built on broadly advancing fundamentals is sustainable, but one built on an imputed link between one company’s outstanding performance and a big, transformative change in the way the world works is inherently less stable – especially if that link eventually turns out to be something other than originally imagined. More specific to this economic cycle, I’ve worried that NVIDIA’s superb results and the way the market has extrapolated them into something far larger might in fact be papering over a slow but steady weakening of the economic environment.  

Which is why I was encouraged not only by NVIDIA’s earnings release last Wednesday, but also the market’s less-than-ecstatic reaction to it. As you’ve probably guessed by now, it was another beat-and-raise quarter for chip manufacturer. And, true to form, the stock reacted by putting up a well-deserved gain. But this time, the S&P 500 as a whole failed to gain much momentum post-earnings and actually declined a bit – something made even more notable by the fact NVIDIA’s post-earnings rally has now turned it into the third largest stock in the index by market cap, ahead of Google’s parent company and behind only Apple and Microsoft. Ordinarily when a stock that big has a 9%-plus day, the index has a pretty good day, too.

I take it as a healthy sign that markets didn’t stage a spectacular rally on Thursday. Surely, NVIDIA’s blow-out performance deserves a blow-out performance by its shares. But it’s far less clear to me that the market’s recent tendency to extrapolate one chipmaker’s performance into a secular trend that will lift all boats equally was a fundamentally sound decision. So on Thursday when the equity market failed to rally broadly, it suggested a measure of skepticism by markets that has been absent in the recent past.

Moving on: It was a very light week for macroeconomic data. The highlight came from Wednesday’s release of the official minutes of the Federal Reserve’s April-May meeting, which turned out to be a little more hawkish than expected. Specifically, “participants noted disappointing readings on inflation over the first quarter (of 2024)” and “assessed that it would take longer than previously anticipated” to gain the kind of confidence necessary to begin cutting rates.¹ There was also an admission that the economy isn’t reacting as quickly to Fed tightening as it has in the past and even a hint that further increases in the Fed Funds rate might be necessary. That was enough to push interest rates higher and expectations surrounding future Fed rate cuts lower, which probably also helped dampen the impulse to rally after NVIDIA’s strong results.

Elsewhere, the view that the Fed’s fight against inflation might not be over yet was also endorsed by Thursday’s release of preliminary “flash” results of S&P’s May purchasing manager’s indices. Cost pressures in manufacturing were widespread, while service providers continued to struggle with rising wages and employment costs. That was enough for the organization’s chief economist to comment that “the final mile to the Fed’s 2% target still seems elusive.”² Not surprisingly, that applied further pressure to rates and kept equity market optimism muted.

But the inflation news wasn’t all bad. For example, the University of Michigan’s read for May consumer confidence included a slight decline in inflation expectations after a mid-month jump that caught many observers off guard.³ Consumers now expect prices to rise 3.3% over the next 12 months before settling at around 3.0% per year over the longer term. Both readings are still uncomfortably high, but nonetheless represent a welcome moderation from previous results. Meanwhile, though, overall confidence dropped by a “statistically significant” 10% since April, mostly on concerns that U.S. labor markets are cooling significantly.

What to watch this week 

This week’s main event will likely be Friday’s income and outlays report, which provides detail around both earnings and spending activity for U.S. consumers. That could prove interesting given the mixed signals currently coming from other metrics like retail sales and consumer confidence. Of particular interest will be the U.S. savings rate, which is simply the plug figure left over when outlays are subtracted from income; if U.S. consumers are indeed being squeezed in ways that aren’t obvious in other economic releases, that might be an important way to triangulate it, no matter how bluntly the figure is calculated. More importantly, however, Friday’s report also includes so-called Personal Consumption Expenditures (PCE) inflation, which provides a slightly different view of price growth than that provided by more popular yardsticks like the Consumer Price Index and the Producer Price Index. PCE inflation also happens to be the inflation metric preferred by the Fed, giving it special relevance given all the current speculation around the future of Fed policy.

Speaking of the Fed, Wednesday’s release of the Beige Book – a collection of economic anecdotes from around the Fed’s various districts – will provide context that supplements more quantitative data released by the Fed and others. Fed officials in each of the Fed’s 12 districts are asked to review and summarize data from banks, businesses and consumers surrounding inflation, hiring and industries critical to each region’s economy. These insights are then stapled together, summarized again and released to the public as a way to cross-check what “harder” data may or may not be saying about the state of the economy. 

We’ll also get a few more housing-related releases this week, including home price readings from Federal Housing Finance Agency and S&P Case-Shiller (Tuesday) and pending home sales (on Thursday). Last week’s existing home sales numbers were weaker than expected, as activity remained subdued once again because of stubbornly high prices and a modest move higher in mortgage rates. As we’ve discussed in the past, it will be difficult to sound the all-clear for the economy at large unless and until the housing market returns to better health. Given that “higher for even longer” seems to be the Fed’s new mantra as far as rates are concerned, relief on home prices looks like the better bet for eventually stoking that improvement. For what it’s worth, I wouldn’t hold your breath just yet.

Finally, Tuesday’s reading on consumer confidence from the Conference Board is also worth a look. As discussed above, the UofM survey has taken a meaningful turn for the worse in May even as consumers become a little less worried about inflation. Whether or not that sentiment repeats itself in Tuesday’s report could be important. Of particular interest will be the gap between consumers who say jobs are “plentiful” and those who say jobs are “hard to get.” That’s because the UofM’s update last week singled out a worsening labor market as a particular risk to consumer sentiment.