Decent Earnings, GDP, Inflation, and Employment Data + Noisy Politics and Imbalanced Indices = Market Correction/Rotation

The U.S. economy accelerated in the second quarter as consumers increased their spending, businesses invested more in equipment and stocked inventories, and inflation cooled.  GDP rose at an annual rate of 2.8% from April through June, an acceleration from the first quarter’s 1.4% rate and well above the consensus expectation of 2.1%.

The much-watched (and much-gamed) PCE price index, which strips out “volatile” components, rose 2.9% in the second quarter at an annualized rate, cooling from 3.7% in the first quarter.  (This index may not be of much real use in describing the felt impact of rising prices for consumers, but it’s one watched by policymakers and therefore important to track.)  Initial jobless claims dropped by 10,000 to 235,000 for the week ending July 20, slightly below expectations.  Continuing claims nationwide fell by 9,000 to 1,851,000, slightly below expectations.

Overall, the data suggest that the U.S. economy remains on solid footing.  While stronger-than-expected GDP growth might make the Fed more comfortable maintaining current policy, recent labor market loosening and slower price growth still support the case for a rate cut in September should the Fed think it expedient. 

In this context, stock market action seems to reflect a normal summer correction (arriving a little late, but still very typical), coupled with a healthy rotation out of some very crowded trades and a tentative broadening out into areas beyond the “Magnificent Seven” and the AI and pharma trades that have been red-hot thus far this year.  Because we knew this seasonal trend was likely, especially after such strong performance year-to-date, we’ve spent the last month trimming some positions in these winning areas. 

AI, Cybersecurity, Portfolio Management, and the Need For Human Judgment

Historically, cybersecurity has been a non-negotiable line item in corporate budgets.  Essential for protecting assets, reputation, and customer trust, cybersecurity spending was often viewed as having a “blank check” from management.  High-profile breaches and the ever-present threat of cyberattacks justified significant investments in firewalls, encryption, and intrusion detection systems.

However, the rise of artificial intelligence (AI) is reshaping corporate priorities.  AI’s ability to revolutionize business operations through data analysis, customer service enhancement, and strategic decision-making has made AI infrastructure an existential necessity, as we have extensively discussed in recent letters.  Investing in AI is no longer optional; it is crucial for maintaining a competitive edge.  This shift presents a new challenge for corporate strategy, as finite budgets force companies to reassess their spending priorities.  When two needs for blank checks are existential, problems can arise.