Are Rate Cuts Factored In The Market?

*Analyzing the markets with Richie Naso, a Wall Street veteran of over 40 years and former member of the NYSE.

DJIA 52-wk: +10.73% | YTD: +7.73% | Wkly: +0.95%

S&P 500 52-wk: +17.03% | YTD: +11.95% | Wkly: +1.59%

NASDAQ 52-wk: +25.20% | YTD: +14.66% | Wkly: +2.03%

Oracle 52-wk: +80.32% | YTD: +75.34% | Wkly: +25.51%

Market Performance

1. The Nasdaq Composite led the pack, gaining about +2% for the week. Reuters
2. The S&P 500 rose roughly +1.6%, closing the week near cycle highs. AP News
3. The Dow Jones Industrial Average had a more modest gain of about +1%. AP News
4. Small caps (Russell 2000) lagged, up only ~ 0.3-0.5%. AP News

Key Drivers

1. Rate Cut Expectations
   Softer inflation signals, less-robust labor reports, and mixed economic data reinforced market expectations that the Fed will cut rates at its next policy meeting. There is now widespread anticipation for a 25 basis point cut, with speculation about possibly larger cuts later in the year. Reuters
2. Strong Tech & AI-related Moves
   Tech stocks and AI / semiconductor-related firms outperformed. Oracle had upbeat forward guidance, and stocks like Nvidia, Tesla, and other AI plays helped push the Nasdaq higher. Reuters
3. Mixed Economic Data
   1. The U.S. jobs report for August was weaker than expected, with revisions showing fewer jobs added earlier in the year. Keel Point
   2. Consumer confidence weakened; University of Michigan’s preliminary reading dropped. The Wall Street Journal
   3. Treasury yields—particularly the 10-year—rose somewhat from recent lows but remain under pressure from rate cut expectations. Home
4. Valuations & Fund Flows
   1. Investors have been pulling money from equity funds—the biggest outflows in five weeks—possibly taking profits after recent gains. Reuters
   2. Meanwhile, broad indices are near record highs, raising concerns about overvaluation among some analysts. Business Insider
5. Stock-specific and Corporate News
   1. Warner Bros. Discovery saw a large jump on takeover rumors involving Paramount Skydance. Barron's
   2. IPO activity (e.g. Gemini Space Station) attracted attention. Barron's
   3. Some companies disappointed (disappointing guidance or weak revenue), which punished their stock performance. Barron's

Risks & Headwinds

• Despite optimism, there is clear concern surrounding economic slowing, especially in the labor market, inflation pressures, and weak consumer sentiment. The Wall Street reports.
• High valuations: Some analysts warn that current multiples may not allow much margin for error if economic data weakens. Business Insider
• Fund outflows, especially from large-cap equity funds, suggest some investors are becoming more defensive. Reuters

The World Is a Mess. Markets Are Ignoring Those Risks—for Now. Barron’s reports

Dr. Pangloss, welcome to Wall Street, where it is indeed the best of all possible worlds.

Voltaire’s oblivious optimist fits in well in a place where domestic political violence and escalating global tensions don’t intrude.

And so major equity indexes notched records again in a week marked by an abhorrent assassination in the U.S. while Russia sent drones supposedly intended for Ukraine into Poland and Israel expanded the Gaza war into Qatar. As Peter Atwater observed in his Financial Insyghts missive this past week, it isn’t known if Chinese President Xi Jinping might tag along with an assault on Taiwan or India’s Prime Minister Narendra Modi could up the ante with Pakistan, but global markets have priced in none of this.

Stocks’ advances in the face of these risks may mainly prove President Calvin Coolidge’s observation that the business of America is business. Even if the U.S. economy is slowing, it is still growing, and profits even more so. As noted, stock and bond markets also continue to advance in expectation of a new round of Federal Reserve interest-rate cuts, even with quite easy financial conditions. That’s evidenced by corporate credit offering slim yield premiums, which sent the popular iShares iBoxx $ High Yield Corporate Bond , HYG, -0.10% exchange-traded fund (ticker: HYG) to a 52-week high this past week.

Among equities, along with the S&P 500 and the Nasdaq Composite ending the week at new high marks (and the Dow Jones Industrial Average setting a record on Thursday), the market for initial public offerings is back. A highlight was the debut of Klarna Group, KLAR, +0.42%, which, as Macro Intelligence 2 Partners helpfully explained, “for those of you who don’t finance your Chipotle burritos,” is a popular buy-now, pay-later service. That Klarna describes itself as “a global, AI-driven” payments platform makes its $31 billion market capitalization easier to explain, they wrote in a client note.

Klarna was followed by Figure Technology Solutions, FIGR, +4.47% and Gemini Space Station , GEMI, +14.29%, both crypto-related outfits that popped following their debuts. “We assure you that the reopening of the IPO window isn’t usually considered a symptom of tight financial conditions,” MI2 dryly added.

Despite that, the Fed will be easing this coming week, which will only be the ninth time it has cut rates within 10 days of the S&P 500 hitting a 52-week high since 1994, according to Bespoke Investment Group. It would also be only the sixth time the Fed has cut since then after a pause of more than six months between rate reductions. In either scenario, the advisory found the S&P higher a year later with bigger gains than the 12-month median return.

Based on that history, equity investors can safely ignore domestic political risks, international tensions, richly priced bonds, exalted equity valuations, and signs of speculative fervor in the IPO market. And with the Cboe Volatility Index, VIX, +0.34%, or VIX, the so-called fear gauge for stocks, trading below 15 and evincing no worries among options trades, could Dr. Pangloss actually be right? Or does complacency reign based on expectations of continued easy money?

Who Says the Stock Market Is Topping Out? The Case for Staying Bullish.
Barron’s reports

The economic headlines look scary, but the market is seeing nothing but good times ahead. There’s every reason to believe that stocks have it right.

There may not have been a scarier piece of economic data than the one that came out of the Bureau of Labor Statistics this past Tuesday reducing estimates of job gains for the 12 months ended March 2025 by 911,000. It reflects that hiring has been far weaker than previously thought, as companies don’t see strong enough demand to aggressively ramp up hiring.

The stock market didn’t see it that way. The S&P 500 index, SPX, -0.05%, was on track to close up 1.3% this past week, while the Nasdaq Composite, COMP, +0.44%, was set to rise 1.4% and the Dow Jones Industrial Average, DJIA, -0.59%, 0.8%. The gains suggest that the stock market is either ignoring an economic slowdown or is keying off something the data don’t show (or OracleORCL, -5.09% blowout earnings report).

It’s not hard to spot what the bears are sniffing out— a late-stage economy. That’s when economic growth has already been expanding for several years, and then starts to slow. If it slows enough, everyone—markets, businesses, and consumers—starts worrying about a recession. The weak data from the jobs market and elsewhere suggest that the economy may be about to hit a w Mike Wilson, chief U.S. equity strategist at Morgan Stanley, isn’t so sure. While investors focused on the revisions to data for a period that began a year and a half ago, he was seeing signs of optimism in more recent payrolls data. He notes that revisions to the monthly numbers have been getting smaller, suggesting that the labor market may have been at its weakest point in June. The bank’s historical data, reaching back to 1979, show revisions tend to see this type of improvement when the economy moves out of a downdraft and into the early stages of a new expansion.

If Wilson is correct, the U.S. has been suffering from a “rolling recession”—individual sectors, such as consumer goods and manufacturing, have taken turns being at the center of slowdowns even though the overall economy never endured a downturn. If that weakness is ending, then the economy may just be starting to accelerate again, not slowing further. “The weak jobs report supports our view that we’re transitioning to early cycle,” writes Wilson, who has a 6500 price target on the S&P 500.

And a series of Federal Reserve Rate cuts, beginning this coming Tuesday, could get it all the way there. Rate cuts essentially pump money into the U.S. economy, which can get the economic juices flowing in the U.S. It’s one of three catalysts, along with tariff policy easing and the stimulus coming from President Donald Trump’s tax and spend bill, that can create “a sustainable shift to earlier cycle,” writes Chris Senyek, chief investment strategist at Wolfe Research.

If it truly is early in the cycle, sales and earnings should keep growing, something the market already predicts. Analysts expect S&P 500 earnings, in aggregate, to grow 13% next year, according to FactSet. That would be another support for the market.

The only thing to fear is fear itself.

What Could Push Them Higher. Barron’s reports.

Small-cap stocks have finally had their day in the sun. They could keep shining if a few factors go their way.

The Russell 2000, which has an average market cap of $4 billion, has jumped just over 9% since Aug. 1, after the market had finished digesting additional U.S. tariffs. Over that span, small-caps outpaced the S&P 500’s 4% rise.

That’s because the economic picture is shaping up just right for small-caps: The Federal Reserve will likely lend the economy a hand and lower interest rates next week. Small-caps tend to see an outsize earnings boost versus larger firms when the economy grows.

The Russell 2000, at around 2400 currently, has already priced in much of this picture. Now, the index is closing in on resistance levels. That means small-caps will need another catalyst to continue outpacing the S&P 500 and its megacap tech stocks.

That catalyst could be none other than the Fed, but not just a simple rate cut. If the central bank says anything that strongly indicates it could reduce interest rates again in the winter, it would boost economic forecasts even further—another boon to small-caps’ profits.

Morgan Stanley’s chief U.S. equity strategist, Mike Wilson, recently upgraded small-caps precisely because he believes the Fed will eventually cut several times, likely next year—catalyzing more small-cap outperformance, even if not quite yet.

Another positive driver could be higher analyst earnings estimates, which small-caps will need to see eventually. Expected earnings and the level of the Russell 2000 are highly correlated, but recently, the index has risen faster than those estimates.

The index’s aggregate expected earnings for the coming 12 months sit around $250 a share, which should correlate to the Russell 2000 trading several percentage points lower than its current level, according to Wilson’s data. But if the U.S. economy does reaccelerate, or these smaller companies’ third-quarter earnings surpass estimates this fall, analysts could revise their estimates higher, justifying the Russell 2000’s current level.

Those upward revisions to small-caps’ profit estimates could come soon. Only about half of all 2026 revisions for the Russell 2000 have been upward, according to FactSet, compared with close to 60% for the S&P 500. Small-cap revisions would eventually catch up if the economy remains strong.

“We still have yet to see relative earnings revisions breadth for small-caps turn higher—a development worth waiting for,” writes Wilson.

Of course, the risk to this picture is that a Fed cut this winter isn’t a shoo-in. Inflation is still a bit above the Fed’s 2% goal, and tariffs could prevent it from slowing to that level soon enough for the Fed to lower rates more than once this year. But what a welcome surprise multiple rate cuts would be for the market.

“Given the risk that the Fed may still be focused on inflation more than the weakness in the labor market, rate cuts may materialize more slowly than is necessary to catalyze a durable rotation to lower quality small cap names in the near term,” Wilson writes.

Still, for anyone who believes in this economy in the long run, sticking with those smaller names makes sense.

1) The FOMC meeting (Sep 16-17) will be the biggest event. A 25 basis-point rate cut is widely expected. Markets will also be looking at the updated “dot plot” and any hints about future rate cuts. S&P Global

2) Data due includes retail sales, industrial production in the U.S., plus inflation and labor market metrics from elsewhere. S&P Global

3) The IWM ETF

Last time I checked, it’s still September. Proceed with caution.

— Richie

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