Euphoria Over Stocks Takes a Breath as Gold Rallies

On Friday, U.S. stocks experienced a slight decline as some disappointing corporate earnings reports dampened the enthusiasm surrounding the expected path of interest rates. The S&P 500 slipped by around 0.2%, pulling back after recently reaching its 39th record high for 2024. Two companies, FedEx Corp. and Lennar Corp., weighed on the market following less-than-stellar financial results.

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FedEx, a key economic indicator due to its global delivery network, saw its shares plunge by 10%. This sharp drop came after the company reported earnings that fell short of analysts' expectations. FedEx also issued a warning about a slowdown in its business, which caused further concern among investors. Similarly, Lennar Corp., a major homebuilder, experienced a decline as its quarterly home orders did not meet Wall Street's projections.

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In contrast, Nike Inc. surged after announcing a significant leadership change, with the company appointing a new CEO. The news helped boost Nike’s stock, providing a counterweight to the otherwise negative performance of the broader market.

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In the bond market, Treasury yields edged higher, reflecting investors' mixed reactions to the latest economic data and corporate earnings. Meanwhile, the U.S. dollar strengthened, with the dollar index—a measure of the currency’s value against a basket of peers—also posting gains. Gold, seen as a safe-haven asset, hit another all-time high, as concerns over potential economic risks continued to drive demand for the precious metal.

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The Federal Reserve’s bold move to cut interest rates by half a percentage point earlier in the week had bolstered market confidence. Investors took this as a sign that the Fed is serious about guiding the economy toward a "soft landing"—a scenario in which inflation is controlled without pushing the economy into a recession. However, warnings from companies like FedEx highlight the lingering risks to the economic outlook.

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Fed officials have indicated that additional rate cuts are likely, projecting another half-point reduction by the end of the year. This has fueled speculation that the central bank may need to act more aggressively if economic risks intensify. Deutsche Bank strategist Jim Reid commented that while markets are generally optimistic, there are still underlying concerns. "Futures markets are pricing in a faster pace of rate cuts than what the Fed suggested in its latest dot plot, so investors believe the central bank may have to accelerate cuts if downside risks materialize," Reid explained.

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Adding to the day’s market jitters was the quarterly “triple witching” event, a phenomenon that occurs when derivatives contracts tied to stocks, index options, and futures all expire simultaneously. This event often leads to heightened volatility as traders roll over positions or start new ones. According to derivatives analytics firm Asym 500, an estimated $5.1 trillion in contracts were set to expire on Friday, potentially amplifying market movements.

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The triple witching coincided with the rebalancing of key benchmark indexes, which is another factor that can cause sudden price swings. The expiration of contracts and rebalancing tend to prompt traders to adjust their strategies, resulting in sharp moves across the market.

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International developments also caught the attention of investors, particularly the Bank of Japan's (BoJ) policy decision. The BoJ opted to keep its monetary policy unchanged, which led to a drop in the Japanese yen. Traders had anticipated a more hawkish stance from BoJ Governor Kazuo Ueda, but his cautious tone suggested that the central bank was in no rush to raise interest rates. Ueda also indicated that inflationary pressures in Japan were easing, which contributed to the yen’s weakness.

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Despite the overall optimism in equity markets following the Fed's rate cut, some experts are warning of potential risks. Michael Hartnett, a strategist at Bank of America Corp., expressed concerns that the rally could lead to a bubble. He advised investors to consider bonds and gold as hedges against a possible recession or a resurgence of inflation.

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Hartnett noted that stocks are currently pricing in further easing by the Fed, as well as an 18% growth in S&P 500 earnings by the end of 2025. "It doesn’t get much better than that for risk, so investors are forced to chase the rally," Hartnett wrote in a note. However, he cautioned that this optimistic scenario could come with significant risks if the Fed’s rate cuts are not enough to sustain economic growth.

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For those looking for alternative investment strategies, Hartnett suggested that international stocks and commodities could be good plays in the current environment. He argued that international equities are more attractively priced than U.S. stocks and are starting to outperform their American counterparts. Additionally, commodities serve as a potential hedge against inflation, making them a valuable addition to a diversified portfolio.

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In conclusion, while U.S. markets remain buoyed by optimism over the Fed's rate cuts, the risks to the economy are still present. Disappointing earnings reports, combined with the potential for increased market volatility from events like triple witching, are reminders that caution is warranted. Investors are advised to consider diversifying their portfolios with assets like bonds, gold, and international equities to hedge against potential downside risks.

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