5 Market Themes at a Crossroads as We Head Into Earnings
This is a market in transition — and how these themes unfold will determine what happens next.
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The market is bouncing modestly on Thursday morning but several of the themes we have been discussing for weeks are hitting key junctures at the same time. Each one is at a point where it either gains momentum or starts to see reversal pressure.
This is a market in a transition phase as we await second-quarter earnings news. The manner in which these themes develop will greatly impact the market reaction to earnings.
One: The AI and Chip Selloff
The pressure on chips and AI infrastructure has been building for weeks. On Wednesday we saw a a bounce with Broadcom (AVGO) up nearly 5% on an expanded Apple (AAPL) agreement and Nvidia (NVDA) higher on reports that Chinese firms plan to increase purchases. Whether that bounce holds or fails is the question.
The margin and capex concerns that drove the selloff have not been resolved and the hyperscalers went the other way on Wednesday with Alphabet (GOOGL), Amazon (AMZN), and Microsoft (MSFT) all lower on data center spending worries.
There is a major issue concerning the pricing power of chip and infrastructure supplies and we will have far more insight into that issue as earnings reports are released.
Two: The Rotation Into Biotech
The rotational action has been the safe harbor that has prevented a deeper market correction. Biotechnology has been the standout and the group is extended now. It needs a rest and the entries are less obvious than they were a few weeks ago. If the rotation stalls, the big risk is that money that has been moving between groups goes to the sidelines instead and breadth deteriorates.
Earnings reports will help to confirm whether this biotechnology rampage is justified. I believe that there will be some very solid reports but there will be some landmines as well.
Three: The Mechanical Index Action
The mechanical moves that distorted the market action are played out. The SpaceX (SPCX) inclusion in the Nasdaq 100 was the last major event in the sequence. The Russell reconstitution and the S&P quarterly changes are behind us.
Whatever mechanical flow was pushing price action around is largely finished, which means that we are now seeing more fundamental positioning in front of earnings.
Four: Inflation and the Bond Market
The inflation theme has gained traction. Bonds are down and yields are ticking higher. The FOMC minutes from the June meeting showed some policymakers making the case for a rate hike.
The iShares 20+ Year Treasury Bond ETF (TLT) has given back its gains and looks technically poor. The bond market is telling us the inflation problem has not gone away.
Inflation is an issue that can be used to justify a broad market selloff. If downside pressure starts to build, inflation is likely to be the primary villain. We need to keep an eye on this narrative.
Five: Oil and Iran
President Trump declared the ceasefire over on Wednesday and oil moved up more than 5% and is still well above the prewar level. The energy-driven inflation concern reinforces the hawkish Fed setup at exactly the wrong moment.
The instability from the Middle East is now feeding directly into the interest-rate issue. There doesn’t seem to be any immediate resolution on the horizon so this issue will continue to disrupt the market action.
Everything Converges on Earnings
Q2 earnings season starts next week with the banks on July 14. Big tech follows the week of July 20. Every one of these themes is going to be magnified to some degree by the earnings reports. We will find out very quickly if investors are too optimistic or too negative.
When chip suppliers report we will have more information on pricing power held. When the hyperscalers report we will find out whether the memory costs are impacting their margins. When the rotation winners report we find out whether the fundamentals justify the moves they have made.
Expectations for some AI names are low right now due to margin and capex concerns. That cuts both ways. Low expectations mean less downside if the numbers disappoint. They also mean the bar for a positive surprise is lower than it has been in a year.
The uncertainty means the reports will move stocks more than usual. When positioning is unsettled and expectations are uncertain, individual reports produce outsized reactions. Add the Iranian instability and the inflation concerns on top, and the setup favors elevated volatility.
Strategy
My positioning has not changed. High cash levels and selective stock picking with a focus on the names that have their own catalysts. That approach has worked through the rotation, and it works even better when volatility is elevated.
The cash gives me the flexibility to move aggressively when the earnings reports create opportunities. Stocks that get hit on a disappointing number and then base out are the setups worth stalking. Stocks that gap higher on a strong report and hold the gain are the ones worth chasing. Neither setup exists yet. Both will appear over the next several weeks as reports hit.
The biotech names have been working and I am protecting profits rather than pressing them. The chip names are bouncing and I have no interest in trying to catch the bottom. The rotation winners are extended and need a rest before they set up again.
Patience is key right now. The information that drives the next move arrives in the earnings reports that are coming soon. Until then the market chops around while everyone positions for what they think is coming.
At the time of publication, Rev Shark had no positions in any securities mentioned.
