The Federal Reserve’s recent decision to pause rate hikes has sparked discussions about the impact of more than a year’s worth of hikes on the market. While the initial outlook from this pause seemed positive, the potential for additional rate hikes soon is of particular concern for the stock market, especially technology stocks.

Understanding the interplay between the Federal Reserve’s rate decisions and their impact on the broader market is crucial for assessing the prospects of a continued bull run in the S&P 500® and tech-heavy NASDAQ®. Additionally, the ongoing AI boom has significantly influenced the tech industry, with AI technologies revolutionizing various sectors and attracting substantial investor interest.

Let’s examine the consequences of the Fed’s rate pause, its implications for the market, and the transformative power of AI in driving the tech industry’s growth.

Assessing the Impact of the Fed’s Rate Pause on the Market

In June, the Federal Reserve broke a string of 10 consecutive rate hikes, standing pat on its benchmark rate within a range of 5% to 5.25%. Fed Chairman Jerome Powell struck an optimistic tone, saying that progress was happening in the fight against inflation, but emphasized that a rate cut was unlikely until inflation significantly subsides, which could be “a couple of years out” in his estimation.¹

However, despite a sunny outlook, there are clouds on the horizon. The Fed’s “dot plot,” used to forecast rate policy, indicates two more rate hikes ahead, including one as early as July.²

The markets initially reacted negatively to the prospect of further rate hikes, taking losses after the announcement before closing with mixed results for the day. That’s because such rate hikes could pose challenges for the stock market, and particularly tech stocks. Tech companies rely heavily on low borrowing costs to finance R&D, acquisitions, and innovation. A persistently high-rate environment risks further tightening access to credit and impeding future growth.

Moreover, if history is any guide, the Fed tends to wait a considerable length of time—as long as seven months in the previous three rate hiking cycles—between rate hikes and any potential rate reductions.³ Consequently, the rate pause and possible future rate hikes play a significant role in the prospects for a continued a bull run in the S&P 500® and tech-heavy exchanges like the NASDAQ®, which have seen increased earnings thanks to the ongoing AI-driven boom in the sector.

How the AI gold rush is transforming the tech industry

Since the debut of ChatGPT in late 2022, AI has been a transformative force, revolutionizing industries and reshaping business models. From machine learning algorithms to autonomous systems, AI technologies have demonstrated their potential to enhance efficiency, productivity, and profitability.

Tech companies leveraging AI capabilities have attracted substantial investor interest, leading to soaring stock prices and market capitalizations. Since ChatGPT’s release, Microsoft and Google (which had previously approached AI research with caution) have jumped into the gold rush, integrating AI functionality into core products such as Microsoft Word and Google Search. Google CEO Sundar Pichai even mentioned “AI” 34 times in a recent earnings call, up from just five times last year.⁴

Facebook, Amazon, and Apple have also been keen to showcase their AI advancements and commitment to the technology in recent months. But perhaps the biggest winner of the AI gold rush so far is chip manufacturer Nvidia. The company’s processors, initially meant for video games, have been instrumental in training AI algorithms, and Nvidia now offers specialized products and software for AI. Nvidia announced that it expected to sell $11 billion worth of chips in Q2, beating analyst predictions by $4 billion.⁵ This surprise sent their stock surging 24% to a market valuation of $1 trillion. Nvidia’s stock is up 182% so far this year due to demand for its AI tools.⁶

Moreover, according to a Goldman Sachs senior strategist, AI-based gains in productivity could boost S&P 500® profits by 30% or more over the next 10 years.⁷ Given AI’s potential for productivity and profitability, it’s little wonder that the S&P 500® & NASDAQ® have both recently entered bull markets.

How the Fed and AI have spurred a bull run

The S&P 500® officially entered a bull market (defined as a rise of 20%+ from its most recent low) in early June, while the NASDAQ® entered bull territory in May.⁸

While the markets have reacted negatively to the Fed’s aggressive rate hikes since March 2022, the Fed has acted so aggressively because of a surprisingly resilient economy that keeps adding jobs. The market had been bracing for a recession that has so far refused to happen. The latest rate pause (while potentially brief) was certainly welcome on Wall Street.

This stubbornly hot economy has combined with record profits from Big Tech, driven by the AI boom happening since late last year. Tech giants have all outpaced the S&P 500® and the full NASDAQ®, with Alphabet (+25%), Apple (+30%), and Microsoft (+44%) delivering some of the most significant returns.⁹

And for a tech-heavy exchange like the NASDAQ®, the boom in tech earnings has been a huge win.

Big Tech and the nature of the NASDAQ®

While the S&P 500® represents a broader swath of the overall economy, the NASDAQ® composite reflects results just from stocks traded on the NASDAQ® market.¹⁰ And while tech-heavy, it will surprise many to learn that the NASDAQ® isn’t just about Big Tech.

More than 3,300 companies are publicly traded on the NASDAQ® exchange, making it the second-largest stock exchange by value and the largest electronic stock market overall. Stocks on the NASDAQ® cover a range of sectors, including energy, finance, healthcare, public utilities, technology, and transportation.¹¹ This diversification helps mitigate the risks associated with a concentrated portfolio while providing exposure to a wide range of industries.

The NASDAQ® Composite and the NASDAQ-100® are the best-known indexes within the NASDAQ®.

The NASDAQ® Composite (often what people mean when they refer to “the NASDAQ”) is a broad index encompassing thousands of companies listed on the exchange. It includes technology companies as well as companies in healthcare, finance, consumer goods, and more. This broad representation makes the NASDAQ® Composite a comprehensive barometer of the overall market.¹²

The NASDAQ-100®, on the other hand, is a subset of the Composite and is focused more closely on the tech sector. It consists of 100 of the largest non-financial companies listed on the NASDAQ®, with heavy representation (~56%) from tech giants, including Alphabet, Amazon, Apple, Nvidia, and Microsoft, amongst others. The NASDAQ-100® serves as a popular benchmark for technology-focused investors.¹³

Sources

1. Mercado, D., “Fed recap: Breaking down the market’s reaction to the Fed’s pause and all of Powell’s key comments,” CNBC, June 14, 2023; https://www.cnbc.com/2023/06/14/live-updates-fed-decision-june-2023.html
2. Matthews, S., “Fed to Pause and Keep Option to Raise Rates in July,” Bloomberg, June 14, 2023; https://www.bloomberg.com/news/articles/2023-06-13/fed-to-pause-and-keep-option-to-hike-in-july-decision-day-guide
3. Mercado, D., “Fed recap: Breaking down the market’s reaction to the Fed’s pause and all of Powell’s key comments,” CNBC, June 14, 2023; https://www.cnbc.com/2023/06/14/live-updates-fed-decision-june-2023.html
4. De Vynck, G., “The tech industry was deflating. Then came ChatGPT.” The Washington Post, June 4, 2023; https://www.washingtonpost.com/technology/2023/06/04/ai-bubble-tech-industry-outlook/
5. Ibid
6. Mozée, C., “Nvidia achieves $1 trillion market cap for the first time as AI-fueled stock surge continues,” Markets Insider, May 30, 2023; https://markets.businessinsider.com/news/stocks/nvidia-stock-price-ai-artificial-intelligence-trillion-valuation-chipmaker-gpus-2023-5
7. Daniel, W., “The A.I. boom will boost corporate profits 30% or more over the next decade, according to a Goldman Sachs senior strategist,” Yahoo Finance, May 18, 2023; https://finance.yahoo.com/news/boom-boost-corporate-profits-30-161954268.html
8. “The S&P 500 is in a bull market. Here’s what that means and how long the bull might run,” Associated Press, June 8, 2023; https://apnews.com/article/bull-stock-market-wall-street-cde5d042da6aa887e7d5ba64b62815ff
9. Ibid
10. Krantz, M., “Dow, S&P 500, Nasdaq: What’s the difference?,” ABC News, December 1, 2011; https://abcnews.go.com/Business/dow-sampp-500-nasdaq-difference/story
11. Treece, D., “What is NASDAQ?,” Business News Daily, February 21, 2023; https://www.businessnewsdaily.com/3403-nasdaq.html
12. Bajpai, P., “What is the Nasdaq Composite, and What Companies are in It?,” Nasdaq.com, May 21, 2021; https://www.nasdaq.com/articles/what-is-the-nasdaq-composite-and-what-companies-are-in-it-2021-05-12
13. Chen, J., “Nasdaq 100 Index: What It Is, How It’s Weighted and Traded,” Investopedia, December 31, 2021; https://www.investopedia.com/terms/n/nasdaq100.asp

 

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