Last Wednesday it finally happened – the Federal Reserve restarted interest rate cuts by lowering its benchmark interest rate by 0.25%.
Fed Chair Jerome Powell specifically cited rising risk to the labor market as the key driver behind the first Fed rate cuts since December 2024. This move brought the federal funds target rate down to a range of 4.00% to 4.25%.
In the official policy statement, the central bank acknowledged its assessment of the labor market had changed, indicating “downside risks to employment have risen.” This is a notable shift. In the past, the focus seemed to remain almost solely on unknown inflation risks.
This change, while arguably a little late, is supported by recent job data. What’s especially important, recent, and noticeable, is the difficulties small businesses (0-249 employees) are having finding workers:
The percentage of small firms with unfillable job openings fell to 32% in August from the month before, hitting the lowest level since July 2020. For smaller companies in hiring mode, 81% claimed there are few or no qualified applicants for the positions they're trying to fill.
Worse For the Economy When Small Businesses Are Struggling
It appears labor tightness is the key catalyst to propel the Fed to announce the quarter-point cut last week. So, the most important takeaway regarding the employment data is that it’s worse for the economy when small businesses are struggling to fill job openings in comparison to big companies.
Small business’ strength has been key to the underlying foundation of our economy. According to the U.S. Bureau of Labor Statistics, since 2022 small companies have hired more aggressively than big businesses and were responsible for about 52.8% of total net job creation between 2021 and 2024’s second quarter.
Through May, small businesses were hiring more than they were laying off. But as you can see in the chart above, that trend started to flip in June.
Small business hiring strength matters for the economy because history shows employment growth among small businesses has been less sensitive to business cycles than larger companies. Thus, the trend reversal is the underlying data the Fed referred to last week to support the rate cut.
More Rate Cuts, Less Inflation Worry
Looking forward, the latest FOMC Summary of Economic Projections showed most Fed officials foresee another 50 basis points of cuts to come by the end of the year:
Notice the downward median movement. The central bank is signaling its intent to transition from its previous “recalibration policy” to more of a risk management policy.
It’s almost as if there’s a sense that the potential employment risk warrants a kind of insurance of sorts to cover the downside.
This pivot from inflation is aligned with the recent significant decrease in inflation mentions on earnings calls. Corporate executives are not discussing it as much:
Specifically, on S&P 500* earnings calls from June 15 – Sept. 12, the term “inflation” was only cited on 178 earnings calls. This reflects a quarterly decline of 24%, after “inflation” was cited on 235 earnings calls the previous quarter:
The current number is below the five-year average of 267 and the 10-year average of 195. Perhaps most importantly, this quarter marked the lowest number of inflation mentions in earnings commentary since 2020.
Now that we’re again officially in a rate cut environment, the question becomes how do the markets react?
Well, last Wednesday the S&P 500 had a mixed reaction, almost seeming not to know how to interpret the news and commentary as its return bounced around 0.23% to -0.78%, ultimately ending the day almost flat at -0.10%:
It’s hard to pinpoint exactly why the market reacted that way. Regardless, it’s more important to analyze how the markets reacted following last Wednesday (i.e.-positively) and what we may expect looking out over the next six to 12 months.
While last Thursday and Friday the market perhaps restarted its upward climb, it’s imperative for us to analyze the data to find objective clarity looking out over the next year.
“Big Money,” Tech, and Data-Based Bullishness
Our data has guided us to remain bullish overall this year. What’s it saying now?
Technology has been an obvious driving force behind the market’s recovery since roughly April of this year. Will tech continue to lead?
First, let’s see how money flows reacted on the day of the rate cut announcements. As you can see, tech saw the most “big money” inflows last Wednesday – almost a third of all buys:
We think this is notable because while the market price itself had significant internal volatility and couldn’t decide where it wanted to go, when you look under the hood, overall equity inflows outpaced outflows at a 2.4 ratio. On Sept. 17, there were 149 “big money” signals, with 105 being inflows and 44 being outflows:
This shows how the top-level underlying data was strong from an inflow standpoint, even though the price point on the S&P 500 seemed to go nowhere. Even further, technology led the inflows, which reflects continued cyclical growth bullishness on behalf of “big money.”
This shouldn't be new information for anybody regarding technology strength. It’s been the theme for months. There's been significant strength in technology flows going back to April 17:
In that time, there have been 1,715 equity inflows versus just 464 equity outflows. That’s lead to a ridiculous 7.9% ratio.
The continuing inflow strength within tech last Wednesday as a reaction to rate cuts is significant. It indicates that we can expect more of the same strength moving forward.
We now know where the money has been flowing. Let’s end with three strong data points showing how rate cuts support further tech growth.
The most important subsector of technology currently is semiconductors due to its fundamental importance in the AI revolution. So, the first bit of data to highlight is that if we look back to 1995, the fourth quarter is historically the best quarter for semiconductors:
That’s an average gain of 7.83%. It’s also notable that the worst performing quarter has been the third quarter, which is coming to a close and hasn’t experienced the same typical weakness this year.
Second, we want to see a fundamental data catalyst to encourage future growth, and that happened in the recently ended earnings season. It was fantastic and future earnings are expected to continue to grow exponentially:
The fundamentals always come down to earnings. Given the current AI super cycle that we’re in, we could see some huge gains if earnings stay strong.
Lastly, again going back to 1995, when the Fed cuts rates and the economy isn't in a recession, the forward 12-month average return for semiconductors is a staggering 71.6%:
Understanding this objective data has provided an opportunity that we've been able to take advantage of this year. This conviction has been reflected in our growth models allocation we set earlier in the year, where we overweighted tech stocks:
Based on objective data, we believed tech would justify this overweight positioning within our growth models this year. It has thus far and the data currently indicates there is room to grow from here.
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