The Nasdaq is on new record highs, led by the dominant tech stocks that are building and delivering the first waves of generative AI.

Meanwhile, the Russell 2000 (small caps) is down on the year, though less so after today.  The nearly 9% divergence started to slowly close today.  The Russell 2000 was up 1.7% on the day.  Nasdaq was relatively flat.

The performance divergence isn’t just small cap related, it’s broad-based, as it was for much of last year.  If we look at the equal-weighted S&P 500, it’s up just half a percent on the year.

But remember, the performance divergence between “big tech and the rest” narrowed aggressively over the final two months of 2023.  And it was triggered by Jerome Powell’s signal that the tightening cycle was over (late October).

At this point in the New Year, the view on the direction of rates remains clear, but the view on “when” and “by how much” has changed.  The view has adjusted to two, if not three fewer cuts this year.  And that adjustment in market expectations has been deliberately manipulated by the Fed.

The higher the borrowing cost, the stiffer the headwind (at the moment) for most companies not innovating on the leading edge of the next industrial revolution.

So, with that in mind, the interest rate market is now leaning in a direction that creates the opportunity for a positive surprise.  In this case, a positive surprise would be (more) weak inflation data, which could influence the Fed to lose its “patience.”

And we have two inflation data points coming over the next five days.  Tomorrow the Bureau of Labor Statistics will publish the revisions to its CPI seasonal adjustments.  These are adjustments that can change the CPI data for the past five years.

That’s a big deal — a big enough deal for both the Fed Chair and Fed governor (Waller) to recently emphasize it as something that could “change the picture on inflation.”  They both pointed to the adjustment last year that reflected hotter than previously reported inflation data.

So, clearing that hurdle tomorrow, with no adverse adjustments to the current inflation trajectory, would be a positive for rate cut outlook. 

And then we get the January CPI report next Tuesday.