Latest / Bull Market Conversations with Fexingo: Rallies, Momentum, and Riding Market Strength / Why the Bull Market Is Dismissing the Risk of a Rate Hike
Transcript
- Lucas: The S&P 500 is at 7,412. The Dow just crossed 51,900. By almost any measure, this bull market still has its legs. But if you look under the hood, there's a pretty interesting disconnect developing. Luna: You're talking about the Russell 2000, right? Down about a tenth of a percent over the last five days while the big caps push higher? Lucas: Exactly. And that alone is worth a conversation. But what I'm really watching is the bond market's signal on rates. We've got oil prices ripping higher — you saw the headlines this week — and the odds of a Federal Reserve rate hike have surged. The CME FedWatch tool is pricing in a meaningful chance of a hike by September. Luna: Which is interesting because the effective Fed funds rate has been flat at 3.63 percent for over a month now. The market was expecting cuts, not hikes. So what changed? Lucas: Oil, for one. Crude has spiked on supply concerns and strong demand. That feeds into headline inflation, which the Fed still watches closely. And then you've got the AI spending story — Moody's just put out a note warning that the 'unprecedented' capex from Amazon, Meta, and Alphabet is threatening their credit quality. These are the very names that have led this bull market. Luna: So on one hand, the market is celebrating big tech's AI investment. On the other, rating agencies are saying it could hurt their balance sheets. And the Fed might have to respond to oil-driven inflation. That's a lot of crosscurrents. Lucas: Right. And the interesting thing is that equity markets are basically shrugging it off. The S&P barely blinked this week. There's a narrative that the Fed won't actually hike — that they'll look through the oil spike as transitory or that geopolitical factors will keep them on hold. The market is betting on a soft landing. Luna: But the Russell 2000 isn't buying it. Small caps are more sensitive to interest rates and credit conditions. The fact that they're lagging tells me some investors are hedging their bets. Lucas: Exactly. And that divergence between large-cap growth and the broad market is exactly what we saw in the early stages of previous tightening cycles. If the Fed does end up hiking, the high-multiple names — the ones that have ridden this AI wave — could be the most vulnerable. Their valuations assume low rates forever. Luna: Let's talk about that Moody's warning specifically. They said Amazon, Meta, and Alphabet are spending at levels that are 'unprecedented' relative to their cash flows. How serious is that? Lucas: It's serious in the sense that these companies are issuing debt to fund AI infrastructure. Their leverage ratios are creeping up. Moody's isn't saying they're going to default — these are still investment-grade credits — but the trajectory is worth watching. In a rising rate environment, that interest expense becomes a bigger drag on earnings. Luna: Which would make them less attractive to the growth at any price crowd. And we've already seen episodes on how growth stocks can become a trap in a bull market. Lucas: Right. So the question is: is the market correctly looking through this, or is it being complacent? The bull case says that AI spending will generate returns that far outweigh the cost of capital. The bear case says we're in a capex arms race that ends with a lot of overcapacity and debt. Luna: And then add the oil shock on top. It feels like a lot of 'ifs'. Lucas: It is. But markets are forward-looking. They're saying the probability of a rate hike is real but still below 50 percent. And even if it happens, it might be a one-and-done — 25 basis points to cool inflation expectations, then hold. The real economy is still strong. GDP growth was 2.1 percent annualized in Q1, and nominal GDP is over 31 trillion. Luna: So the bull market is effectively saying: we can handle a small hike, oil will stabilize, and AI spending will pay off. That's a pretty confident bet. Lucas: It is. And confidence is what drives bull markets. But the Russell 2000's sluggishness is a caution flag. Small caps are a better proxy for Main Street, and they're not feeling the same euphoria. If that divergence persists, it could be a sign of a top-heavy market. Luna: So where do you come down? Are you in the camp that says the market is right to dismiss the hike risk, or do you think there's more danger than the indices suggest? Lucas: I think the biggest risk is that the oil spike proves sticky and forces the Fed's hand. If we get a 25 basis point hike in September, I don't think it kills the bull market. But it will reset the narrative. The easy money era is over, and the market has been acting like it's still 2021. A rate hike would be a reality check. Luna: And if the AI spending does lead to credit downgrades, that could compound the pressure on those mega-cap names. Suddenly the leaders become laggards. Lucas: Exactly. And that's the kind of regime change that catches most investors off guard. But for now, the bull market is alive and well. It's just a little bit selective. Luna: Speaking of being selective, I appreciate that this show doesn't try to be everything to everyone. We focus on the stories that matter. Lucas: Yeah, and that's actually part of our philosophy. We deliberately don't run ads on these conversations. If you find value in the way we break down the numbers and the narratives, and you want to support keeping it ad-free, there's a simple way. Luna: Just head to buy me a coffee dot com slash fexingo. No pressure at all. It just helps us keep doing this without selling your attention to sponsors. Lucas: Right. And it genuinely makes a difference. So back to the market — if we do see a rate hike, what would you watch first? Luna: I'd watch the Russell 2000. If it starts to rally on a hike, that means the market thinks the tightening is over. If it drops, that's the confirmation that the bull market is narrowing. Lucas: Good point. And I'd watch the bond market's reaction. The two-year Treasury yield is the most sensitive to Fed policy. If it spikes and stays high, that tells you the market expects more than one hike. That would be a bigger risk for equities. Luna: So stay diversified, maybe add some value or small-cap exposure as a hedge, and keep an eye on oil prices. Lucas: That's a solid takeaway. The bull market isn't over, but the easy part might be. The next leg will be about picking your spots carefully.