Unfriendly Fed and Meta Disappointment
The hawkish bloc is growing, and the rotation that was absorbing the damage reversed.
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The market enjoyed a brief bounce as it digested the Federal Reserve policy statement and listened to the Kevin Warsh press conference.
Warsh was encouraging about the Fed eventually hitting its 2% inflation target, but the minute the press conference ended the selling picked up steam. The indices went from the day’s highs to the day’s lows in about 40 minutes and stayed there into the close.
It was an awful day. The Dow gave back all of Tuesday’s 537-point gain and more. The S&P 500 (SPY) fell 1.3%, the Nasdaq 100 (QQQ) dropped 3%, and the semiconductor sector (SMH) was crushed for 8%. Breadth finished at just 30% positive after running 35% at midday, and the chips were down 3.7% when I wrote at that time, so more than half of that decline came in the final hours.
On Tuesday, the money leaving the chips went into the Dow names, into pharmaceuticals, insurance and consumer stocks. On Wednesday, it came back out. The rotation that has been absorbing the damage for two weeks did not just stop working. It reversed.
Warsh Has Changed the Dialogue
While Warsh is an impressive guy and has gained the respect of many folks on Wall Street, he has a tough job. He has changed the entire dialogue of the Fed and it isn’t just a matter of being hawkish or dovish. His mission is to kill inflation and he is moving in that direction in a methodical and sober way, but he can’t do that without some pain.
Warsh was not overtly hawkish and made several optimistic statements, but there were three dissenters within the committee who wanted to raise rates a quarter point. We were watching the dissent count on Wednesday morning as the clearest signal available from a chairman who declines to telegraph anything, and three is more than expected. That view appears to be gaining traction.
The next Fed meeting isn’t until September 16 and the likelihood of a quarter point hike is now up to 57% from about 48% a month ago.
Inflation Pressure Is Not Easing
There will be a lot of data in the interim, but with oil prices spiking back up and the Iran situation still a mess, inflationary pressures are not coming down.
Semiconductors continue to crash as doubts grow about pricing power in the group. That should be disinflationary. Falling chip prices ought to make the buildout cheaper. Instead the concern about the cost of data center construction and the mountain of debt funding it keeps rising. AI infrastructure is not getting cheaper even as its components come down in price, and that will keep the pressure on inflation.
The Reports
Expectations were low going into tonight as pessimism built after the Alphabet (GOOGL) disappointment and the carnage in chips.
Microsoft (MSFT) delivered on both lines with adjusted earnings of $4.74 per share against a $4.24 consensus, on revenue of $90.01 billion versus the $87.63 billion expected. The stock is up about 4% after hours.
Meta Platforms (META) is down about 6%, and the reason is the story of this entire month. Revenue came in at $60.8 billion against expectations of $60.29 billion, so demand was fine. Earnings came in at $6.18 per share against a consensus of $7.22, a miss of roughly 14%. The demand is there and the cost of serving it ate up the profit.
That is different from what happened to Alphabet last week. Alphabet’s problem was guidance, which is spending that has not happened yet. Meta’s problem is that the spending already hit the income statement. The capex worry stopped being a forecast tonight and showed up in a reported number.
Mark Zuckerberg made the case that AI is accelerating the core business and said he is optimistic about the potential ahead. That is the same argument Elon Musk made last week about capex returns, and the same one every hyperscaler has been making. Investors have not been buying it, and a 14% earnings miss does not make it easier to sell.
The two are moving in opposite directions, which is the change. For two weeks, the Magnificent Seven have traded as a bloc, all red or all green. Tonight investors are separating them based on who can absorb the spending and still deliver earnings.
I would not read too much into the first hour either way. Alphabet was down 4% in the initial reaction last week and lost 7% the following session. Micron (MU) celebrated its blowout for a day or two before losing 30%. The reaction that matters is the one that develops over the next few days.
Game Plan
The market closed at its lows with breadth at 30% and the chips down 8%. Expectations are finally low and the selling has been broad enough to produce dislocations.
I am not doing anything right now. On Thursday, I want to see whether the Microsoft strength survives a full session and whether the names on my watch list that held up today continue to act well. If Microsoft fades the way Alphabet did, we have more work to do on the downside and the shopping list gets cheaper. If it holds, the stocks that are innocent victims in this meltdown are the opportunity.
Either outcome works for me. I have the cash and the list.
Have a good evening. I’ll see you tomorrow.
At the time of publication, DePorre had no positions in any securities mentioned.
