Last week was the turning point for the markets
Last week, I suggested that we might be at a turning point where the bearish consensus is finally starting to head higher after realizing that earnings, economic growth and the Fed’s rate-hike cycle are not not as bad as feared. Considering that we just crowned the stock market’s best performing month since November 2020, I’d say voila. The broad-based rally was led by four of the five mega-cap tech stocks, which still account for nearly a quarter of the value of the S&P 500. Earnings and outlook reports were well received by Apple, Amazon, Google and Microsoft, while Meta Platforms, otherwise known as Facebook, was the only disappointment. While second-quarter GDP fell again, meeting the vague definition of a recession, consumer spending remained resilient. The Fed raised rates by 75 basis points, but Chairman Powell acknowledged that we are making progress in slowing growth, which has reduced expectations for rate hikes later this year. If we can see a significant drop in headline inflation numbers for July, which will be released in August, this bear market bounce could turn into a baby bull market.
We are halfway through the earnings season and the results are impressive, given the headwinds. According to FactSet, the earnings beat rate for the 56% of S&P 500 companies that reported was 73%, with all 11 sectors seeing year-over-year revenue growth of 10% or more. More importantly, the index’s earnings growth rate in the second quarter has risen from 4% at the start of the month to 6% today. The revenue growth rate increased from 10.1% to 12.3%. The gains are not as bad as feared. The most encouraging aspect of this earnings season is that estimates for the rest of this year and next are down, but stock prices continue to rebound. This is largely because valuations have fallen below their 5- and 10-year moving averages. This sets a much more realistic bar for beats moving forward.
The recession debate may continue after last week’s negative impression, but the group of eight economists who make up the National Bureau of Economic Research’s committee and decide are likely to say the expansion continues. Indeed, their definition of a recession is “a significant decline in economic activity that spreads throughout the economy and lasts for more than a few months.” The key word here is “spread,” which I believe cannot be satisfied when consumer spending, which accounts for 70% of the economy, rose in the first and second quarters of the year. Moreover, the labor market was strong. In fact, the six factors used to make the official decision have shown an expansion since the start of the year. There is no recession.
The reason this debate is relevant is that bear market declines that are accompanied by an official recession are much worse and last longer than those that are not. Therefore, if we can conclude with a high degree of certainty that we are not in a recession, as I am doing, then the likelihood of the June low being the ultimate low increases significantly. Bear markets not accompanied by recessions last an average of four months and achieve declines of 22%. We exceeded both in the first six months of this year. Bear markets, in concert with recessions, decline on average about 37% and last more than a year. The GDP report was not as bad as feared because the source of the weakness was inventories and housing rather than the engine of economic growth, consumer spending. This is why the market reacted favorably.
While there was a lot of trepidation about last week’s rate hike by the Fed, which led to back-to-back 75 basis point increases in the fed funds rate to a range of 2.25 to 2.5%, stock and bond markets eagerly awaited expectations. inflation and the possibility of further rate increases. Both eased, which is why risk assets rallied. Again, it wasn’t as bad as feared.
Investors now see short-term rates peaking in the 3.25-3.5% range after a 50 basis point rate hike in September and two 25 basis point hikes in November and December. These are followed by a rate cut in May. This is a lower peak rate than expected just a few weeks ago, and this is due to the rapidly slowing rate of economic growth and lower inflation expectations.
While the base rate of the Personal Consumption Expenditure (PCE) price index appears to have peaked, the nominal rate which includes food and energy has yet to prove it.
I think that will happen in August with the headline inflation reports for July. Oil prices have fallen sharply over the past 60 days, along with several other hard and soft commodities. Year-over-year comparisons become much more difficult for crude oil as we enter the fall months, which is when oil hit $85 a barrel. What was equivalent to a 100% year-over-year increase would drop to around 25% at today’s prices.
Sector performance last week was as supportive of growth as the previous week, with cyclical sectors outperforming defensive sectors. In my opinion, this indicates a soft landing that translates into a slight increase in the rate of economic growth as the end of the year approaches. It depends on whether the inflation rate comes down and the Fed rate hike cycle ends this year.
Now, a word of caution, because while I hailed last month’s rally and the growing likelihood of June marking the bear market bottom, I don’t want to see major equity indices return to their January highs anytime soon. . The reason for this is that the second half recovery is based on the porridge not being too hot or too cold, but just right. The surge in stock and bond prices over the past month has resulted in a significant easing of financial conditions, which is NOT what the Fed wants to see at this point. If the US economy is to thread the needle toward a soft landing, we need to see very gradual improvements rather than a renewed speculative fervor that has helped drive price increases. Pullbacks that result in higher lows will be the glue that keeps the uptrend going.
In addition to more than 100 companies in the S&P 500 report this week, we have the jobs report for July on Friday, which needs to calm down in terms of the number of new jobs and wages in order to control inflation expectations.
We’re very close to what I consider overhead resistance at 4,150-4,200 on the S&P 500, so I wouldn’t be surprised to see a pullback towards the 50-day moving average at around 3,900 from current levels. .