The Week in Review 7/25/22

“Successful investing is about having people agree with you… later.” – Jim Grant

Good Morning,

Headlines that suggested a slower growth environment were persistent last week, which is a “double edged sword”. On one hand, a slower economy could help stem the tide of inflation allowing the Fed to slow down or pause on raising rates. On the other hand, a slower economy could depress earnings. The markets are conflicted…

As the market sorted out this conundrum, we saw the Bulls gain control and we had a solid week!

One major casualty to the vanishing earnings argument was Snap, which went “crackle pop” in the wake of its Q2 earnings report and a poor view of conditions for online advertising.
Snap plummeted 39% on Friday.

Before the Snap news after Thursday's close, the Nasdaq Composite was up 5.2% for the week and the S&P 500 was up 3.5% for the week. They would eventually close the week with gains of 3.3% and 2.5%, respectively, while the Russell 2000, and Dow Jones Industrial Average gained 3.6%, and 2.0%.

In turn, they all reclaimed a posture above their 50-day moving average and the S&P 500 briefly traded above 4,000 on Friday after flirting with 3,600 in mid-June. This is meaningful!

Overall, it was a good week for stocks despite Friday's pullback but not quite as good a week for the economic outlook.
Specifically…

• The July NAHB Housing Market Index fell to 55 from 67, registering its biggest monthly drop on record outside of the drop seen in April 2020.
• June housing starts were weaker than expected and building permits (a leading indicator) for single-unit dwellings fell in every region.
• Existing home sales were weaker than expected in June and declined for the fifth straight month.
• Initial jobless claims topped 250,000 for the first time since mid-November 2021.
• The July Philadelphia Fed Index fell to -12.3 from -3.3, paced by a sharp decline in the new orders index.
• The June Leading Economic Index decreased 0.8%, which was the fourth consecutive decline, prompting the Conference Board to suggest that a U.S. recession around the end of this year and early next year is now likely.
• The preliminary July IHS Markit Manufacturing PMI slipped to 52.3 from 52.7 while the IHS Markit Services PMI slumped to 47.0 from 52.7 (a number below 50.0 is indicative of a contraction in business activity).

As we pointed out the conundrum… the Fed raises rates and the economy slows. Mission accomplished… now we have to deal with the growth Bears.

On top of the economic data, Apple, Alphabet's Google, Microsoft, and Snap were reported to have indicated that they plan to slow their hiring activity.

The deteriorating economic environment registered more in the Treasury market than it did in the stock market. The 2-yr note yield fell 14 basis points for the week to 2.99% and the 10-yr note yield fell 15 basis points for the week to 2.78%. The inversion, whereby shorter-dated securities yield more than longer-dated securities, is a reflection of growth concerns and is seen by some as a harbinger of a possible recession.

The “dreaded yield curve inversion”… which has coincided with all recessions in the past, but it is significant to mention, not all inversions had a recession follow.

The recession view didn't register in the stock market -- not this week anyway. The best-performing sector was the consumer discretionary sector (+6.8%), which was helped by a huge move in Tesla after its better-than-feared Q2 report, followed by the materials (+4.1%), industrials (+4.1%), information technology (+3.6%), and energy (+3.5%) sectors.

Conversely, two of the three sector losers this week were the countercyclical health care (-0.3%) and utilities (-0.5%) sectors.

It was the communication services sector (-1.2%), though, that was the worst-performing sector this week. Netflix did what it could do to lend support, rallying nicely after its better-than-feared Q2 earnings report; however, some gloomy earnings results and/or guidance from AT&T and Verizon, coupled with the retreat in Alphabet and Meta Platforms after Snap's disappointment, undercut the sector.

The stock market behaved as if the bad economic news and more challenging earnings environment heard throughout the week was not a surprise. It wasn't in one respect, as the fallout in the first half of the year was largely predicated on a belief that the stock market would be dealing with the bad economic news and more challenging earnings environment it heard about this week. The market is a forward discounting mechanism.

Aside from that, though, the stock market found a rally catalyst on Tuesday in the BofA Global Fund Manager Survey, which revealed the lowest equity allocation since the Lehman Bros. crisis and the highest cash level since 2001. This news became the focal point for a contrarian-minded approach that supported the market throughout the week.

It overshadowed the poor economic data, as well as the first rate hike from the ECB in 11 years that was more aggressive than most investors expected it would be. Specifically, the ECB raised its key lending rates by 50 basis points when the majority of market participants thought it would raise rates by only 25 basis points. The Bank of Japan for its part left its key lending rate unchanged at -0.10% (negative rates, no typo), as expected.

With clear signs of slower growth and falling long-term rates, it was the growth stocks that took the lead this week in driving the broader market's gains.The Philadelphia Semiconductor Index surged 5.5%, aided by reports that the bill that will provide $52 billion for the semiconductor industry should pass the Senate next week.

Market Snapshot…

• Oil Prices – West Texas Intermediate crude fell 1.8% to $94.58/barrel while Brent crude futures settled 0.64% lower at $103.20/barrel.
• Gold – Gold made its first weekly gain in six last Friday on a pullback in U.S. Treasury yields and the dollar’s decline. Spot gold was up 0.29% to $1,723.34 per ounce, while U.S. gold futures settled 0.8% higher to $1,727.04 per ounce. Silver finished the week at $18.325.
• S. Dollar – The dollar index was 0.1% higher at $106.73 but down 1.2% for the week. Euro/US$ exchange rate is now 1.035.
• S. Treasury Rates – The yield on 10-year Treasury note declined 12 basis points to roughly 2.76%.
• Asian shares were lower in overnight trading.
• European Markets are trading in the red.
• Domestic markets are once again higher this morning.

All eyes will be watching the Fed meeting this week and second-quarter U.S. gross domestic product data. While the U.S. central bank is expected to again raise interest rates by 75 basis points to curb runaway inflation, the GDP data is likely to be negative again. The European Central Bank (ECB) raised its interest rates by 50 bps., bringing its deposit rate to 0.00% (yes, they raised to zero), this week in order to combat inflation in the Eurozone – a smaller hike of 25 basis points was expected.

This marks a reversal in the bank’s stance on inflation. Since 2014, its key inflation rate has been held negative to incentivize banks to lend more because inflation was too low.

Inflation has certainly been increasing in the U.S, but this is the ECB’s first hike in this cycle and its first in 11 years. Russia’s invasion of Ukraine has sent energy prices skyrocketing and has resulted in massive supply disruption for most of the member nations, which has delayed the ECB's response.

We have a big week ahead… On Wednesday, the Fed will make its decision on interest rates and provide its outlook for the second half of 2022. A 75 bps. hike is still the consensus expectation but a 1% hike could be in the cards after June’s higher than expected 9.1% CPI print. On Thursday, Q2 GDP will be released. The first quarter report came in at an annualized rate of -1.6%. This quarter’s report will have to be positive for us to stay out of a technical recession.

The consensus estimate is an annualized rate of 0.4%, but several economists and the Atlanta Fed have gone against the grain and indicated that they expect negative growth for the quarter. Finally, on Thursday, the PCE report for June will be released. On top of that economic news, we will be getting earnings reports from 35% of the S&P 500.

Whew! Have a wonderful week!

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