As I’ll show in a moment, earnings and economic data last week generally propped up the case for a soft landing for the US economy and should have been celebrated, but the stock market seemed jumpy and afraid of its own shadow - seizing on anything negative it could find.
There’s a downside to the current high level of economic strength. In something of a return to the old “good news is bad news” narrative of 2021 and 2022, solid evidence of stronger growth was viewed suspiciously as possibly fueling inflation, maybe prompting the Fed to raise interest rates higher or at least hold them high for longer. These concerns are severely pushing up market interest rates (Treasury yields). This is being reflected in more new recent highs in mortgage rates (see AVERAGE 30 YEAR FIXED MORTGAGE below).
Rising yields are also a problem for stocks, because investors will be tempted to rotate out of riskier equities and into less-risky bonds because the additional expected return in stocks maybe isn’t worth the extra volatility. Rising risk-free payouts in Treasury bonds are simply getting too rich and tempting for many to resist.
Are traders rethinking the one year + inversion of the yield curve? The benchmark 10-year Treasury note interest rate is moving substantially higher and at a faster rate than the 2 year, leading to a flattening of the curve (see US TREASURY INTEREST RATE YIELD CURVE below). The 10 year closed the week at 4.26%, having earlier touched its highest level since that well known crypto shill Soulja Boy suggested that we all crank that in October, 2007.
When it comes to interest rates, it’s no longer how high that matters though, it’s how long for. The market is always looking for what’s next, for what’s over the horizon. With the Fed almost certainly done (or almost done) with rate hikes, what comes next is rate cuts and the question then becomes: when? Current consensus is that the first cut will either be at the March 2024 Fed meeting or, perhaps more likely, the May 2024 one.
The week began with a raft of negative China headlines, the Wall Street Journal even speculated that this may be “China’s Lehman moment” (see EXPLAINER: FINANCIAL TERM OF THE WEEK below). Real estate firm Country Garden suspended trading in select offshore bonds on Monday and Zhongzhi Enterprise Group, one of the country’s biggest private wealth managers, missed payments on multiple high-yield investment products, reminding investors of the Chinese property market volatility from a few years back and reinforcing that recession risks in China could be very real. Portfolios with heavy exposure to emerging markets are already being affected.
Data last week showed that the US consumer economy and housing market are doing just fine. Americans’ spending is still outpacing inflation. Retail sales soared by 0.7% in July, a bigger burst of spending activity than economists had anticipated. The strong spending came as consumers spent more at online retailers (+2%, helped by Amazon Prime Day), restaurants (+1.4%), sporting goods stores (+1.5%) and clothing shops (+1%).
US industrial production reversed a two-month decline with a 1.0% increase in July, per a Federal Reserve survey.
There's still a nationwide shortage of homes available for sale, keeping prices elevated, but builders are ramping up activity. July Housing Starts hit 983k, 9.5% up on a year ago. New-home construction and related activities can have multiplier effects throughout the economy.
The latest estimate from the Atlanta Fed GDPNow (which I will now be tracking weekly in this report, see LATEST GROSS DOMESTIC PRODUCT (GDP) GROWTH ESTIMATE FOR THIS QUARTER below) is that Q3 GDP growth in the US will be a mind-boggling 5.8%. For context, the growth for both Q1 and Q2 was well under half that.
Minutes released last week from the last Fed meeting which unanimously agreed to resume the campaign of interest rate hikes after a one-meeting break, suggested that there may be at least one more rate hike penciled in for the cycle. Most of the participants still saw a "significant" risk of continued above-target inflation, however at least two members appeared to voice an opinion that raising rates may not have been necessary. Bullish investors would have liked the objections to have been a little more robust.
Quarterly results and guidance from Target (TGT), Walmart (WMT), Home Depot (HD), Cisco (CSCO), Applied Materials (AMAT) were all well received, while those of Agilent (A) disappointed.
Are we seeing just a consolidation in a still-upward trending market or the start of a more significant pullback? As things stand, I’m still in the camp of calling it an appropriate consolidation and pause in an uptrend, caused by the sheer speed and relentlessness of the March-July rally.
The Three Pillars of that rally that I always talk about (1. No Landing / Soft Landing, 2. Disinflation, 3. Fed Done/Almost Done with Rate Hikes) are still in place and will likely prevent a really nasty decline from happening as long as they persist, but we need something new to push meaningfully forward and right now we just aren’t getting it.
Investors have had time on their hands to focus on things like the Chinese economy, the 10 year Treasury rate, dysfunction in Congress, inflation still being above target etc. During the rally, none of these relatively mild negatives would have been top of mind, but traders are now fixating on them because there are no big new positive catalysts. This is what is behind the difficult market conditions of the last two or three weeks.
So what are the catalysts that could lead to a resumption of the rally? ..
1. Treasury yields (market interest rates) declining modestly. We don’t want them to collapse, as that’d signal a hard landing. But a slow drift lower, especially in the 10 year, could help reverse that traffic moving from stocks to short term treasury bonds. This could come from either Fed Chair Jerome Powell confirming that the Fed is done with rate hikes, more in-line economic data and/or a continued decline in inflation readings.
2. Better than expected earnings. So far so good, earnings season has been generally positive. The biggest of them all, the Nvidia (NVDA) announcement this Wednesday, will be absolutely crucial. The company’s blow-out earnings ignited the summer rally and another strong report will help boost S&P 500 earnings expectations.
3. A change in sentiment. Negative sentiment was the unsung hero of the 2023 rally, as January’s strongly negative expectations never materialized, leaving money managers having to chase stocks higher. Now, it’s flipped, where higher stock prices are the consensus expectation. If the market continues to modestly pull back, then sentiment can become more negative and that can ironically be a springboard to the resumption of the rally.
4. Surprise good macro news. An improvement in the US/China relationship, large-scale Chinese economic stimulus, some kind of a ceasefire in the Russia/Ukraine war would all provide a surprise boost and reduce global recession chances and that would help lift stocks.
The bottom line is that the outlook for markets remains solid as long as those Three Pillars remain in place, but we need something new to kick start the rally back into gear because currently the market is just treading water and growing tired doing so. It will likely remain susceptible in the near term to any kind of unpleasant news, however modest.
OTHER NEWS ..
Just One Letter .. Single letter ticker symbols are the stock exchange’s equivalent of corporate vanity plates. They bestow a degree of Wall Street cred. AT&T has long had the ticker T, which is short for its original main product, the telephone. Citigroup (C), Ford (F), Macy’s (M), Kellogg (K) and Visa (V) are among the other one-letter firms. US Steel, the world’s first billion dollar capitalization company, has been the proud owner of the X ticker symbol for over a hundred years. Elon Musk is weirdly obsessed with that letter and probably has one jealous eye on it for if and when he ever decides to take the company formerly known as Twitter public again.
If US Steel is purchased by Cleveland-Cliffs (CLF), as is being rumored, it is possible that Cleveland-Cliffs would decide to switch its ticker symbol to the better-known X, rather than keep its rather lame existing one. But if US Steel is bought by Esmark or another private company or an overseas-listed company like ArcelorMittal, the X ticker symbol could become available.
According to the strict rules that govern the use of ticker symbols (yes, there are such things), if a company is taken over, it can hand over or release its ticker symbol or else hold on to it for a maximum of 24 months. There are still a handful of single-letter ticker symbols still available out there: I, N, P, Q and Y are all up for grabs.
UNDER THE HOOD ..
The S&P 500 index SPX closed on Friday at 4370, down over 2% for the week. The next upside resistance points are to be found at 4420, 4452 and 4464. Downside support levels are at 4332, 4320 and 4297.
Since the beginning of August, shorter term technical indicators have retreated from their prior overbought levels to what could soon be considered to be an oversold state. While the market works off these overbought conditions caused by the March-July rally, a rotation out of those heavily-weighted mega-cap technology names which have propelled the major price indexes higher so far in 2023, is likely to produce some headwinds to these indexes in the near term, not least because nearly 29% of the S&P 500 Index is comprised of the Technology sector.
We are also witnessing something of a loss of support from the small-cap segment. The most obvious problem is small-cap price underperformance relative to the rest of the market indicating that the small-cap engine is running out of fuel. The good news is that the longer-term indicators have not yet reversed course, which suggests that the current price slide is part of a digestion process following months of gains.
However, a key takeaway for investors during this shaky phase is that this rotation from growth into the previously-lagging more value-oriented sectors and industry groups could end up being a strong positive for markets in general as it has both simultaneously contributed to the major price indexes’ recent pause but also cushioned the decline.
The technical data emanating from the stock market still justifies a positive intermediate-term outlook, but with ample short term caution.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
The majority of Q2 earnings season is over, but there are still some technology and retail names left to report this week, including the massively important report from Nvidia. Focus will also be on any news from the annual jamboree of monetary policy thinkers and practitioners in Jackson Hole, Wyoming.
As well as Nvidia on Wednesday, earnings reports will come out from, among others, Lowe’s, Zoom Video, Intuit, Snowflake, Dollar Tree, Bath & Body Works, Advance Auto Parts, Nordstom and Ulta Beauty.
The 2023 Economic Policy Symposium will be in full swing from Thursday through Saturday in Jackson Hole. This year's topic will be "Structural Shifts in the Global Economy." Fed chair Jerome Powell is scheduled to address the conference on Friday.
Economic releases will include Existing Home Sales and New Home Sales data and the Durable Goods report.
LAST WEEK BY THE NUMBERS ..
Last week’s market color courtesy of finviz.com
Last week’s best performing US sector: Energy (two biggest holdings: Exxon Mobil, Chevron) for the third week in a row - down 0.8% for the week.
Last week’s worst performing US sector: Consumer Cyclical (two biggest holdings: Amazon, Tesla) - down 4.5% for the week.
The proprietary Lowry's measure for US Market Buying Power is currently at 151 and fell by 10 points last week and that of US Market Selling Pressure is now at 137 and rose by 11 points over the course of the week.
SPY, the S&P 500 Large Cap ETF, is made up of the stocks of the 500 largest US companies. It is now below its 50-day moving average but still above its 90-day and its long term trend line, with a RSI of 35***. SPY ended the week 8.6% below its all-time high (01/03/2022).
IWM, the Russell 2000 Small Cap ETF, is made up of the bottom two-thirds in terms of company size of the group of the 3,000 largest US stocks. It is now below its 50-day moving average but still above both its 90-day and its long term trend line, with a RSI of 35***. IWM ended the week 23.9% below its all-time high (11/05/2021).
*** RSI (Relative Strength Index) above 70: technically overbought, RSI below 30: technically oversold
The VIX, the commonly-accepted measure of expected upcoming stock market risk and volatility (often referred to as the “fear index”) implied by S&P 500 index option trading, ended the week 2.5 points higher at 17.3. It is above its 50-day and 90 day moving averages but still below its long term trend line.
AVERAGE 30-YEAR FIXED RATE MORTGAGE ..
7.09%
(one week ago: 6.96%, one month ago: 6.78%, one year ago: 5.13%)
Data courtesy of: FRED Economic Data, St. Louis Fed as of Thursday of last week.
LATEST GROSS DOMESTIC PRODUCT (GDP) GROWTH ESTIMATE FOR THIS QUARTER ..
Q3: +5.8%
(Previous .. Q2: +2.4% provisional .. Q1: +2.0% final)
This data comes from the Atlanta Fed which periodically issues its GDPNow model “now-cast”, which is a running algorithmic estimate of real seasonally-adjusted GDP growth for the current measured quarter based on multiple data points of recent economic releases. There are no subjective adjustments made to GDPNow—the estimate is based solely on the mathematical results of the model.
FEAR & GREED INDEX ..
“Be fearful when others are greedy and be greedy when others are fearful.” Warren Buffet.
The Fear & Greed Index from CNN Business can be used as an attempt to gauge whether or not stocks are fairly priced and to determine the mood of the market. It is a compilation of seven different indicators that measure some aspect of stock market behavior. They are: market momentum, stock price strength, stock price breadth, put and call options, junk bond demand, market volatility and safe haven demand.
Extreme Fear readings can lead to potential opportunities as investors may have driven prices “too low” from a possibly excessive risk-off negative sentiment.
Extreme Greed readings can be associated with a sense of “FOMO” and investors chasing rallies in an excessively risk-on environment, possibly leaving the market vulnerable to a sharp downward correction at some point.
Data courtesy of CNN Business.
AAII US INVESTOR SENTIMENT (outlook for the upcoming 6 months) ..
↑Bullish: 36% (45% a week ago)
⬌ Neutral: 34% (30% a week ago)
↓Bearish: 30% (25% a week ago)
Net Bull-Bear spread: ↑Bullish by 6 (Bullish by 20 a week ago)
For context: Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Net Bull-Bear spread: Bullish by 8
Weekly sentiment survey participants are typically polled on Tuesdays and/or Wednesdays.
Data courtesy of: American Association of Individual Investors (AAII).
FEDWATCH INTEREST RATE PREDICTION TOOL ..
What are the latest market expectations for what the Fed will announce re: interest rate changes (Fed Funds rate, currently 5.375%) on September 20th after its next meeting?
⬌ No change .. 89% probability
(one week ago: 90%, one month ago: 85%)
↑ 0.25% increase .. 11% probability
(one week ago: 10%, one month ago: 14%)
Where will interest rates (Fed Funds rate, currently 5.375%) be at the end of 2023?
↓ Lower than now .. 9% probability
(one week ago: 8%, one month ago: 13%)
⬌ Unchanged from now .. 60% probability
(one week ago: 59%, one month ago: 62%)
↑ Higher than now .. 31% probability
(one week ago: 33%, one month ago: 25%)
Data courtesy of CME FedWatch Tool. Calculated from Federal Funds futures prices as of Friday.
US TREASURY INTEREST RATE YIELD CURVE ..
The interest rate yield curve remains “inverted” (i.e. shorter term interest rates are generally higher than longer term ones) with the highest rate (5.55%) being paid currently for the 3-month duration and the lowest rate (4.26%) for the 10-year.
The closely-watched and most commonly-used comparative measure of the spread between the 2-year and the 10-year fell from 0.73% to 0.66%, indicating a flattening in the inversion of the curve during the last week.
Historically, an inverted yield curve has been regarded as a leading indicator of an impending recession, with shorter term risk deemed to be unusually higher than longer term. The steeper the inversion, the greater the deemed risk of recession.
The curve has been inverted since July 2022 based on the 2 year vs. 10 year spread.
Data courtesy of ustreasuryyieldcurve.com as of Friday.
ARTICLE OF THE WEEK ..
Before your child goes to college, you should complete these six important documents
EXPLAINER: FINANCIAL TERM OF THE WEEK ..
A weekly feature using information found on Investopedia to try to help explain Wall Street gobbledygook (may be edited at times for clarity).
A “Lehman Moment” describes a point at which one company’s problems become everyone’s problems.
The term refers to the late 2008 bankruptcy of global investment bank Lehman Brothers, which many see as the turning point when the problems of U.S. investment banks became the world’s problems.
Following the bankruptcy, the U.S. government stepped in with a massive bailout package to rescue the entire financial sector, especially investment banks and insurance companies.
The contagion spread, and it became the 2008 global financial crisis.
In the early 2000s, banks and other financial institutions began offering mortgages to borrowers who historically would not have qualified, such as people with poor credit, people who could make only a small down payment, or those who applied for loans beyond their means to pay. These loans were referred to as subprime.
Banks were able lend to these people for two reasons:
Banks created new investment products into which they pooled the loans and then sold to investors, dramatically reducing their own risk by passing it on.
Housing prices were rising steadily, so even if borrowers could not keep up with mortgage payments, they could easily sell at a profit and pay off the mortgage or simply borrow more against the now-higher market value of the property.
When price rises began slowing, it became more difficult for borrowers to sell at a profit or to refinance. Mortgage losses began to rise.
By early 2007, leading subprime mortgage lender New Century Financial filed for bankruptcy. Shortly thereafter, large numbers of mortgage-backed securities were downgraded to high risk, and more subprime lenders closed.
As investors began to shun subprime mortgage products, lenders stopped writing mortgages for subprime borrowers, which cut demand for housing; this, in turn, caused house prices to fall further.
Borrowers suddenly could no longer simply sell or refinance, and when the value of their homes fell below what they owed in mortgage payments, many simply walked away.
By the summer of 2008, the Federal National Mortgage Association (FNMA, commonly known as Fannie Mae) and the Federal Home Loan Mortgage Corp. (FHLMC, commonly known as Freddie Mac), both quasi-government lenders, had incurred losses so large that they needed to be bailed out by the federal government.
Lenders began making it even more difficult for homebuyers to borrow, which pushed down housing prices even further. With foreclosures climbing, even more homes were offered for sale, increasing supply in an already oversupplied market.
By early 2008, the problems began hitting the nation’s largest financial institutions. In March 2008, the Bear Stearns Cos. notified the Federal Reserve Bank that it would not have enough financing to meet its obligations. As one of the largest securities firms in the U.S., with assets of nearly $400 billion, Bear Stearns’ problems rattled the market.
The Fed offered financing to keep Bear Stearns afloat, and when that did not work, it brokered a deal for Bear Stearns to merge with JPMorgan Chase, committing some $29 billion to make the deal happen. The bailout meant Bear Stearns avoided default and bankruptcy.
Six months later, Lehman Brothers Holdings, at the time the fourth-largest investment bank in the U.S. by assets, filed for bankruptcy.
The S&P 500 fell some 5% on the day of the Lehman bankruptcy filing. Shortly thereafter, a major money market fund that held large amounts of Lehman debt announced that it would not be able to repay its investors all the money they had put in, causing a run on money market funds, which prompted the Fed to step in to guarantee money market fund assets.
Despite efforts to stabilize the market, less than 48 hours after Lehman filed for bankruptcy, the Fed was forced to bail out global insurer American International Group (AIG). The S&P 500 fell a further 5%.
Several weeks later, with the contagion spreading, Congress passed the Troubled Asset Relief Program (TARP), which provided some $700 billion to stabilize the financial system.
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