Q2 and H1 2023 came to close on Friday. I’ll be releasing a full deep-dive review of the quarter in the financial markets in my feed in the next few days. For the moment, suffice to say that the TL;DR for the month of June is that it was defined by higher stock index prices but with a modest narrowing of the performance gap between the Super-Cap tech stocks and the rest of the market.
Recent events in Russia have obviously injected more geopolitical uncertainty into the world, but as long as commodity prices don’t spike meaningfully higher (which they didn’t during the March To Moscow and the aftermath), the stock market is largely ignoring any Russian political volatility.
Stock markets wilted early in the week when the International Monetary Fund (IMF) came out with a statement that gave a thumbs up and a gold star to central banks around the world for continuing with their aggressive interest rate-hiking campaigns, reserving special praise for the highly-proactive European Central Bank (ECB) which reiterated again last week that it plans to regularly raise interest rates over the summer.
The world's leading central bankers from Europe, the UK, Japan and the US (including Fed Chair Jerome Powell) gathered in the pretty resort town of Sintra in Portugal to sit on a lengthy panel. They all conceded that their forceful rate-hiking campaigns are taking much longer than expected to bring inflation back down to target, forcing them all into a higher-for-longer interest rate stance.
While the respective outlooks for major economies have begun to diverge, the US currently looks best positioned to avoid a recession. Nevertheless, Powell put resuming consecutive rate hikes over at least the next two Fed meetings very much back in play, making it clear that the Fed has absolutely not switched to an "every-other-meeting" cadence. "I wouldn't take moving rates on consecutive meetings off the table at all" he said.
These were fighting words aimed at a market that finally and reluctantly seems to be coming round to the idea that maybe the Fed isn’t bluffing about not soon pivoting to rate cuts (see FEDWATCH INTEREST RATE PREDICTION TOOL below).
So if interest rates aren’t coming down any time soon, the best (only?) hope for an accelerating continuation of this stock market rally seems to be higher earnings. And that will begin to come into focus very soon as the Q2 2023 earnings season kicks off in a couple of weeks. As is the way of things, expectation-busting earnings reports will likely cause short-lived euphoria while disappointments will likely be severely punished.
Forecasts are mostly calling for a slight rise in earnings across the board, but there obviously will be outsized attention paid to what the big dogs (AAPL, MSFT, GOOGL, TSLA, NVDA etc.) and proxy stocks for economic activity (WMT, TGT, AMZN, FDX, UPS etc.) have to say. If earnings disappoint (particularly in mega-cap tech), there is definitely a downside risk to stock prices. I’ll stay on top of things there for you so you don’t have to.
Things got progressively more optimistic as the week went on.
In yet another blow to those recession truthers who bore on about how we already in a recession, the third and final estimate of Q1 2023 Gross Domestic Product (GDP) showed an annualized increase of 2.0%, a marked jump from the second estimate of 1.3%. The upward revision (along with the extremely low unemployment rate) refutes any mad idea that the US is currently undergoing any kind of recession.
Consumer confidence in June rose to the highest level since January 2022 and the durable goods numbers were consistent with the soft landing hypothesis.
Wall Street’s biggest banks passed the Federal Reserve’s annual stress test (see EXPLAINER: FINANCIAL TERM OF THE WEEK below).The 23 largest US lenders showed they could successfully withstand a severe global recession and turmoil in real estate markets, the central bank said on Wednesday.
Confidence abounded about the level of travel and hotel bookings for the July 4th holiday period
This is a market that is looking for any excuse to keep rallying and recently that excuse has been provided by some very solid economic data. If it’s this economic data that is going to help carry the S&P 500 even higher going forward, then it needs to remain really, really good. One of the problems is that it is not always that easy to define what is good and what is not-so-good.
A great example of what I mean by this was last week’s release of the highly-anticipated Personal Consumption Expenditures (PCE) price index, the measure of inflation that the Federal Reserve likes to use to make its interest rate decisions.
It cooled much more than expected, with the headline number rising just 0.1% in the last month for an annualized inflation rate of 3.8%, substantially down from 4.4% the previous month. Looks great, right? Surely, the Fed can back off now, we are charging hard towards its target rate of 2%!
However, the important Core version (which strips out volatile food or energy prices) only inched down to 4.6% from 4.7% year-over-year. This metric’s much slower pace of decline confirms just how sticky proper inflation is proving to be, once you take out the effects of wildly-swinging commodity prices. The market knows that it is this Core number that the Fed focuses hardest on when planning its interest rate policy and that the central bank likely feels that there’s still a lot more work to be done to get core inflation to move down faster.
Momentum in stocks remains higher and the previous week’s pullback needs to be viewed primarily as digestion/consolidation of a pretty intense rally that dates back to April.
The two biggest threats to this rally, as mentioned earlier, are a) an economic slowdown, and b) a downside surprise in Q2 earnings. We need to continue to monitor these data points because disappointment in one or the other - or worse still, both - does have the power to quickly erase the current giddy optimism towards stocks and potentially cause a meaningful pullback.
OTHER NEWS ..
In The Money .. Wall Street interns are getting fatter paychecks. For finance jobs across the US, median intern pay jumped 19% at sixteen top firms studied by Levels.fyi and reported by Bloomberg. At Citadel and Citadel Securities for example, median intern compensation rose 37% in the space of a year to $120 an hour. That’s $19,200 per month before taxes or the annualized equivalent of a $230k salary. Shocker; the firms received 65% more applications compared to last year.
D.I.V.O.R.C.E. .. Goldman Sachs (GS) is desperately trying to end its partnership with Apple (AAPL). The bank had recently extended its partnership with the tech firm through the end of the decade, recently agreed to support Apple’s “buy now, pay later” offering and launched a collaborative retail bank account initiative.
Now it is apparently in talks to offload those businesses and its Apple credit-card partnership to American Express (AXP) and it seems that Goldman has also discussed transferring its credit card partnership with General Motors to Amex or, frankly, to anyone else who’ll listen.
A retreat from Apple and credit cards would basically end Goldman’s consumer-lending business after it recently stopped issuing personal loans, is trying to sell off GreenSky, the home-improvement lender it bought just last year and announced that it would be de-emphasizing its Marcus savings account product (corporate-speak for: we’ll probably be shutting it down or selling it off sometime soon).
Why is Goldman scrambling so hard to bail out of this arena and consign this experiment to the garbage can? Easy. In January, the bank disclosed that it had lost about $3 billion on its consumer-banking project since 2020.
Three Trill .. Unfazed by any imminent split with Goldman Sachs, Apple saw its valuation break through the $3,000,000,000,000 level last week. Apple is now worth more than the entire UK stock market, which is itself the third largest in the world.
UNDER THE HOOD ..
Based on price action and breadth, the S&P 500 and NASDAQ-100 look solid. Therefore, if that is your entire investing world then, yes, we are in a bull market. The classic definition of a rising or bullish trend in prices is a series of higher highs and higher lows. No doubt, both these two indexes fulfill that basic requirement.
But that is where the label ends. As we move across the list of other major and minor market indexes, bull trends are almost entirely absent. Even the equal-weighted version of the S&P 500 (RSP) is in a flat range and well below its February high. A brief hope-inducing resurgence of smaller stock performance proved to be just a temporary tease.
If new bull markets are supposed to embrace risk, this is clearly not evident in the performance of the Mid-, Small- and Micro-Cap indexes, the last of which has already spent time beneath its prior October 2022 lows.
Based on decades of history, the high probability is that this weak breadth will eventually matter. Sustainable rallies have almost always depended on broad and robust participation from all corners of the market, which is not the case in at the moment.
Though against the odds, it is still possible however that the indicators will catch up to price rather than price falling to the indicators. However, until we see technical evidence of this, it’s important not to get infected with a bad case of FOMO.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
The stock market will close early on Monday ahead of the July 4th holiday and remain closed on Tuesday. Investors will return on Wednesday to a busy set of macro-economic news.
The highlights will be two big data releases related the critical matter of the state of the US labor market. On Thursday, we get the latest Job Openings and Labor Turnover Survey (JOLTS). The consensus call is for 9.9 million job openings, which would be down slightly from the previous month.
Then comes Jobs Report Friday. A gain of 212k payrolls in June is expected when the number is released before the market opens, following an increase of 339k in May. The unemployment rate is forecast to hold steady at 3.7% and average hourly earnings are seen rising an unchanged 0.3%.
Also out this week will be the minutes from the Fed's mid-June monetary policy meeting which will be closely combed through for any enhanced insight into how the committee is thinking.
LAST WEEK BY THE NUMBERS ..
Last week’s market color courtesy of finviz.com
Last week’s best performing US sector: Consumer Cyclical (two biggest holdings: Amazon, Tesla) - up 4.0% for the week.
Last week’s worst performing US sector: Utilities (two biggest holdings: NextEra Energy, Southern Co.) - down 0.4% for the week.
The proprietary Lowry's measure for US Market Buying Power is currently at 165 and rose by 9 points last week and that of US Market Selling Pressure is now at 128 and fell by 12 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 remains above its 50-day and 90-day moving averages and above its long term trend line with a RSI of 68**. SPY ended the week 7.2% 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 remains just above its 50-day and 90-day moving averages and above its long term trend line with a RSI of 61**. IWM ended the week 22.8% 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 0.2 points higher at 13.6. It remains below its 50-day and 90-day moving averages and below its long term trend line.
AVERAGE 30-YEAR FIXED RATE MORTGAGE ..
6.71%
(one week ago: 6.67%, one month ago: 6.79%, one year ago: 5.70%)
Data courtesy of: FRED Economic Data, St. Louis Fed as of Thursday of last week.
US INVESTOR SENTIMENT (outlook for the upcoming 6 months) ..
↑Bullish: 42% (43% a week ago)
↔ Neutral: 31% (29% a week ago)
↓Bearish: 27% (28% a week ago)
Net Bull-Bear spread: ↑Bullish by 15 (Bullish by 15 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 usually polled on Tuesdays and/or Wednesdays.
Data courtesy of: American Association of Individual Investors (AAII).
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.
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 (5.50%) being paid currently for the 4-month duration and the lowest rate (3.81%) for the 10-year.
The closely-watched and most commonly-used comparative measure of the spread between the 2-year and the 10-year last week fell slightly from 0.97% to 0.96%, indicating a very slight flattening of 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 deeper 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.
FEDWATCH INTEREST RATE PREDICTION TOOL ..
Where will interest rates (Fed Funds rate, currently 5.125%) be at the end of 2023?
↓ Lower than now .. 1% probability
(one week ago: 5%, one month ago: 30%)
↔ Unchanged from now .. 14% probability
(one week ago: 32%, one month ago: 34%)
↑ Higher than now .. 85% probability
(one week ago: 63%, one month ago: 36%)
What are the latest market expectations for what the Fed will announce re: interest rate changes (Fed Funds rate, currently 5.125%) on July 26th after its next meeting?
↔ No change .. 16% probability
(one week ago: 26%, one month ago: 19%)
↑ 0.25% increase .. 84% probability
(one week ago: 74%, one month ago: 53%)
Data courtesy of CME FedWatch Tool. Calculated from Federal Funds futures prices as of Friday.
ARTICLE OF THE WEEK ..
I don’t know about you, but I already know what I’ll be doing on September 22nd!! :-)
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 bank stress test is an analysis conducted under hypothetical scenarios designed to determine whether a bank has enough capital to withstand a negative economic shock. These scenarios include unfavorable situations, such as a deep recession or a financial market crash. In the United States, banks with $50 billion or more in assets are required to undergo internal stress tests conducted by their own risk management teams and the Federal Reserve.
Bank stress tests were widely put in place after the 2008 financial crisis. Many banks and financial institutions were left severely undercapitalized. The crisis revealed their vulnerability to market crashes and economic downturns. As a result, federal and financial authorities greatly expanded regulatory reporting requirements to focus on the adequacy of capital reserves and internal strategies for managing capital. Banks must regularly determine their solvency and document it.
Stress tests focus on a few key areas, such as credit risk, market risk, and liquidity risk to measure the financial status of banks in a crisis. Using computer simulations, hypothetical scenarios are created using various criteria from the Federal Reserve and International Monetary Fund (IMF). The European Central Bank (ECB) also has strict stress testing requirements covering approximately 70% of the banking institutions across the eurozone. Company-run stress tests are conducted on a semiannual basis and fall under tight reporting deadlines.
All stress tests include a standard set of scenarios that banks might experience. A hypothetical situation could involve a specific disaster in a particular place—a Caribbean hurricane or a war in Northern Africa. Or it could include all of the following happening at the same time: a 10% unemployment rate, a general 15% drop in stocks, and a 30% plunge in home prices. Banks might then use the next nine quarters of projected financials to determine if they have enough capital to make it through the crisis.
The main goal of a stress test is to see whether a bank has the capital to manage itself during tough times. Banks that undergo stress tests are required to publish their results. These results are then released to the public to show how the bank would handle a major economic crisis or a financial disaster.
Regulations require banks that do not pass stress tests to cut their dividend payouts and share buybacks to preserve or build up their capital reserves. That can prevent under-capitalized banks from defaulting and stop a run on the banks before it starts.
Critics claim that stress tests are often overly demanding. By requiring banks to be able to withstand once-in-a-century financial disruptions, regulators force them to retain too much capital. As a result, there is an under-provision of credit to the private sector. That means creditworthy small businesses and first-time homebuyers may be unable to get loans. Overly strict capital requirements for banks have even been blamed for the relatively slow pace of the economic recovery after 2008.
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