Investment Insights

 — Steve Orr 

Almost

Mid-July is upon us. Can we say summer is halfway over? We wish the election season were halfway over, but this being the Republican convention week, it’s just gearing up. The secular Bull market for stocks is not over, but last week’s choppy action was a prelude for the next several weeks.

Last Monday, the S&P 500 and NASDAQ, both home to big tech stocks, set new records as earnings season neared. Tuesday and Wednesday traders focused on Powell’s testimony before Congress. Then Thursday’s soft CPI print created a head-turner of a day as traders bought anything Not Magnificent 7. How many hundreds of trading days had it been since small company stocks outperformed big tech? We ran out of time counting before going to press. After-action reports from the front lines showed that flows did not appreciably change on Thursday. A lot of the buying appeared to be the result of computer algorithms chasing the soft print headline, as opposed to a real trend change. Sure enough, Friday’s price action saw big tech back in the driver’s seat, as though Thursday never happened.

A daily blow-by-blow is not our usual style, so why now, you ask? Two reasons: 1) This earnings season has a lot of good news baked into stock prices to generate those 9% year-over-year gains. Expect a repeat of last quarter’s activity — day-to-day choppiness while traders decide if earnings outlooks warrant current price multiples. 2) Traders are looking for any excuse to get ahead of rate cuts. The thinking is that any lowering of short-term rates will let smaller and more levered companies refinance, etc. Like my father used to say when I would ask for the car keys: “Maybe, maybe not.” You should also expect more of these “false rotations” until the Fed actually says they are cutting rates.

Almost deflated

The “soft” CPI report was just the headline, as June’s initial reading came in at negative 0.1%, its first negative reading since May 2020 at the height of the shutdowns. Disinflation is almost here! Cheer falling prices! Cue our favorite Corso phrase, “not so fast, my friend.” That headline negative print was largely driven by gasoline prices, which fell from May to June. Since the survey period in June, wholesale gasoline has risen 6%. Overall CPI continues to rise at 3%.

Core CPI strips out gas and food. We think food and gas are core to our existence, but the Bureau of Labor Statistics thinks differently. Stripping rent out of Core CPI, the remaining basket of services is rising at a mere 1% rate over the past six months. Remember that some components are always above, and some are below the growth rate of the headline. We expect June’s reading to be revised higher in the next couple of months. 

Almost 2

The Fed’s favorite gauge of inflation is the Personal Consumption Expenditure Price Index. June’s reading will come out on the 26th. The PCE shares many components with the CPI, but at slightly different weights. It has been running at a 2.6% rate over the past year and 2.8% the past six months. A dip to 2.5% would send traders begging to the Fed for a rate cut.

In an interview Monday, Fed Chair Powell stated that the FOMC is gaining greater confidence that inflation is on a path to 2%. He reiterated a recent shift in the Committee’s focus to the job market. Any further slowdown in the economy would push unemployment toward the Fed’s 2022 goal of 4.5%. The transportation from 3.1% two years ago to 4.5% unemployment today would be around 1.5 million jobs lost. Not something we would want for anyone.

Is the economy shifting from first gear down to second? The real GDP rate in the first quarter of 1.4% looked like first gear to many. What matters is the series Real Final Sales to Domestic Purchasers. This series focuses just on the U.S. portion of GDP without imports. It is running above 2.5% and should stay around that level. So, the economy, while not as vibrant as two months ago, should avoid a recession. 

Let’s go.

Earnings season is here. The big three banks reporting Friday did OK on the income statement but left traders disappointed in their outlook for the rest of the year. Citi, Wells Fargo and JPMorgan Chase all reported better than expected earnings, but traders took profits after the group had run close to 20% gains this year.

Goldman, BlackRock, PNC and Bank of America continue the financials sector parade this week. JB Hunt and Steel Dynamics will shed some light on transportation and industrial activity. Forty-six names from the S&P 500, putting 10% of the index in the books. At 9% growth over the second quarter last year, earnings look good so far.