This commentary was excerpted from the weekly roundup sent to subscribers of Action Alerts PLUS, a charitable trust co-managed by Jim Cramer and Jack Mohr. Click here to learn about this actively traded stock portfolio.
Despite a strong start to the week and an upbeat feeling throughout the market on Thursday, stocks ultimately finished the week on a sour note after the Friday decline that followed the U.K.'s decision to leave the European Union (i.e., Brexit). While Friday's downtick in equities was hard to stomach, our historically high cash balance helped protect the Action Alerts PLUS portfolio and offers us the opportunity to selectively add to our positions. We ultimately will look for lower levels as we wait for the market to fully digest the unknown implications of the Brexit.
Treasury yields slumped lower this week as investors fled toward safety following the Brexit vote; the dollar strengthened against the euro in similar fashion, and gold was stronger as well. Both West Texas Intermediate (WTI) and Brent crude fell lower on Friday despite a relatively flat week prior to the U.K. referendum.
First-quarter equivalent earnings were relatively mixed, but somewhat positive compared with expectations, as 72.3% of companies have surprised to the upside vs. estimates.
On the economic front, although data at the beginning of the weak were light, Fed Chair Janet Yellen testified before Congress on Tuesday and all but waved a figurative white flag by acknowledging the slow-growth, low-rate trajectory of the U.S. economy just may be the new norm. With seven years of disappointing U.S. growth behind us, and what appears to be an increasingly dour future ahead of us (marked by deteriorating productivity and weak job creation domestically and myriad risks externally), the Fed finally admitted that it lacks a crystal ball, lest the ability to provide a credible outlook around economic growth.
This should not come as much of a surprise, nor does it mean all is lost; rather, it confirms that the Federal Reserve is not as smart as the FOMC has led us to believe. Its previously emphatic arguments around the "temporary" nature of external headwinds and heavy reliance layered with high conviction around its own forward guidance have been replaced by a far more sober reality, with Yellen conceding headwinds may be persistent and forward guidance around inflation unreliable.
With the Fed constantly shifting its policy stance, inflation timeline, interest rate policy and forward guidance, conventional wisdom is no longer relevant. Yellen this week confessed the FOMC no longer views its own forward guidance as credible. While we view this as a step in the right direction -- an inevitable tipping point -- we fear that by ceding control the Fed may cast doubt on its prior decisions and blunt its ability to influence outcomes in future decisions. The conventional wisdom only works when the central bank has credibility: In other words, its ability to manage expectations is only as powerful as its ability to deliver on its promises and follow through on its prior guidance.
In our view, the rate hike conversation should be placed on hold until there is clear, convincing and sustainable evidence that our economy can increase productivity, create jobs and deliver adequate growth in both real and nominal incomes over the long term.
On Wednesday, the National Association of Realtors reported that sales of existing homes climbed 1.8% in May from April to a seasonally adjusted rate of 5.53 million, marking the fastest pace since 2007 and beating expectations for a 1.1% increase. The surge is very encouraging for the housing market given that existing home sales make up roughly 90% of total sales (new-home sales comprise the rest). The positive figure also adds to recently reported, better-than-expected retail sales data, providing a slightly more upbeat view of the economy. Overall, sales were up 4.5% from last year, adding another positive to the story. Recall that existing-home sales reached their highest total figure last year since 2006. Impressively, sales are expected to continue to rise above that number throughout this year. Demand is expected to remain strong by continued low mortgage rates and solid wage growth.
To that point, however, the strong demand in the housing market -- which has provided a boost to the economy and helped offset slowdowns in other areas (e.g., the energy sector) -- has not been met by equal levels of supply. The national median sale price for an existing home, in the latest report, was shown to have been $239,700, up 4.7% from last year and the highest figure ever recorded since the National Association of Realtors began keeping track. Notably, the rise in home prices is outpacing wage growth across the country, raising some skepticism about the potential longevity of the housing market's strength. The persistently low inventory numbers (2.15 million existing homes were available for sale at the end of May, down 5.7% year over year) could be taken as a sign that builders are unsure of the environment moving forward, or that they simply have not been able to keep up with rising levels of demand. We will continue to monitor the housing market as its strength has been key to holding the economy in place.
The Department of Labor reported on Thursday that initial jobless claims for the week ending June 18 dipped to 259,000, which was 18,000 claims lower than the previous week's revised figure and 11,000 lower than expectations. The number is the lowest we have seen since March, when jobless claims hit a 43-year low. Claims have remained below 300,000 -- the threshold typically used to categorize a healthy jobs market -- for 68 straight weeks, which remains the longest streak since the early 1970s.
The four-week moving average for claims (used as a gauge to offset volatility in the weekly numbers) fell by 2,250 claims to 267,000, maintaining historically low levels. Importantly, the four-week moving average of claims declined by 8,750 throughout the May-June survey periods, implying relatively strong job growth throughout the period. Recall that nonfarm payrolls increased by the smallest amount since 2010 on the May report. We get the June jobs report on July 8.
On Friday, we finally got the news the market was waiting for -- the outcome of the U.K. referendum. Despite upbeat sentiment throughout the week that pointed toward a potential win for the "Bremain" camp, the Brexit camp ultimately emerged victorious, rattling markets across the globe. Along with the people's decision to leave, Prime Minister David Cameron noted he will honor his pledge to step down from his position.
As the results began to trickle in overnight, it became clear which way the scale was tipping, erasing the positive sentiment after Thursday's relief rally, which was sparked by increased hopes for Bremain.
The uncertainty that accompanies this decision will continue to haunt investors, paralyzing the market and putting a stake through any near-term optimism that had accumulated over the past week or so. In the near term, the dollar will continue to appreciate, oil will be pressured and volatile (which, in turn, will flow through to equities) and Treasury yields will decline as global investors turn to the U.S. as a safe haven because we are least impacted.
We cannot expect the markets to correct themselves all in one day. There are still several unknowns, and while the people have spoken, we still await what this will definitively mean for trade agreements, jobs in the U.K. and international relations. Recall that under Article 50 of the Treaty on European Union, a member state's decision to leave the EU begins a two-year exit process. We are not saying the pain will last for two years, but there are further elements of confusion set to unwind as the exit process moves forward.
On the commodity front, crude oil prices remained relatively flat for the week heading into the Brexit vote, but were hammered lower on the open on Friday. Oil inventories were reported to have declined on Wednesday, but by a smaller amount than expected (900,000 barrels vs. forecasts for a 1.6-million-barrel draw). That being said, continued global outages, curbing the oversupply of crude in recent weeks and months, supported prices from any significant dip.
Then we moved from Thursday night into Friday morning and received word of the U.K.'s decision to leave the EU. On this news, the euro and pound depreciated, resulting in a stronger dollar and downward pressure on crude oil prices. With volatility in the broader markets expected to heighten in the coming days, we expect crude oil to oscillate as well. Similar to last week, we continue to watch rig counts to get an idea of the recovery timeline in U.S. production.
Moving onto the broader market, first-quarter earnings were disappointing, but somewhat positive compared to estimates. Total first-quarter earnings growth was down 6.7%; of the 409 non-financials that reported, earnings growth was down 6.7% vs. expectations for a 7.1% decrease. Revenues decreased 1.5% vs. expectations throughout the season for a 1.38% decline; 72.3% of companies beat EPS expectations, 20.4% missed the mark and 7.3% were in line with consensus. On a year-over-year comparison basis, 59.2% beat the prior year's EPS results, 37.8% came up short and 3% were virtually in line. Health care, materials and consumer staples had the strongest performance vs. estimates, whereas financials, telecom and utilities posted the worst results in the S&P 500.
Next week, 11 companies in the S&P 500 are set to report earnings. Key reports for the broader market include: Carnival (CCL), IHS (IHS), Nike (NKE), Acuity Brands (AYI), General Mills (GIS), Monsanto (MON), Pier 1 Imports (PIR), ConAgra (CAG), Constellation Brands (STZ), Darden Restaurants (DRI), McCormick (MKC), Paychex (PAYX) and Micron (MU).
