The first week of "earnings season" is in the books. Primarily, the large financials led the way. As a group, one would have to admit that the season is off to a good start. Yet, one would also have to admit that market internals have eroded quite severely from within, as not only market participants, but U.S. consumers themselves appear to be losing faith. Losing faith not just in the equity market's ability to keep on keepin' on, but in the economy's ability to do so as well.
It's not so much that equity markets floundered last week, it would be that equity markets sold off across all market caps and for the most part all non-defensive sectors. It would be that our domestic large-cap indices closed on Friday at the lows of both the session and the week. It would be that according to Refinitiv Lipper US Fund Flows that for the week ended July 14th (last Wednesday), domestic equity funds (ex-ETFs) reported net outflows of $3.078 billion, a third consecutive weekly aggregate withdrawal, while net inflows for all taxable bond funds amounted to $4.746 billion. The charts tell us that these trends likely extended through Friday.
Back to sector performance. There is no way to disguise investor sentiment when, for the week, the four defensive sectors take the top four slots easily led north by Utilities (XLU) as investors placed a premium upon yield. By the same token, the five cyclical sectors took the bottom five slots, led lower by Energy's (XLE) 7.9% smackdown. With OPEC+ agreeing to crude oil production increases over the weekend, I would expect to see Energy stocks melt a little more this (Monday) morning.
The Russell 2000 has posted three consecutive weekly declines, just like those fund outflows. When do cyclicals and small to mid-cap stocks turn for the better? When investors believe that the economy has more room to run would be my quick answer. Yes, earnings are going to be outstanding this reporting season. Unfortunately, as we know, or at least have been led to believe since we were the ones going out for coffees and cigarettes (that's how old I am) for our employers twice a day... is that markets are forward looking.
Where Is Here?
A week from this Thursday the Bureau of Economic Analysis will publish the agency's first estimate for second quarter U.S. economic growth. We all know as most of the nation engaged in some kind of re-opening activity during the months of April, May and June of this year, that growth will appear robust. Of course there is a huge base effect in play. Of course much of this growth was less than organic, supported by either the federal government or the "independent" central bank. Most economists are now expecting a print with a Nine handle (quarter over quarter, annualized and then salted and peppered according to taste).
Facts are facts, and data are data. We have plenty of both. We think. Well, we have plenty of data. Let's go with that. Last week, the Bureau of Labor Statistics published a red hot report for June CPI, up 5.4% at the headline led by used cars and up 4.5% at the core, led by everything else. The very next day, the same BLS told us that red hot was even redder and even hotter at the producer level. On Thursday, the Federal Reserve published June Industrial Production data that disappointed. That left June Retail Sales for Friday. The Census Bureau tallied that performance. They went to the tape with month over month growth of 0.6% at the headline. An outright contraction had been expected. At the core (ex-autos), retail sales screamed 1.3% higher month over month. The good old U.S. consumer would save us again. Markets rejoiced. For a minute, maybe two or three.
Just one thing. Okay, two things. First, the May estimates for retail sales were revised significantly lower for both the headline and core levels. This made June's "growth" considerably less impressive. Second, and this is incredible. As we understand, retail sales are reported in dollar amounts. Hang with me, just so I don't steal someone else's work... As David Rosenberg of Rosenberg Research points out (which I read about in Randall Forsythe's weekend column in Barron's.), that 0.6% increase in retail sales was all inflation. Sales measured in actual volumes of goods were lower for June from May. Gut punch.
Can you picture what will be?
So limitless and free
Desperately in need
Of some stranger's hand
In a desperate land
- (credits below)
Here and There
So, here we are. Each and every large-cap equity index stands close enough, even after a tough week to all-time records. The Treasury yield curve has flattened considerably as the long end folded over on itself. Obviously enough investors are either embracing the Fed's "trenaistory" inflation narrative or they see growth as well past peak. Maybe both. Maybe not. That's called stagflation, gang... and for you young 'uns... it pucks. The S&P 500 still trades at 21.4 times forward looking earnings. Peak earnings on peak growth. Factset tells us that Wall Street now expects to see Q2 earnings growth of an incredible 69.3% year over year on revenue growth of 20.2%. Recall that above, GDP is expected to print with a Nine handle.
All as we know that very early here in the third quarter, margin has contracted, the consumer faced with higher prices has become more disciplined, and the macroeconomic data showed less activity toward the end of that quarter. Now, to be sure, our sponsors... the federal government and the central bank are not going away. Yes, the weekly federal stipend to state level jobless benefits is set to run out in September, but the Treasury is currently shoveling out more helicopter money to households with children. That said, the future of fiscal policy is anything but sure. Yes, extremely large (and probably extremely irresponsible) spending plans are being bandied about and negotiated on in our nation's capital. There remains a possibility of more cash for more folks for... eva, and no ability to fund such outlay. There also remains a possibility of something passing legislatively that is much smaller than is being discussed. Equity markets would not take that well.
Then there's inflation and our friends at the Fed. Talk about a tough spot. Suppose that at least some of the inflation... Let's say the parts of these price increases created around wage growth (lower margin) and shelter are stickier than the parts created around shortages caused by kinks in supply chains. All inflation has to do is outpace wage growth to cause problems. Now, let's say that the central bank goes ahead and plans a methodical withdrawal of accommodation not next Wednesday, but at Jackson Hole in August... As real cracks show in the macroeconomic story, as inflation remains uncomfortably above trend if not meteoric, and as the federal government cuts off weekly payments to those receiving jobless benefits.
Lastly, and perhaps most importantly... There are the Delta and Lambda variants of the SARS-CoV-2 virus that causes COVID-19. No telling how much these variants constrict economic activity going forward. Obviously the unvaccinated are playing with fire. Not just their own fire, but everyone's. Even the vaccinated face the increased possibility of infection the longer the nation and the planet remain under-vaccinated. Bottom line... The Fed could possibly end up being forced to tighten monetary policy into weakness. Other than that, the coast is clear.
It hurts to set you free
But you'll never follow me
The end of laughter and soft lies
The end of nights we tried to die
This is the end.
- Morrison, Densmore, Manzarek, Kreiger (The Doors), 1967
Economics (All Times Eastern)
10:00 - NAHB Housing Market Index (July): Expecting 82, Last 81.
The Fed (All Times Eastern)
Fed Blackout Period.
Today's Earnings Highlights (Consensus EPS Expectations)