Traders and investors experienced an increase in trading volume this past Friday. Not exactly the increase that some had hoped for. Not even close. The public had been warned earlier in the month that there could be sizable equity outflows, globally after what had been a strong month, a strong quarter, and a strong half year for stocks.
The fact, is that market participants had already worked their way through a triple witching expirations event, an S&P index rebalancing and a Russell index reconstitution over the two weeks prior to last, and all that was really left were those funds that by mandate must re-allocate their equity and debt security portfolios on either a quarterly or month basis.
By last week, the numbers being thrown around as estimates for end of June equity outflows for US markets...had fallen to the mid-$20B's. Large enough, but certainly not HUGE as far as these things can go. It became quite apparent on Friday that traders had bunched up in the aggregate in their attempt to play the other side of pension and mutual funds forced to move capital. They ended up having to pay up in order to flatten their positions. Likely, this included a fair share of short positions. Hence, equities moved higher on Friday.
There was more to it last week than just preparing for the end of the first half, the quarter, the month, and the week. There was plenty of key macroeconomic data released, the kind of data that could potentially change the mindset of the very central bankers who set and then implement monetary policy. Then there were these central bankers themselves. They were not scattered about as they sometimes can be, and they were not out in large numbers.
However, the Fed Chair was in Europe where he spoke twice. The first of those two appearances included his colleagues that head the European Central Bank, the Bank of England, and the Bank of Japan, so this was seen as a big deal. The leaders of the "big four" central banks that at least in theory represent the planet's key free market economies.
Then, there were the Fed's stress tests for the 23 largest lenders in the US. Would all of them pass? Had the regional banking crisis or semi-crisis early this past spring changed expectations around what would be a tougher than usual simulation? Could the banks return more capital to shareholders even after having passed, as the Fed Chair had indicated that increased required reserves for the larger banks might (probably will) become reality as soon as possibly early 2024 in response to Basel III requirements?
The Federal Reserve Bank
Last Wednesday, Fed Chair Jerome Powell participated in a panel discussion held at the ECB Forum at Sintra, Portugal. The other members of the panel were ECB President Christine Lagarde, BOE Gov. Andrew Bailey, and BOJ Gov. Kazuo Ueda.
The main topic was of course, how to move consumer level inflation back toward target, and how to do so without severely damaging the pace or velocity of economic activity. To be sure, all four of these leading central bankers are coming at this problem from different angles.
The US and the European single-currency zone (The EMU) are both well into their battles with inflation and now seen as trying to discern for just how long policy will have to remain restrictive as they are concerned with how far they expect to take their respective benchmark interest rates.
The Bank of England is still more concerned with how high rates must go in order to put a dent in the pace of inflation, while the Bank of Japan really has not been put in the same position yet of having to choose between allowing economic growth to accelerate and aggressively taking on inflation.
After this discussion in Sintra and Powell's speech from Madrid, Spain early on Thursday morning, one thing is clear. The FOMC may have chosen to "skip" a month in June as far as increasing short-term rates is concerned, but he is not taking the idea of increasing the Fed's target for the Fed Funds Rate at consecutive meetings off of the table going forward, if that's what is necessary. Powell was as he always is, a master at leaving room for plenty of optionality.
Ironically, Atlanta Fed Pres. Raphael Bostic was also in Europe, speaking from Dublin, Ireland, where he expressed his more dovish views for future monetary policy. Bostic feels that the Fed Funds Rate is already restrictive enough to move consumer level core inflation back toward target over an acceptable timeframe. This is not the first time that Bostic has stated this view, and he is becoming a leader at the Fed on the dovish side of what is becoming an actual debate.
Atlanta does not vote this year, but will vote in 2024, when most interestingly enough Cleveland also happens to regain its voting rights in the Fed's rotation. Cleveland Fed Pres. Loretta Mester, for those unaware, is considered to be a leader among the Fed's hawkish camp.
Treasuries and Fed Funds Futures
Equities moved higher last week despite a slightly more hawkish sounding Jerome Powell. Fed Funds Futures markets, along with markets for Treasury securities are starting to believe the "higher for longer" mantra and have been pricing in that reality. The yields for both the US Two and Ten Year Notes moved higher during the month of June...
With the yield for the US Two Year Note (in red) more highly impacted by the Fed's likelihood to maintain its upward pressure on short-term rates than the yield for the US Ten Year (in green), readers can see that the spread between these two yields, already deeply negative, was forced to new multi-decade records almost every single day as the month wound down to its end. This next chart will illustrate the spread between the two, unlike the chart above that displays the actual yields nominally.
As Treasuries have behaved as if the FOMC will resume rate hikes on July 26th, so has the market for Fed Funds Futures. As late Monday evening was busy melting into early Tuesday morning, I see Futures trading in Chicago showing an 84% likelihood of the FOMC voting for an increase of 25 basis points to be made on that date (July 26th) to their targeted range for the Fed Funds Rate. There is currently a 16% likelihood priced in that the FOMC takes no action whatsoever on that day.
The Fed Funds Rate now stands at 5% to 5.25%. Such an increase in late July would take the FFR up to 5.25% to 5.5%. Now, though, these markets show a 65% chance for another "skip" on September 20th, but then a 60% probability for another 25 basis point rate hike on November 1st, bringing the Fed Funds Rate up to 5.5% to 5.75%.
At this time last week, these markets were pricing in a terminal rate of 5.25% to 5.5%, so this is new, and could be seen as a big deal. Should this schedule of probabilities hold into the shortened regular trading session on Monday morning, I would not be surprised to see some profit taking on what would be expected to be thin trade.
The Macro
Last week, of course, was a busy week for macroeconomic releases and most of it looked rather solid versus what had been expected. The data of late has forced many of us in the field of economics to come to terms with the fact that we had at least been quite early in our calls for a US recession, and frankly, that we may have simply been wrong. Bear in mind though, that as we see above, the US Treasury Treasury yield curve is still screaming "recession" and in fact is doing so louder than ever. There is plenty of lag still working its way through the economy, just based on what the Fed has done so far to include its quantitative tightening program.
Last Monday, the Dallas Fed Manufacturing Index surprised nobody with a dreadful print for June. That was the week's low point economically, as the picture gets much better from there. On Tuesday, Durable Goods Orders for May surprised to the upside in fantastic fashion, posting month over month growth of 1.7% at the headline, when a contraction of 1% had been the consensus call. No matter how one sliced and diced this release... ex-transports, ex-defense, or core capital goods (ex-air, ex-defense), the number printed above expectations.
Also on Tuesday, Case-Shiller showed a less drastic contraction in year over year home prices than expected for May, as Consumer Confidence for June crushed projections. The real surprise was in New Home Sales for May, where the result simply obliterated Wall Street's consensus view.
Wednesday, the Fed released their banking stress test results, which we'll get to in a minute. Then Thursday, the Bureau of Economic Analysis revised Q1 GDP from growth of 1.3% to growth of 2% (q/q, SAAR), which was a really huge pop for a second revision. That took everyone by surprise.
Finally on Friday, Personal Income for May beat Wall Street, as the University of Michigan's survey for June showed a consumer that was feeling better about his or her situation and inflation expectations that at least had held steady from the preliminary release two weeks earlier. However, Core PCE price inflation for May, which is what the Fed looks at first and foremost among data concerning inflation, printed at growth of 0.3% month over month, which was expected and at growth of 4.6% year over year, down from 4.7% a month earlier.
That might be a bit too slow of a pace for disinflation for Jerome Powell and the gang. Hence, the movement in the market for Fed Funds Futures that we have seen of late.
Stress Tests
No worries. I think that's what they tried to tell us. The Fed ran the nation's largest 23 lenders through a simulation that included a 10% unemployment rate as well as 40% declines in the value of commercial real estate among a number of other absolutely awful possibilities. The banks did take a beating in the simulation, but all 23 passed and the industry, at least in the simulation, was able to keep lending. Hey, it was a simulation.
I know and you know, that if the economy does roll off of a cliff, these kids will all stop lending in a heartbeat. Interestingly, the two worst performers in the simulation, though all did technically pass, were the US subsidiaries of two foreign-based banks, those being Deutsche Bank (DB) and UBS (UBS) .
Major banks will be watched this week for the possibility of increased returns to shareholders, especially in the form of dividends. Share repurchase programs are more than likely to be less energetic going forward in the wake of last spring's multiple regional banking failures and the coming increase in reserve requirements via Basel III. On Friday, Wells Fargo (WFC) , JP Morgan (JPM) and Citigroup (C) all announced their respective intentions to increase dividend payments to shareholders going forward.
Earnings
As readers well know, we are in between earnings seasons and have been for weeks now. For the first quarter, the S&P 500 posted "earnings growth" of -2.0% on revenue growth of 4.1% as 78% of S&P 500 firms did beat earnings expectations and 75% did beat revenue projections. Aggregate net profit margin dropped across the S&P 500 to 11.5% from the year ago comp of 12.2%. That's all old news by now.
Second quarter earnings season begins in earnest not this week, but late next week. According to data provided by FactSet, the community of sell-side analysts currently sees S&P 500 earnings growth for the second quarter at -6.8%, down from -6.4% a couple of weeks ago, on revenue growth that has stood pat for weeks at -0.4%. For the full year, consensus is for earnings growth of 0.9%, down from 1.1% two weeks ago, on revenue growth of 2.4%, as there still seems to be some kind of aggregate expectation that the fourth quarter will be able to bail out the entire year from the perspective of corporate execution.
For the second quarter, only four sectors are seen sporting contracting earnings growth from the year ago period despite the consensus headline drop overall. That said, the Energy (XLE) and Materials (XLB) sector funds are seen experiencing earnings declines of 47% and 30%, respectively. This would be a second consecutive quarter of ugliness for the Materials sector, which was down 25% for the first quarter. Discretionaries are again seen leading the way to the upside, but in far less significant fashion (+25% versus +54% for Q1).
Markets
As mentioned above, equity markets posted yet another positive week last week. The S&P 500 has now put together weekly gains for six of the past seven weeks individually, while the Nasdaq Composite has put together eight winning weeks in the past nine. There has been a bit of broadening across equity markets as smaller caps and other specialized indexes have started performing as well as, or even in some cases, outperforming high tech.
Remember several weeks back, we mentioned that the Nasdaq Composite had finally started to round at a rough 400 points above the 13,000 level that had been talked about so much and well above the 12,250-ish area that had been where there had been stiff resistance throughout this past winter into early spring? Well, the index ended last week making another run at the recent highs of just two weeks ago.
The Nasdaq Composite, again found support at its 21 day EMA (exponential moving average). Relative Strength remains almost, but not quite overbought, but the daily MACD ( Moving Average Convergence Divergence) of this index did turn negative as the index peaked two weeks ago, and now looks to be trying to curl the 12 day EMA back toward the 26 day EMA, which would flip the indicator back toward something more positive.
The S&P 500 closed out last week at its highest point since April of 2022...
Readers will see that over the past nine months or so, the S&P 500 had been developing a giant ascending triangle, which as we have mentioned in the past, is one of the most purely bullish signaling technical indicators that we have at our disposal. Based on a pivot of 4,200, a very loose target for the S&P 500, which I would still not bet the farm on, would be around 4,830. That said, a garden variety 38.2% Fibonacci retracement back to the 4,200 level is almost as likely... especially if the coming earnings season disappoints.
We see that same cup form for the Russell 2000, or in this case, the iShares Russell 2000 ETF (IWM) as we had for the S&P 500. That said, the IWM is on the verge of benefiting from a "golden cross", which is a bullish crossover of its 200 day SMA (simple moving average) by its 50 day SMA. That could come as early as Monday's opening bell depending on how stocks start the week.
Results
For the week past, the S&P 500 gained a robust 2.35%, after adding 0.84% on Friday. The S&P 500 closed the year's half-way point up 15.91% year to date. The Nasdaq Composite enjoyed yet another up week at +2.19% after tacking on 1.45% on Friday, even if this did not put this index among the week's leading indexes. This put the Nasdaq Composite up 31.73% for 2023. The Nasdaq 100 closed up 1.93% last week. The Philadelphia Semiconductor Index, as usual, was a leader last week, up 4.74% over the five day period after gaining 1.63% on Friday. The "SOX" still stands up an eye-popping 45.06% for the year.
This leaves us with the Russell 2000. The small-cap index gained a pedestrian 0.38% on Friday, but a beefier 3.68% for the week. The Russell is now up 7.24% for 2023. The KBW Bank Index, because we will continue to keep an eye on this one especially after what happened earlier this year, coming out of the Fed's stress tests and heading into earnings, had a solid week last week, gaining 3.37% after the index added just 0.22% on Friday. The KBW is now off (down) 20.47% this year.
All 11 S&P sector-select SPDR ETFs shaded green for this past Friday's session, just as all 11 also finished the week in the green. For the week, performance was easily led by the REITs (XLRE) , Energy (XLE) , and Materials (XLB) as the economy appears to be pulling further away from the likelihood of imminent recession. All three of those funds gained more than 4% last week, the REIRs more than 5%. Only three sectors, the Utilities (XLU) , Health Care (XLV) and Staples (XLP) brought up the rear, all still gaining more than half of one percent over the past five trading sessions.
According to FactSet, the S&P 500 now trades at 18.9 times forward looking earnings, up from 18.5 times just a few weeks ago. This ratio has now moved beyond the high end of the range created by its two key moving averages. The S&P 500's five year average valuation still stands at 18.6 times, while its ten year average stands at 17.4 times.
The Week Ahead
For one, this is a holiday week. Equity markets will close at 13:00 ET on Monday and will not open on Tuesday. The bond market will close at 14:00 ET on Monday and also will not open on Tuesday.
...The MacroThis week will obviously get off to a slow start, economically, as most federal agencies slow down schedules around holidays, but then this week will finish with a bang. Monday brings us the ISM Manufacturing Index (PMI) for June and May Construction Spending data. As already mentioned, Tuesday is a federal holiday. The FOMC will release the minutes of the meeting that culminated with a "skip" on June 2nd on Wednesday afternoon. Thursday will be focused on the weekly initial jobless claims number as well as the ADP (Private) Employment Report for June as well as May data for JOLTs job openings and JOLTs job quits.
Finally, Friday is indeed June "Jobs Day'', and yes, it really matters again this month. The key data for markets will, as always, be the Non-Farm Payroll number for job creation as well as the unemployment, underemployment, and participation rates. Also keyed upon will be the data for wage growth as well as weekly hours worked, which is a proxy for demand for labor that tends to lead job creation or the lack thereof.
... CorporateThere really is nothing of note in the way of conferences or trade shows headed your way this week. As for earnings, this may be one of the thinnest weeks that I have seen in my now very long career. On Thursday afternoon, we'll hear from Levi Strauss (LEVI) , and on Friday afternoon (yes, Friday afternoon), electric equipment manufacturer AZZ Inc (AZZ) will post their numbers. Other than that, there's almost nothing.
Economics (All Times Eastern)
09:45 - S&P Global Manufacturing PMI (Dec-F): Flashed 46.3.
10:00 - ISM Manufacturing Index (Dec): Expecting 47.1, Last 46.9.
10:00 - Construction Spending (May): Expecting 0.5% m/m, Last 1.2% m/m.
The Fed (All Times Eastern)
No public appearances scheduled.
Today's Earnings Highlights (Consensus EPS Expectations)
No significant quarterly earnings scheduled.
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