The week that ended this past Friday evening was active from an economics perspective, even if we're not hearing from a lot of public companies in mid-to-late June. Markets ended another "risk-on" week, with a rather "risk-off" day that still left the major equity indexes perched at some fairly lofty heights. Heights that to be held, will require another catalyst or investment theme beyond mere enthusiasm for the potential for generative artificial intelligence, or the Fed simply skipping a hike in an attempt to slow but still stiffen monetary policy from here.
The headline news last week did indeed come from the Fed as the central bank released their most recent policy statement along with their updated quarterly projections for the U.S. economy. These releases were accompanied by the FOMC press conference on Wednesday afternoon. The Fed was "sandwiched" in between a literal horde of macro-economic data-points that can and did impact not just financial markets, but the interpretation of those numbers by market participants.
The Fed
The time was last Wednesday afternoon. Investors and traders were gifted exactly what they had already priced in.
Key voting members of the FOMC had signaled ahead of the event that there would be no short-term rate hike made by the U.S. central bank in June. The question coming in was whether or not the Fed would go more for a "skip" of one meeting and move forward sounding hawkish, or go for a pause potentially lasting more than one meeting and come out of it all sounding dovish. Finesse would be required by a group seemingly more comfortable in making use of sledge-hammers than with surgical instruments.
The official statement really only made some subtle changes from what the group had published in May and came off as if the Fed were trying to maintain maximum optionality moving ahead.
However, the economic projections posted by the same group told a different tale. A hawkish tale. All Fed Governors and regional Fed Presidents are included in this "survey," so, though we refer to this release as the "FOMC" quarterly economic projections, these projections include the famous (or is it infamous) "dot plot," which really includes everyone that sits in on committee meetings, those voting this year as well as those not currently in positions with voting rights.
Using median expectations as our guide, the Fed (inclusive of those voting and those not) now sees U.S. GDP growing 1% in 2023, up from their view three months ago for growth of just 0.4%. Over those same three months, the Fed reduced their expectation for 2023 U.S. unemployment down to 4.1% from 4.5%, while also nudging expectations for headline consumer-level inflation down to 3.2% from 3.3%.
Here's where it gets a bit gnarly, gang. The Fed took their expectation for core consumer-level inflation up to 3.9% from 3.6%, and their expectation for their own Fed Funds Rate target ("own" because this they control completely) up to 5.6% by year's end from 5.1%.
To summarize: The Fed thinks that economic activity, labor market conditions and core inflation are all going to finish this year anywhere from moderately to significantly hotter than they expected just three months ago, and they -- at least on paper when expressing themselves -- expect to react accordingly, in terms of tightening monetary policy. That's not just hawkish, that's pretty darned hawkish.
Just one thing.
The marketplace did not believe the Fed. To be honest, it really did not sound very much like Fed Chair Jerome Powell was really on board with 50 basis points worth of future rate hikes during the press conference either. Remember, it was Powell who first signaled the likelihood of a June "skip" or "pause," and then two key voting members of the FOMC, Fed Gov. Philip Jefferson and Philadelphia Fed Pres. Patrick Harker, seemed to pick up the ball and move it forward.
On that thought, though Friday was a down-ish kind of day, it was no bloodbath, and it came on very heavy options expirations-related trading volume. Really, how much can we trust any price discovery that occurred on such a day?
I'll tell you what, the Fed will be out in force this coming week. If the market has the central bank wrong, they will be outspoken. Though a four-day week lies to our immediate front, do not be surprised if keyword-seeking algorithms take control of price discovery early and maintain a certain level of volatility.
Fed Funds Futures
This market reacted counter to what the Fed tried to tell us through their projections last week. That leaves this market especially susceptible to the onslaught of Fed speakers that now come our way. Once they open the cage and let them run wild, these markets will react.
As the late holiday Monday evening hours melt into early Tuesday morning, I currently see Futures trading in Chicago that show a 74% likelihood of the FOMC voting for an increase of 25 basis points to be made on July 26 to their targeted range for the Fed Funds Rate. There is currently a 26% likelihood priced in that the FOMC takes no action on that day.
The Fed Funds Rate now stands at 5% to 5.25%. That increase in late July would take the FFR up to 5.25% to 5.5%. These markets currently see this as the terminal rate, in disagreement with the Fed's dot plot, but also see this range holding through to year's end. Before getting fired up either way, understand that both the Fed dot plot and these futures markets have been rather poor predictors of where policy rates will be more than six months into the future.
Futures markets are not pricing in any first rate cut until January 2024, which might be a tough sell at the committee level as Cleveland rejoins the ranks of the FOMC's voting membership in 2024 and Loretta Mester remains one of the Fed's most ardent and influential hawks. A second rate cut at this time is not seen until May 2024, though year-end 2024 (18 months from now) is still seen with an FFR as low as 3.75% to 4%.
Macro Attack
Of course, traders, investors and the Fed all had to tackle some high-profile macroeconomic data that were released this past week, much of it having to do directly with inflation for May. May CPI hit the tape on Tuesday morning a bit cooler than expected at the headline level on both a month-over-month and year-over-year basis. Core inflation cooled as well, but more in line with expectations and has certainly proven to be far more stubborn in the pace of its descent, which is far slower.
A day later, still ahead of the FOMC's three-ring (statement, projections, press conference) circus that afternoon, May PPI was published. Producer-level inflation printed far cooler (one might say the PPI was downright frigid) at the headline both month over month and year over year. In fact, headline-level producer prices have printed in outright deflation (not disinflation) for three of the past four and four of the past six months. Producer prices have also, like consumer prices, been more stubborn at the core, but they are coming in. If producer prices do lead consumer prices (and most economists think they do), then the Fed is winning this fight with core inflation. It may have been "transitory" if we redefine what the word means when used to describe forward-looking expectations.
On Thursday, May Retail Sales did beat expectations, so there is that, but not impressively so. The hottest growth in the space were in items such as autos and building materials and not in the kinds of things that an aggressive consumer might have you picturing in your head. May Industrial Production was a disappointment and printed in outright contraction as capacity utilization declined slightly.
That said, the soft or survey-based data did seem to improve. Though the Philadelphia Manufacturing Index printed in contraction for an incredible tenth consecutive month, the New York (The Empire State) district showed some life in that space.
On Friday, the preliminary version of the June University of Michigan Consumer Sentiment Survey illustrated a picture of a U.S. consumer still mired in some pessimism, but this pessimism has indeed stopped finding new lows, and one year out inflation expectations are not only anchored, but are indeed receding.
China
China's National Bureau of Statistics released a bevy of data-points (retail sales, industrial production, fixed asset investment, employment) that showed the Chinese economy currently in much worse shape than anyone had expected and that unemployment among young people in that country had hit a record 20.8%.
The People's Bank of China (state-controlled central bank) reduced its one-year medium-term lending facility rate, after earlier in the week also cutting its seven-day reverse repo rate. Most economists who follow the region ended last week looking for a cut to the benchmark lending loan prime rate this Tuesday, which is what they got and more.
Late Monday night in New York or early Tuesday in Beijing, the PBOC cut that one-year loan prime rate from 3.65% to 3.55% and the five-year loan prime rate from 4.3% to 4.2% in an attempt to revive domestic demand for credit and re-energize that economy.
This could be a positive for Chinese stocks that trade in the U.S. and elsewhere, but could also be seen as a stimulant globally, though not to the degree that such action taken by the Chinese central bank would have had prior to the pandemic. This might also be seen as disappointment as these cuts may not have been aggressive enough to accomplish much of anything.
Off Season
We are in between earnings seasons. 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 beat earnings expectations and 75% beat revenue projections. Aggregate net profit margin dropped to 11.5% from the year-ago comparison of 12.2%.
Now, we turn our attention to the second quarter, where professional opinion is for something significantly uglier than what we saw during the first quarter. Still using one-week-old data provided by FactSet, the pros see S&P 500 earnings growth for the second quarter at -6.4% on revenue growth of -0.4%. For the full year, consensus is for earnings growth of 1.2% on revenue growth of 2.4%, as there appears to be some kind of massed expectation that the fourth quarter will be strong enough to bail out the entire year from a corporate performance perspective.
For the second quarter, only four sectors are seen sporting contracting earnings growth from the year-ago period despite the consensus headline year-over-year decline. That said, the Energy (XLE) and Materials (XLB) are seen hitting a brick wall. That would be the second consecutive quarter of ugliness for the Materials sector. Discretionaries are again seen leading the way, but in far less significant fashion than we saw last quarter.
Second-quarter earnings season will not begin in earnest until the second week of July. JPMorgan Chase (JPM) , Wells Fargo (WFC) and Citigroup (C) will all report on Friday, July 14.
Marketplace
Equity markets posted yet another positive week over the past five trading sessions. The S&P 500 has now put together five consecutive "up" weeks, and as if that's not enough, the Nasdaq Composite has now posted eight straight green weekly candles.
There has been some belief that the recent market success has started to broaden, and there is some evidence of that, as the S&P 500 and equal-weight S&P 500 are running neck and neck over the past three months (though not close together over six months).
Check this out. S&P 500 vs. equal-weight S&P 500 over six months:
Now, look at this. S&P 500 vs. equal weight S&P 500 over three months:
The chart, above, may take many readers by surprise given the way this topic is covered in the financial media. Does this mean that away from market capitalization and sector allocation, that much of the market still needs to catch up? Or is moving in sync, but not quite catching up going to be enough?
That said, in general terms, the semiconductors outperformed their Nasdaq siblings last week, as the Nasdaq siblings outperformed the S&P 500, and they all outperformed the small-to mid-cap stocks.
Remember last week, I told you that the Nasdaq Composite had finally started to round roughly 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 stiff resistance throughout winter into early spring? Well, (so much for that) that index now has a chance to round again about 800 points above that 13,000 level. This index closed out last week at its highest end of week level since April 8th, 2022.
Will the Nasdaq Composite try to consolidate here? Fed speak and the algorithms that react to their spoken words electronically, will likely make that determination. The 21-day exponential moving average (EMA) for this index does need a chance to catch up. The Relative Strength Index still looks almost, but not quite overbought and the daily Moving Average Convergence Divergence (MACD) of this index still shows the 12-day and 26-day EMAs converging toward each other well above the 9-day EMA base.
Market Recon readers from Friday will find these charts familiar. Readers will see here that the S&P 500 moved from really moving almost sideways the week prior to last... back to breakout mode last week.
However, when stepping back a tad, we see that over the past nine months or so, the S&P 500 had been developing a giant ascending triangle, which is one of the most cut-and-dry 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 not bet the farm on, would be around 4,830.
Point is, that there could be some room to run, after we get through some volatility this week. All bets are off should a recession strike later this year.
Readers will also see here that the Russell 2000, or in this specific case, the iShares Russell 2000 ETF (IWM) , above, continues to find support at the upper trendline from its range-bound price channel that lasted from mid-March into early June. Holding that line is key to the "catch-up" thesis.
The Numbers
For the week past, the S&P 500 gained a robust 2.58%, after giving back just 0.37% on Friday. The S&P 500 closed the past week up 14.85% year to date. The Nasdaq Composite enjoyed yet another up week at +3.25% despite a selloff of 0.68% on Friday. This put this index up 30.79% for 2023. The Nasdaq 100 closed up 3.82% last week and is up 37.88% for the year. The Philadelphia Semiconductor Index, after one "down" week coming into the week prior to last, has now posted back-to-back winning weeks, gaining an impressive 4.2% over the past five sessions, even after giving up 0.94% on Friday. The "SOX" now stands up a still stunning 45.06% for the year.
This leaves us with the Russell 2000. The small-cap index surrendered 0.73% on Friday, but still managed to post a weekly gain of 0.52%. The Russell is now up 6.49% for 2023. The KBW Bank Index, because we will continue to keep an eye on it for the time being, had a lonely week last week, closing almost in isolation, in the red. The KBW Index gave up 0.7% on Friday, flipping the week into the red overall at -0.54%. The KBW is now off 19.04% year to date.
Only three of the 11 S&P sector-select SPDR ETFs shaded green this past Friday, but 10 of the 11 finished the week in the green. For the week, performance was easily led by growth and certain cyclical sectors. Technology (XLK) led the way, up 4.33% over the five trading days, followed by Materials (XLB) and Discretionaries (XLY) , both of whom were up more than 3% for the week. Only Energy (XLE) closed out the week in the red, at -0.58%.
According to Dow Jones, the S&P 500 now trades at 20.12 times forward-looking earnings. I have not seen if FactSet is still showing a 19 handle, I think that may be the case. Either way, 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 as of 10 days ago was still at 18.6 times, while its 10-year average still stood at 17.3 times.
The Week Ahead
The Macro
The flow of macroeconomic data cools off a great deal this week. With only four days on the calendar, May Housing Starts on Tuesday will be followed by Existing Home Sales for May on Thursday. This will give the week something of a housing market feel.
The Conference Board will release their index of Leading Indicators for May on Thursday as well. Finally on Friday, S&P Global will release the preliminary or "flash" versions of their June U.S. PMI surveys for both the Manufacturing and Services sectors of the economy.
You May Need Ear Plugs
Correction. You will need ear plugs. Right now, there are 14 public appearances to be made over these four days by Fed officials. There will likely end up being more than that as some appearances will probably be announced after the week begins. No, this is not normal. The Fed is not usually out and about during shortened holiday weeks. "They" definitely have something to say.
Of course, the headline events of the week will be Fed Chair Jerome Powell's twin testimonies before the House Financial Services Committee and the Senate Banking Committee this Wednesday and Thursday mornings.
Now, here's where you have to pay attention. St. Louis Fed Pres. James Bullard speaks ahead of the opening bell on both Tuesday and Friday morning. Cleveland Fed Pres. Loretta Mester speaks on Wednesday afternoon, Thursday morning and Friday afternoon.
Really? Two of these 14 appearances are mandated. That's Powell. Five of the other 12 are by the two most hawkish members of the Fed.
Wear your helmets, gang and buckle those chinstraps. I don't see any John Waynes among us.
Corporate
Earnings are very light this week, even lighter than last week. There are, however, a couple of well known (or at least you may have heard of them) firms that will be reporting their quarterly numbers.
FedEx (FDX) will report after the close on Tuesday, followed by Winnebago (WGO) on Wednesday morning and KB Home (KBH) on Wednesday afternoon. On Thursday morning, we'll hear from Accenture (ACN) , Darden Restaurants (DRI) , and FactSet Research (FDS) . Finally, CarMax (KMX) will put their numbers to the tape on Friday morning.
Economics (All Times Eastern)
08:30 - Building Permits (May): Expecting 1.429M, Last 1.417M SAAR.
08:30 - Housing Starts (May): Expecting 1.4M, Last 1.401M SAAR.
The Fed (All Times Eastern)
10:00 - Speaker: St. Louis Fed Pres. James Bullard.
11:00 - Speaker: New York Fed Pres. John Williams.
