Wentz Weekly Insights
Busy Week Ahead As Earnings Reports Ramp Up and Fed Meeting Concludes
Stocks bounced last week for another positive week despite ending the three-day winning streak on Friday with the day’s 0.93% decline. Earnings have taken front and center stage and will continue to do so in the week ahead. There were several disappointments including Netflix losing a more than expected one million subscribers and AT&T and Verizon saying it is taking customers longer to pay their bills along with higher costs pressuring the bottom line.
But the biggest earnings headline came Friday from Snap (parent company of Snapchat) with a nearly 40% drop after suspending its guidance and saying revenue was trending flat in the current quarter. It was just several weeks ago that the company forecasted a 20%+ growth in the quarter. Some even took it as a more broad warning. Advertising spend is one of the items on a company’s expense budget and if there is pressure on the top or bottom line, advertising is one of the easiest and quickest expenses a company can cut and could been seen as the first area impacted if companies come under cost pressures. We will watch to see if this is part of a broader trend.
As of Friday, almost one-quarter of S&P 500 companies have reported with an earnings growth rate of 4.3% year-over-year, driven by cyclical stocks like energy, materials, and industrials that benefit from a rise in prices like we saw in the second quarter. The gains in these sectors were offset by weakness in financial with a 39% contraction in earnings primarily due to a large build in loan loss reserves as banks prepare for potentially bad loans.
The other headwind over the past several months, particularly for global companies that do business outside of the U.S., has been the strong dollar. The dollar index is at its strongest in two decades as foreign capital flows to the U.S. to buy dollar denominated assets. When this happens the demand for the dollar increases which increases its value. Many executives in conference calls have cited it as a drag on second quarter results with the expectation it will continue in the current quarter. When the dollar rises in value relative to other currencies it makes imports of foreign goods cheaper for U.S. consumers and businesses but makes U.S. exports more expensive abroad and less competitive, a potential hit to U.S. exporters. Yardeni Research estimates 40% of S&P 500 earnings come from abroad and, all else being equal, a 11% increase in the dollar (like we have seen this year) decreases S&P 500 profits by approximately 4.4%.
Despite these mixed results and economic worries, operating margins have remained strong. Second quarter margins are currently at 12.8%, ahead of the 12.7% expected at the start of the quarter and ahead of the long-term average of 9.9%, but still below the 13.0% margin a year earlier, which was the highest in years. While margins have been resilient, this week should provide more color on cost pressures with about 50% of the S&P 500’s market cap reporting, including from at least 175 S&P 500 companies, among others.
The other major event this week is the FOMC meeting that concludes Wednesday, so what should we expect? We believe it will be more uneventful than the prior meeting with the Fed raising rates 75 basis points again (one basis point is one hundredth of a percent, or 0.01%). There was a brief period two weeks ago where markets were beginning to price in a full percentage point increase after the very hot CPI report that showed 9.1% inflation, but a recent survey showed inflation expectations fell and that may have been enough to convince officials to stick with the 75 bps move instead of acting more aggressively. The focus will be on Chairman Powell’s press conference where we think he will reiterate the Fed’s intention on getting rates to a neutral level but our focus will be on his assessment of the current economic slowdown and how it will affect Fed policy, especially with markets beginning to price in the first rate cut near the beginning of 2023 over recession worries.
Week in Review:
Markets got off to a solid start to the week Monday after a WSJ article noted the Fed is likely to hike 75 basis points rather than a 100 bps increase the market was beginning to bet on. However, the rally quickly faded with stocks moving lower and trading to session lows into the close with the S&P 500 down 0.84%. The reversal appeared to have begun after a Bloomberg report said Apple was planning to slow hiring and spending growth next year due to economic uncertainty.
Stocks moved sharply higher on Tuesday and closed near the highs of the day. There was no specific reason for the move higher but most believe it was due to the pullback in the dollar (it was up 11% so far in 2022, but pulled back about 1.5% over the past several days, a large move for a currency) along with a Bank of America fund manager survey saying capitulation could set the stage for a stock market bounce. In economic data news, housing starts and permits were in line with estimates and relatively unchanged from the previous month. All sectors participated in the rally with growth outperforming as the NASDAQ gained 3.11% and the S&P 500 rose 2.76%, while Treasury yields remained steady.
Netflix was the highlight after the bell Tuesday after it reported Q2 results where it lost more subscribers than expected, but its guidance showed less subscriber gains in Q3 than expected. Housing data showed existing home sales fell for the fifth consecutive month, although remain above the 5 million annualized pace. After closing above the 50-day moving average Tuesday for the first time since April, stocks found support at those levels Wednesday and bounced higher with riskier sectors (tech, consumer discretionary) leading the way again. The S&P 500 closed 0.59% higher while the NASDAQ gained 1.58%.
Jobless claims showed an uptick in the latest week on Thursday morning while several more earnings report were released with mostly mixed results. In international news, the European Central Bank raised rates by a larger than expected 50 basis points, while the Bank of Japan left rates unchanged at 0%, bucking the global trend of raising rates to fight inflation. In positive news out of Europe, Russia resumed natural gas flow through the Nord Stream pipeline to Europe, although at a lower volume, that supplies the region with one-third of its natural gas imports. Even though the S&P 500 saw a 0.99% gain and NASDAQ saw a 1.36% gain on the day, internals were poor with just 225 net advancers in the S&P 500 and only 53% up volume.
Stocks got off to a mixed start on Friday after digesting several social media earnings reports that showed a slowdown and caution on the outlook in the advertising space, sending most advertising stocks like Facebook, Snapchat, and Twitter lower, along with the NASDAQ and growth stocks. In addition, the flash PMI survey suggested further weakening in manufacturing and service activity, leading to additional recession fears and sending Treasury yields lower. Defensive sectors took the lead again on Friday with the Dow down 0.43% while the NASDAQ fell 1.87%.
Treasury yields moved lower during the week over possibility of a peak in inflation as well as recession fears. The yield curve remains inverted with the spread between the 2- and 10-year Treasury yield still at the widest since early 2000’s. The dollar fell 1.3% after rising six of the past seven weeks while oil fell 3.0% for its third consecutive weekly decline. Earnings have been very mixed thus far but the theme so far is a cautious outlook. Major indices finished as follows: Russell 2000 +3.58%, NASDAQ +3.33%, S&P 500 +2.55%, and Dow +1.95%.
Recent Economic Data
- After hitting the highest pace since 2006 just two months ago, the pace of housing starts has fallen 14% from those levels in June. There were 1.559 million new housing starts in June, on an annualized basis, dropping 2% from May’s levels and relatively in line with consensus expectations. Compared to the same month a year ago starts are 6.3% lower. Housing permits, which peaked in December at 1.896 million, fell by less than 1% to an annualized pace of 1.685 million, and about 1% above the June 2021 rate. There are still a high number of projects sitting in the pipeline with the largest number of projects authorized but not yet started since 1999.
- Existing home sales fell a little more than expected in June, at an annualized rate of 5.120 million existing homes sold in June the sales pace was down 5.4% from May, for the fifth consecutive monthly decline, and down 14.2% from a year ago. The sales pace is now below pre-pandemic levels and all of 2019’s pace. Remember these numbers represent closings, so represents contracts signed in April/May so is a bit of lagging data. Supply of homes improved by almost 10% with 1.260 million units on the market, leaving inventory at 3.0 month supply, up from 2.6 month supply in May. The median price is 13.4% higher from a year earlier at $416,000. Details of the report shows activity remains strong at the higher end of the market where there is much more supply. Sales for homes in the $100k-$250k range were down over 30%, while sales for those over $1 million grew 2%.
- For the week ending July 16 there were 251,000 unemployment claims, a rise of 7,000 from the week prior with the four-week average rising to 244,000. Claims have steadily ticked higher since the beginning of April when they sat at 50 year lows, however are still relatively low. The number of continuing claims was 1.384 million, up 51k from the week prior, bringing the four-week average 13k higher to 1.353 million.
- The Philly Fed manufacturing survey index was -12.3 for July, a sharp decline from -3.3 in June and signals manufacturing activity has contracted for the second consecutive month. The survey measure many things from new order, backlogs, and shipments to employment, inflation, and expectations. Respondents noted new orders declined further into negative territory, shipments continue to rise, while unfilled orders decline. Employment remained positive while prices remain elevated and firms are saying they expect declines in activity over the next six months. The past two months have suggested a reversal in the manufacturing sector with activity consistently weakening.
- Bloomberg reported Apple will slow hiring and spending growth next year, a decision driven by the economic uncertainty, but is maintaining its product releases through 2023.
- Netflix said it will take another step to crack down on password sharing by implementing new fees for those that share their accounts with others outside the household for the Latin America region. For example, those sharing will pay another $2.99/month.
- GE unveiled the brand names of its new business units, which will be official after GE splits into three separate publicly traded companies. In 2023 the company will execute a tax-free spinoff of its healthcare business that will be named GE Healthcare. In 2024 the company will do another tax-free spinoff of its energy businesses, named GE Vernova, leaving the company with the aviation unit which it will name GE Aerospace and will maintain the GE trademark and long-term licenses.
- Ford said it will cut as many as 8,000 jobs in the coming weeks to cut costs and in effort to help fund its push into the electric vehicle market. Recently, the CEO Jim Farley said the plan was to cut $3 billion in costs by 2026 and reducing headcount would be one way of doing so.
- Amazon announced it will acquire One Medical, an operator of membership based primary care clinics, for $3.9 billion, as it continues its push into healthcare. Pharmacy operators like CVS and Walgreens were down as a result, who have recently announced similar deals to expand into primary care.
- Netflix reported mixed results in its latest quarter with a net subscriber loss of 970k, versus expectations of a 2 million loss. Its guidance was light, with net subscriber adds of 1 million, versus consensus of 1.8 million. The company said content spend should moderate and it should see “significant growth” in free cash flow. Its largest subscriber loss was seen in U.S./Canada markets, followed by EMEA (Europe, Mid East, Asia), partially offset by gains in Asia Pacific and Latin America. Its new ad-supported service will take a little longer to roll out, expecting early 2023. Regarding password sharing, executives said they are “not asking customers to not share” but to pay a little more to add a member or another home by adding a fee on those accounts.
- Snapchat reported mixed results, with daily active users growing 18% from last year. Given the uncertainties in the current environment the company is refraining from providing guidance for the current quarter. The company said it would slow its rate of hiring and its operating expense growth. The CEO said the quarter was “more challenging than we expected” and revenue has been flat from a year ago so far in the current quarter, versus analysts expectations of close to 20% growth, the main reason the stock fell over 30%.
- A Bank of America Fund Manager Survey received a lot of attention the beginning of last week after it showed fund managers had the lowest equity and risk asset allocation since 2008. The survey noted investors had extreme levels of pessimism and expectations for global growth was at one of the lowest levels ever. Cash levels rose to the highest levels since the early 2000’s (9/11) while equity allocations were the lowest since 2008. Some market strategists suggested this type of capitulation would lead to a bounce in stocks because when positioning reaches such extreme levels, things typically reverse. We are hesitant to make that call as too many uncertainties remain, but there is the possibility for a short-term bounce due to oversold levels.
- Two central banks met last week and more are expected to meet over the next several days including the U.S. Federal Reserve. Last week, the European Central Bank, after being rumored to be considering a larger than expected 50 bps rate hike, raised rates a more than expected 50 bps for its first increase in 11 years and finally rising from the 0% levels due to increased inflationary pressures. An issue it said it would address at its last meeting, widening spreads between different government bonds in Europe, it will address with “Transmission Protection Instrument” that ensures policy is “transmitted smoothly across all euro area countries.” It will continue to reinvest maturing securities under its QE program. Separately, the Bank of Japan maintained its zero interest rate policy (keeping short-term rates at -0.1% and pegging 10-year government bond at 0%), bucking the global trend with central banks of raising rates and tightening monetary policy. It warned of risks to economy and raised its inflation forecast for this year to 2.3% from 1.9% and next year to 1.4% from 1.1%.
- Several positive new headlines out of Europe last week relating to Russia and Ukraine – After being reported by Reuters, Russia restarted natural gas flows through the Nord Stream 1 pipeline to Europe after being shut down for its annual maintenance. There was speculation Russia would delay the restart as a punishment to Europe for opposing its war in Ukraine. The pipeline supplies one-third of Europe’s natural gas imports. Separately, the Financial Times says Ukraine is nearing a deal with Russia that would allow Ukraine to secure a safe route for million of tons of grain through the Black Sea which would ease concerns about a global food crisis and additional inflationary pressures. Russia has blocked the route for months which has cut off Ukraine’s exports. Meanwhile, the European Commission is asking member states to cut gas consumption by 15% over winter and update emergency plans and report to the commission every two months to be ready for a potential cut off of Russian gas.
As an update we would like to announce that David Trainor has departed Wentz Financial Group. Over the past year many of you have probably talked with David at various times and it is with great excitement that we announce he is leaving to take the Head Golf Coaching Position at Boise State University. David brought great passion to our team and was always focused on our clients but is real passion is with being a golf coach. While we are sorry to lose him around the office, we are very excited for the tremendous opportunity he has earned to once again lead a division one golf program. Good Luck David and Go Broncos!
Please be aware that starting Memorial Day and running until Labor Day, Wentz Financial Group will begin its summer hours. Our hours on Monday will be 8:30 to 4:00 and Tuesday through Friday will be 9:00 to 4:00. As always, if you need to speak or meet outside of those hours, please reach out and we will be happy to set up an appointment.
The Week Ahead
The week ahead will be one of the busiest weeks of the quarter with many earnings report, economic data releases, and the Fed meeting. Economic data begins to roll in Tuesday with a couple housing reports including the Case Shiller Home Price Index, which is expected to show home prices continued to rise at a strong pace in May, and new home sales which are expected to have seen a slight decline in June. A survey on consumer confidence is released Tuesday, along with the University of Michigan consumer sentiment survey on Friday that show in the previous month sentiment was at its lowest level since the 1970s. Wednesday’s data includes durable goods orders and trade data. Jobless claims and the first estimate on second quarter GDP are released Thursday. There will be more talk about recession going into the GDP report as it is expected to be right around 0%, but a negative reading would make it two consecutive quarters of negative GDP growth. Finally on Friday, personal income and outlays and the employment cost index are released. It will be the busiest week of earnings reports for the quarter with over 30% of the S&P 500 index reporting. Notable reports will come from Whirlpool on Monday, GM, GE, Microsoft, Alphabet (Google), Chipotle, Visa, and McDonald’s on Tuesday, Ford, Boeing, Shopify, Meta (Facebook), Qualcomm on Wednesday, Pfizer, Southwest, Intel, Amazon, Apple on Thursday, and Exxon Mobil, Chevron, and AbbVie wrapping up the week on Friday. However, the main event will be the FOMC meeting beginning Tuesday and ending Wednesday afternoon with a policy decision at 2:00 followed by Chairman Powell’s press conference. The Fed is widely expected to raise rates three-quarters of a percent, although the probability of a full percent increase has moved higher. A lot of focus will be on the press conference and hints on future policy moves.