Wentz Weekly Insights
Economy Grew Faster in Q2 & Fed Raises Rates to New 22 Year High (ADV)

The resiliency of the equity markets and US economy continues with stocks advancing again last week for the third consecutive weekly gain. The S&P 500 rose 1.01%, the growth heavy NASDAQ index increased 2.02%, while the blue chip Dow index gained 0.66% after snapping its 13-day win streak – the longest since 1987. Meanwhile, bond yields rose with a slight flattening of the curve as the 10-year Treasury yield hit 4.0% again but finished the week just below that level and rising 11 basis points for the week.
It was a very busy week with one-third of the S&P 500 reporting earnings, updates on second quarter economic growth, release of the Fed’s preferred measure of inflation, the FOMC July meeting and policy decision, and other central bank decisions abroad. The overall theme has been “better than expected” with some calling it “goldilocks” conditions.
What we thought markets would focus on the most – second quarter earnings – continue to come in as in-line with expectations. Coming into the quarter (July 1) the earnings growth rate was expected to be -7% from a year ago, it started last week at -9% and finished the week with a slight improvement, now at -7.3%. High profile reports came from Microsoft and Alphabet last week where Microsoft shares were lower on results that were solid but concern over increasing expenses every quarter this year, and Alphabet shares were higher on better ad demand and faster ad revenue growth along with strength in its cloud segment and optimism over plans for its AI-assisted search.
Growth in the second quarter was better than expected with the economy growing 2.4% (a quarter-over-quarter rate that is annualized) which was beyond the consensus range of 1.5% to 2.0%. Growth was driven by the largest component – consumer spending which makes up 70% of GDP. Consumer spending grew 1.6% in the quarter and contributed 1.1% of the 2.4% GDP growth. Business investments, helped by spending on AI, contributed 1.0% to GDP, and government spending contributed 0.5%, while housing and exports were contractors to GDP. Overall growth was strong but setting a higher bar will make growth more difficult to achieve as the consumer becomes more pressured from higher prices and higher rates.
On Friday, the monthly personal income and outlays data was released which includes the Fed’s preferred measure of inflation with the PCE price index. Consumer spending rose a better than expected 0.5% in the month, incomes were 0.3% higher (but wages and salaries increased a higher 0.6% – something worth watching), while the PCE price index rose 0.2%. This matched June’s consumer inflation data that inflation cooled further. Core inflation continues to run hotter though, with a 4.1% annual increase in June.
Finally, the Fed meeting concluded on Wednesday with a 25 basis point increase in the Federal Funds rate, bringing the range to 5.25% to 5.50%, the highest it has been in 22 years. The policy statement was basically the same as from the June’s meeting, except the FOMC described economic growth as “moderate,” a slight upgrade from “modest.”
In Chairman Powell’s post-meeting press conference, many questions from reporters attempted to get Powell to reveal what the Fed would do at the remaining three meeting of the year, more specifically at the next meeting in September. Powell refrained from providing any forward guidance, rather repeatedly said the decision will be data dependent, saying we will see two additional labor market reports and two additional inflation data points until the meeting. Powell made it clear the September decision will depend on the data from those two months of data.
Also important, most of the Fed staff and FOMC members saw the economy as more resilient than expected and acknowledged headline inflation has come down and that is positive for consumers, but core inflation is still too high. They are uncertain on if risks are balanced but Powell reiterated the worst outcome is not bringing inflation down and that the historical record is clear of the economic damage that would cause and that is what the Fed is trying to avoid. Powell stuck to the message that the risk of doing too little to bring down inflation still outweighs the risks of doing too much. Because of this, unless data comes out substantially better than expected, we believe there will be at least one more rate increase this year.
Inflation could very easily turn in either direction. The data will continue to cool due to base effects and coming off easier comparisons from a year ago, but that will begin to roll off which will make comparisons easier (and make the inflation number look higher). The labor market is very tight and employers continue to add jobs at a rate that is consistent with solid economic growth. In a tight labor market the risk is this could lead to building wage inflation and then consumer inflation. Also, commodity prices are up 10%-15% in the past several weeks and could re-ignite headline inflation and the stronger the economy is the more likely that could happen. However an economy slowing just enough would reduce demand and cool inflation further.
With no certainty on what the path will be, despite volatility falling in recent weeks due to these “goldilocks” conditions and data and an expected earnings recovery in 2024, volatility could easily pick back up. The obsession with rising interest rates is likely behind us, now the markets will be looking at when rates will begin to fall. Current market probabilities see that happening by March 2024 with a 54% chance. Markets are banking on rate cuts and rising earnings in 2024. We believe focus will shift to the earnings picture, where markets are still expecting a 13% recovery in 2024 after a decline in 2023, but that is at risk and we will have a more clear picture by the end of the year.
Jerome Powell – “The staff [economists from the central bank] now has a noticeable slowdown in growth starting later this year in the forecast, but given the resilience of the economy recently, they are no longer forecasting a recession… My base case is that we will be able to achieve inflation moving back to our target without the kind of really significant downturn that results in high levels of job losses that we’ve seen in some past, many past instances… The Federal Funds Rate is at a restrictive level now, so if we see inflation coming down, credibly, sustainably, then we don’t need to be at a restrictive level anymore… You’d stop raising [rates] long before you got to 2% inflation and you’d start cutting before you got to 2% inflation, too.”
Week in Review:
Monday saw a calm start to a rather busy week. Not much to report on. There was added attention to the weekend box office due to a strong showing from Warner Bros’ Barbie and Universal’s Oppenheimer. The Dow rose for the 11th consecutive day with a 0.52% gain, the longest winning streak since February 2017, while the S&P 500 gained 0.40%. Treasuries were slightly weaker with a small pickup in yields while oil rose 2.2% to $78.74/barrel, the highest close in three months, over a tighter supply outlook and a stronger economy.
Earnings reports began to roll in after the bell Monday and into Tuesday morning with mostly better than expected results from companies such as GE, GM, Kimberly Clark, and 3M however for the most part performance was muted. Chinese markets had a strong session after talks of additional policy stimulus from the government and central bank. In addition, consumer confidence reached the highest level in two years with confidence on both the current conditions and expectations. Oil gained again, Treasuries held relatively steady, while stocks saw small gains with the S&P 500 up 0.28% and the Dow up for the 12th straight day.
New home sales that fell in June after a surge in May and another wave of earnings reports were highlighted Wednesday morning, including overnight results from Alphabet and Microsoft, but the Fed meeting in the afternoon was the main event of the day. The FOMC raised rates in a unanimous decision another 25 basis points and Powell gave no clear path forward in his press conference, reiterating several times the Fed will be data dependent in what it does at the upcoming meetings, while acknowledging the economy picked up slightly recently and inflation remains too high. Treasury yields did not have a large move but ended up finishing lower with stocks mixed but the Dow closed 0.23% higher for its 13 day win streak, the longest since 1987.
It was another strong opening for US stocks on Thursday which followed global markets higher. It was helped by strong economic data in the morning where the first look at second quarter GDP showed the economy grew at a better than expected annualized rate of 2.4% in the quarter, as well as weekly jobless claims at the lowest level since February. Overseas, the European Central Bank raised rates again as expected and signaled potentially more rate hikes. The better data and follow on from the FOMC meeting Wednesday pushed bond yields higher again with the 10-year Treasury yield rising 15 basis points to 4.00%. Stocks initially rose, but saw a big reversal mid-day and finished near the lowest levels of the day with S&P 500 falling 0.64% and the Dow snapping its 13 day win streak.
A solid earnings beat by names like Meta (Facebook parent), McDonald’s and Lam Research, along with additional inflation data in the PCE price index Friday morning, sent stocks higher again on Friday in another strong session. The biggest global news was the Bank of Japan being more flexible in letting its government bond yield rise above 0.0% target for the first time in nine years, somewhat shocking global markets but little impact on yields. Treasuries were higher with yields giving up some of Thursday’s gains and stocks finished higher with the S&P 500 gaining 0.99%.
Stocks saw another week of gains for the third consecutive week. Earnings and central banks took headlines with earnings results continuing to beat expectations at a higher pace, but earning growth only improved slightly over the week. Treasuries were weaker as yields moved higher, mostly on Wednesday and Thursday, with the 2 year yield rising 2 basis points to 4.88% and the 10 year rising 11 basis points to 3.95%. The dollar was stronger again, gold finished down 0.3%, and oil saw its fifth straight weekly gain with a 4.6% increase and the highest level since April. The major US stock indices finished as follows: NASDAQ +2.02%, Russell 2000 +1.09%, S&P 500 +1.01%, Dow +0.66%.

Recent Economic Data

  • Home prices appear they may have bottomed, according to the S&P Case Shiller home price index. The index reported a 1.2% increase in May (0.7% increase after seasonal adjustments) which follows a 0.5% monthly increase in April and is now the fourth consecutive monthly increase, after falling for seven consecutive months. Home prices are now just 1.0% below the peak from June 2022. The recovery in home prices is broad based with increases in all 20 cities tracked (similar to March and April). Over the past year home prices are still down 0.5%. Believe it or not, the rust belt is seeing the greatest year-over-year increase in home prices with Chicago (+4.6%) and Cleveland (+3.9%) topping the list! While the Pacific rim area is seeing the largest y/y declines led by Seattle (-11.3%), San Francisco (-11.0%) and Phoenix (-7.6%).
  • The pending home sales rose 0.3% for the first increase in four months, (pending home sales is based on signed contract not closings, so this reflects people shopping in June). New listings were down 26% from last year with total inventory down 14%. Sales were the strongest in the Midwest (also where home prices are rising the strongest), rising 4.3% with the Northeast flat and West and South regions seeing slight declines. The forecast from the National Association of Realtors sees home sales to be 13% lower in 2023 than in 2022. Sales of newly built single family homes fell 2.5% in June for the first decline in four months to a seasonally adjusted annualized rate of 697,000. May saw a surge in new home sales to 763k but this was revised down to 715k. Despite the decline and breaking the upward trend, the June sales pace is still 23.8% above the rate from June 2022. Keep in mind new home sales are based on signed contracts, not closings like the existing home sales report so this data was taken when rates jumped in June. Supply of new homes is no better, relatively unchanged in the month and unchanged for all of 2023. Meanwhile, home builders look like they may be getting more behind as the number of new homes sold where construction has yet started jumped 50% to 164k.
  • In the first estimate of Q2 GDP, the economy grew at a much better than expected seasonally adjusted annualized rate of 2.4% in the second quarter which is above the high end of the consensus range. Growth was driven by consumer spending (albeit a slower rate than Q1), business investment, government spending, inventory growth, and offset by weaker net exports and housing. The components of GDP (numbers are q/q and annualized):
  • Consumer spending rose 1.6% with a 0.7% increase in goods spending and 2.1% increase in services spending. Consumer spending contributed 1.1% to GDP
  • Fixed investment by businesses grew 4.9% driven by a 10.8% increase in investments of equipment. Business investment contributed 1.0% to GDP
  • Residential investment (new housing) declined 4.2% as the housing market continued to be weaker. Housing contributed -0.2% to GDP.
  • Government spending increased 2.6% which contributed 0.5% to GDP.
  • The change in inventory investment grew, which contributed 0.1% to GDP.
  • Exports declined 10.8% while imports declined a lesser 7.8%. This contributed a net -0.1% to GDP.
  • Durable goods orders in June rose a much higher than expected 4.7%. However, as is typical when you see a large increase in durable goods orders, this is all due to transportation orders, more specifically aircraft (non-defense) orders which spike 69% (due to the large cost of aircraft). New orders for durable goods, excluding aircraft, were still solid, rising 0.6% in the month with increases broad-based. Shipments of durable goods rose 0.3% with the only weakness in electronics. The input to GDP, shipments of nondefense capital goods excluding aircraft, was flat in the month, with new orders up 0.2%.
  • The number of unemployment claims filed to states for the week ended July 22 was 221,000, a decline of 7k from the week prior, matching the lowest level since February. The four week average was down another 4k to 233,750. The number of continuing claims was 1.690 million, down 59k from the prior week for the lowest level since January, with the four-week average at 1.719 million. Jobless claims have steadily trended lower after their short-term peak at the beginning of June.
  • Compensation costs for workers, measure by the Employment cost index and data the FOMC follows closely, increased 1.0% in the second quarter compared to the first quarter which was in line with expectations. Wages and salaries increased 1.0% while benefit costs increases 0.9%. For the 12 month period ended in the second quarter, compensation costs increased 4.5%, down slightly from the 4.8% annual rate in Q1 (wages/salaries up 4.6% while benefit costs up 4.2%). With data here in line with expectations Powell and the Fed will likely focus more on upcoming inflation data prior to the September meeting in making the policy decision.
  • The final July consumer sentiment reading, a survey compiled by the University of Michigan, index level was 71.6, down from the mid-month reading and consensus of 72.6, although down still a solid number and better than where it stood most of the past year. The current conditions index was 76.6, down from the mid-month read but up from 69.0 in June, while expectations index was 68.3, also down from the mid-month read, but higher than the 61.5 from June. The one-year ahead inflation expectation was unchanged at 3.1%, up from June’s 3.0%.
  • The Consumer Confidence index by the Conference Board was 117.0 for July for the highest level since July 2021, and is up from 112 last month which was a 18 month high. The present situations index rose to 160, up from 155.3, for the best level since March 2020 while the expectations index rose to 88.3 for the best since January 2022. Importantly, the reading is above the key level of 80 – a level that historically signals a recession over the next year. A lot of the improvement in present and expectations is due to better employment conditions.
  • Data on money supply released for June show the money supply increased 0.2% in the month for the second consecutive increase and comes after nine consecutive monthly declines. A bounce back in money supply is not a positive sign for bringing inflation down. The money supply is still down 3.8% from the peak in July 2022, which beside April and May’s 4.6% and 4.0% decline from peak, is the largest decline in the money supply since the Great Depression.
  • Personal income & outlays data showed incomes and spending continuing to grow with wages and salaries accelerating and consumer spending still strong with a shift toward goods for the first month in almost two years.
  • Personal income rose 0.3% in June, slightly lower than the 0.4% increase that was expected, but net in line after accounting for May’s upward revision to a 0.5% increase. Wages and salaries will raise some attention with its 0.6% monthly increase (equivalent to a 7.2% annualized rate). Compared to a year ago incomes are up 5.0% with wages/salaries up 5.3%
  • Consumer spending was up a better than expected 0.5% and includes a slight upward revision in May to a 0.2% increase. Spending on goods actually increased at the fastest rate in months, rising 0.8%, while spending on services was one of the lowest monthly increases in months, rising 0.4%. Compared to a year earlier, spending is up 5.4%, slowing from May’s year-over-year increase of 6.1% with spending on goods up 1.5% and spending on services up 7.5%.
  • The savings rate fell slightly to 4.3%, still at historically low levels compared to the 20-year average of 7.5%.

Company News

  • Apple has asked its suppliers to produce 83-85 million iPhone 15s models in 2023, below its initial production target of 90 million, according to sources and reported by Bloomberg. This would put the production of the newest 15s models in line with the previous iPhone 14 product line. Apple is trying to keep shipments of the new iPhone steady amid worries about the global economy and weakening smartphone market. It was days prior to this that another report said Apple and its suppliers were having trouble manufacturing the screens for the iPhone 15 Pro and Pro Max.
  • With the release of its earnings, regional bank PacWest Bancorp said it will merge with rival Banc of California in an all-stock transaction and will operate under the Banc of California name with approximately $36.1 billion in assets. With the deal, private equity firms will invest $400 million in newly issued securities of the combine company. PacWest shareholders will receive .6569 shares of Banc of California for each share owned and will represent 47% of the combined company, 19% will be owned by the capital raise from PE groups, and 34% will be owned by Banc of California shareholders.
  • The Justice Department and EPA are now investigating the possible health and environmental issues from lead covered cables (from telecoms like AT&T and Verizon) after last weekend’s WSJ article on its own investigation that revealed the telecoms still had the lead cables in their networks. The DoJ and EPA are requesting inspections and sampling data from AT&T/Verizon within 10 days. They will also be investigating whether the companies knew of the potential risks to workers and the environment.
  • The WSJ reported Netflix is restructuring its advertising deal with Microsoft to reduce the guarantee of its revenue share. It was a year ago Netflix made an agreement with Microsoft to use its service to provide technology for the service and have it sell ads on Netflix’s behalf, offering Microsoft a “revenue guarantee.” In addition, it is lowering ad prices in effort to boost growth in that segment of its business.
  • Reuters is reporting, citing an internal company town hall, that Meta is working on retaining its users of its new Thread platform (a platform similar to Twitter and seen as a rival platform) after it has lost more than half its users in recent days following what was seen as a successful launch. CEO Zuckerberg told employees it will focus on user retention because “we’re not there yet,” and will focus on things that drive retention, followed by a focus on monetization.

Other News

  • The International Monetary Fund raised its global growth forecast last week, now forecasting the global economy to grow 3.0%, up from its April forecast of 2.8%. Meanwhile, it kept its 2024 growth forecast unchanged, despite its concerns for tighter credit conditions, dwindling household savings in the U.S., and a slower than expected economic recovery in China. For the US, the IMF sees GDP growing 1.8% this year and 1.0% in 2024 and forecasts Chinese growth of 5.2% this year and 4.5% for 2.24.
  • Last week UPS and the Teamsters union reached a tentative deal that averted a strike in what is the largest contract in the US. The union represents about 340,000 workers and those workers walking out of the job would have caused a massive disruption to the US economy. The deal raises wages for all workers, bringing the average top rate to $49/hour, with part-time workers starting at $21/hour which is a $6/hour increase. Importantly for workers, it ends a two-tier classification system which some workers were being paid less for doing the same work, and they also get paid overtime now.
  • Chinese officials met early last week to discuss current economic conditions and policy but refrained from providing detail on a shift in policy despite what they called a “tortuous” economic recovery and recent weakening of economic data. They discussed a number of challenges the economy faces including demand domestically and the external environment. To boost demand and confidence they talked about supporting growth of the middle income households and providing support for the property market where they saw heightened risk.
  • Global Central bank meetings:
  • The European Central Bank raised interest rates last week for the ninth consecutive meeting, bringing its deposit rate to 3.75% and main refinancing rate to 4.25% for the highest levels since 2000. ECB President Lagarde had a slight shift in tone, somewhat similar to Powell, in avoiding giving guidance on what the central bank will do at its next meeting in September, instead saying all options remain on the table and the decision would depend on the data between now and then. Markets took the ECB meeting and Lagarde’s comments as more dovish, sending the euro lower.
  • The Bank of Japan made one of its biggest policy announcements in years, saying it will add flexibility to its yield curve control – this was where the Central Bank would target the Japanese 10-year government bond yield at 0% in effort to keep market rates low to spur demand by buying an unlimited amount of those bonds (buying bonds equals higher demand and pushes prices higher and yields lower to spur borrowing and demand). The BoJ was one of the very few central banks around the world that still had very accommodative policy, while the rest of the world has engaged in rate hikes and tighter monetary policy. This may have pressured the BoJ to at least do something. It said it will allow yields to fluctuate in a range of +/- 0.5% and conduct yield curve control with “greater flexibility.” At the same time, it left its policy rate unchanged. After the announcement, the yield on the Japanese 10 year government bond spiked to 0.5%, the highest in 9 years, while the yen spiked but that gain faded throughout the day.

Did You Know…?

Growing Shareholder Returns

Dividends and share buybacks end up being a large part of an investors total return, for example for the 12 months ended March 31, total shareholder returns (including dividends and share buybacks) was $1.431 trillion, according to data by S&P Dow Jones Indices. In the first quarter 2023, the data revealed companies paid out a record high amount in dividends, with a payout of $146.8 billion for a 0.5% increase in the quarter and a 6.7% increase from a year ago. Despite the record high dividend payout, the number of companies issuing dividend decreases tripled compared to last year. in addition, the size of dividend increases have declined and are expected to remain modest for at least the remainder of 2023 and potentially 2024. Share buybacks fell 23.3% from a record high of $281 billion in Q1 2022 to $215.5 billion in the first quarter this year. The amount of buybacks have been at relatively the same level since Q2 2022 The sectors seeing the highest share buybacks are financials, technology, and health care.

The Week Ahead

This week is jobs week, while second quarter earnings results continue to pour in. The economic calendar will give us an update on the labor market with the job openings and labor turnover survey on Tuesday, the ADP employment report Wednesday, jobless claims on Thursday, and the DOL employment report for July on Friday. The current consensus expectation is another 200,000 jobs were added in the month with wage growth of 0.3% (4.2% from a year ago). Also on the economic calendar updates on the manufacturing sector will come from the PMI and ISM manufacturing survey index on Tuesday and then factory orders on Thursday. Construction spending for May is released Tuesday as well, along with July vehicle sales, second quarter productivity and labor costs and the ISM services survey index on Thursday. The busiest stretch of second quarter earnings season continues with another roughly 35% of the S&P 500 index set to report this week. Some of those notable companies include Pfizer, AMD, Starbucks, Uber, Marriott, Caterpillar on Tuesday; Qualcomm, CVS, PayPal, Shopify, KraftHeinz on Wednesday; Apple, Amazon, Anheuser-Busch, Alibaba, Wayfair on Thursday; and Dominion and FuboTV on Friday. The political space is expected to be quiet with Congress on its summer recess until after Labor Day.