Wentz Weekly Insights
Markets Post Best Week in 25 Months, What’s Next?
U.S. stocks rebounded last week, coming off depressed sentiment and oversold conditions from the week prior. Recession fears have rippled through the markets, creating concern that demand would slow which in turn resulted in lower commodity prices like oil and copper. Investors moved to safe-haven assets like Treasuries which sent yields lower after a bout of selling sent the 10-year Treasury yield to over 3.50% for its highest level since 2011 before the week began. Similarly, the underlying performance of the stock market favored more defensive sectors such as consumer staples and utilities, with tech seeing a bounce as well due to the move lower in yields. At the same time, cyclical sectors that do well in a late cycle environment underperformed, particularly energy which lost about 7% on the week as commodities moved about 4% lower.
It is said on Wall Street that the stock market predicts nine of the past five recessions. That is the concern right now and is what investors are pricing into the markets based on recent performance. As Raymond James notes, last week was only the 11th time in the past 20 years the markets moved at least 6.5%. As mentioned over that period defensive sectors outperformed which rarely happens in a market rally, indicating investors are increasing defensive positions, even in rallies. The number of concerns and uncertainties that remain, in addition to our economic clock, are the reasons we continue to favor defensive and dividend paying investments over growth.
We are now in a quieter period over the next two weeks where a lack of any major headline or catalyst is likely to keep stocks on a flat or upward path over the short term. What we are looking for next on the schedule is the personal consumption and expenditure report on Thursday. This report from the Bureau of Economic Analysis includes the personal consumption expenditure price index, the Federal Reserve’s preferred measure of inflation. It tends to be lower than the consumer price index, but any indication of higher inflation will likely send markets lower. It will also be interesting to see the pace of wage growth for May. Wage growth has picked up in recent months, rising 11.6% year-over-year in April and doing well in keeping up with inflation at this point, driven mostly from the lower end of the wage scale. Any slowdown would be a negative for the consumer who is seen their purchasing power eaten away by a 8.1% increase in prices, but any move higher increases the chance of inflation intensifying as businesses look to pass higher wages to consumers through higher prices.
The next big report will be next Friday’s employment report where approximately 390,000 jobs are expected to be added in June. But the biggest upcoming catalyst will be earnings season that begins in two weeks. We will be watching several things including hiring trends (several companies have announced hiring freezes or layoffs, particularly the technology sector), but more importantly right now how companies are handling higher costs, and how that is affecting profit margins. In the first quarter, margins were strong as companies were able to preserve profitability in the face of surging costs with margins holding up very well and continuing to be near the highest levels in years. But as inflation becomes more entrenched into the system margins are seeing a higher chance of moving lower. Lower margins equal lower profits which equal lower stock valuations and lower stock prices. Most of this became priced into the markets, but much will depend on the path of inflation going forward.
Week in Review:
Markets were closed last Monday but attempted a rebound on Tuesday after experiencing the worst week the week prior since March 2020. There was a lot of Fed speak throughout the week and Tuesday’s included several Fed officials supporting 75 bp rate hike in the July meeting if data comes in as expected. All sectors saw moves higher with energy the leader with a 5.14% gain. Growth slightly outperformed value for the day as the S&P 500 gained 2.45%.
Stocks opened lower on Wednesday as weakness in commodities accelerated over recession fears, particularly oil, lumber, and copper. On the political front, President Biden made a speech to call on Congress to implement a gas tax holiday, and other steps, to help alleviate the pressure at the pump. It was reported he would also announce a decision on student loans by the end of the week, and is increasingly likely to remove China tariffs on consumer goods. Federal Reserve Chairman Powell began his two-day testimony to Congress where the major topic was inflation. In the testimony, Powell essentially acknowledged tightening policy could cause a recession. Stocks had a volatile day, opening in the red and down 1.3% at its lows before recovering and moving positive by over 1%, but ultimately settling lower by 0.13%.
Markets continued to rebound from oversold conditions and supported by a move lower in yields on Thursday with no major market headlines. Continued weakness in commodities and lower yields supported stocks move higher with the S&P 500 closing near the highs of the day up 0.95%.
Friday was a relatively quiet day as well. Results from the consumer sentiment survey showed consumers’ feeling about the economy was at the lowest level on record but the expectation of longer-term inflation moved slightly lower, possibly a catalyst for stocks move higher. It was the sudden move higher in inflation expectations from the mid-month reading that drove Powell’s decision to raise rates three-quarters of a point in its June meeting, so this reading was closely watched. Stocks continued to post gains, but internally more cyclical stocks have struggled and yields have declined, suggesting investors are trading like a recession is coming. Stocks had a very strong day with the S&P 500 gaining 3.06%.
For the week stocks traded positively from an index level, but under the surface the trend has been as if investors are expecting a recession – cyclical stocks struggled, yields moved lower (and bond prices higher, indicating investors are buying up safe haven assets like Treasury bonds), and commodities have moved lower because demand declines in a recession. Yields on the 10-year moved up to 3.31% on Monday before falling to 3.05% on Friday and finishing at 3.12%. Oil moved lower over recession fears dampening demand, down 2.4% for the week while the major U.S. indices finished as follows: NASDAQ +7.49%, S&P 500 +6.45%, Dow +5.39%, Russell 2000 +4.23%.
Recent Economic Data
- Existing home sales fell 3.4% in May, just in line with expectations and not as bad as feared after disappointing data on housing starts last week. The annualized sales pace for existing home sales was 5.410 million, the fourth consecutive monthly decline, down 8.6% from May 2021, and returning to levels seen in 2019 prior to the pandemic. In addition, the balance between single-family home sales and multi-family sales (condos, etc) is also back to pre-pandemic levels suggesting the preference for suburban living over city/downtown living is fading. Inventory of existing homes improved, rising 13% to 1.160 million units, although still down 4% from a year ago. The median home price was $407,600, up 14.8% from a year ago for a record 123 consecutive months of positive gains. Sales are expected to continue to slow as affordability poses more challenges.
- Sales of new single-family homes increased 10.7% in May to an annual rate of 696,000, well above the expectations of 590,000, signaling the housing market may be flattening out after four consecutive monthly declines. Compared to May 2021 sales of new homes were down 5.9%. The inventory of new homes rose just 7,000 in May to 444,000, representing a supply of 7.7 months at the current sales rate, down from 8.3 months in April. The decline was because of the faster sales pace in May however, the increase in inventory is due to homes where construction is underway or still not started. The median home price was $449,000, up 15.0% from a year ago.
- Unemployment claims declined 2,000 to 229,000 for the week ended June 18. The four-week average was 223,500. Continuing claims for the week ended June 11 was 1.315 million, up 5k from the week prior, bringing the four-week average to another 52-year low of 1.310 million.
- The index on consumer sentiment, according to the University of Michigan consumer sentiment survey, was 50.0 for June, down from 57.2 in May, for its lowest level on record dating all the way back to the 1970s. Most importantly, the median expected year-ahead inflation rate was 5.3%, little changed, while the long-run expectation was 3.1%, falling from its mid-month reading of 3.3% and providing support for the markets.
- Kellogg said yesterday it will split into three separate companies with one of each focused on snacks, cereal, and plant-based foods. The company said these “businesses all have significant standalone potential” and giving them greater focus on their areas “will enable them to better direct their resources toward their distinct strategic priorities.”
- DocuSign said its CEO Dan Springer has left the company effective immediately. It was a sudden and unexpected departure, with the company said the current board chairman Mary Wilderotter will serve as the interim CEO until a replacement is found.
- Disney’s Pixar movie “Lightyear”, its first Pixar theatrical release since the start of the pandemic, did not do as well as expected, bringing in just $50.6 million in its opening weekend, still trailing Jurassic World in its second weekend which brought in another $59 million.
- The Food and Drug Administration rejected Juul’s application to sell its e-cigarettes in the U.S., banning the sale of Juuls. The move comes after a review of the vaping industry and pressure from public health groups over the marketing of the product to the youth, including high schoolers. Altria, maker of the Marlboro cigarettes and other nicotine products, bought a 35% stake in Juul in 2018 for $12.8 billion. However, the value of the investment has been cut to $1.6 billion for Altria in March of this year, valuing Juul itself at about $4.5 billion.
- Intel said its expansion plan for its $20 billion Ohio plant is on hold as it waits for Congress to pass the CHIPS Act that provides $52 billion in subsidies for semiconductor companies. The Senate already passed the bill but House is holding it up over unrelated issues such as climate and trade with China, according to the Washington Post.
- If you have a flight over the next several months there is a good probability it could be canceled, if it hasn’t already been. The past weekend was another weekend of massive delays and cancellations for airlines due to staffing shortages with pilots, flight attendants, and air traffic controllers. Over 1,500 flights were canceled and over 8,000 were delayed, lower than recent weekends but the weather was much better this weekend with no major storms. Airlines have taken steps lately to reduce the impact of last minute changes. Last week American announced an end of service to four cities and United said they would cut 12% of flights from Newark over pilot, among other cuts. It was also reported by CNBC that all together, airlines have cut their July schedule by 17% since January.
- President Biden made a speech Wednesday afternoon laying out his plan to address high gasoline prices. The first step was asking Congress for help on passing a gas tax holiday. This would suspend the federal gas tax (currently $.18/gallon) for three months. This tax is used to fund infrastructure improvements like highways. The second step was calling on states to do the same – suspend the state gas tax (average is $.30/gallon). The third step is calling on oil companies to use profits to increase refining capacity. In fact, capacity is at the highest level its been in years. The last step was calling on gas stations to pass along the decrease in oil prices to consumers. This will likely not happen either as gas stations are making the least amount of profits in years. Most think that when gasoline prices go up, gas stations make more money, but it has actually been the opposite. We believe what would be a better solution than any of these four items, all of which are out of the President’s control, would be to incentive U.S. oil producers to pump more and approve more permits for drilling which will increase supply and bring it more in balance with demand.
- An energy crisis could be in the early stages in Europe after Germany announced it moved to an “alert stage” in its emergency gas plan due to the higher risk of longer-term gas shortages. The issue began when Europe imposed a ban on Russian gas for seaborne imports (not via pipeline though), but has been exacerbated by Russia restricting flows through the Nord Stream pipeline. China and India imports of Russian oil have surged, with the White House saying sales to both are larger than what was initially believed. In addition, India has been assisting Russia on re-classifying Russian tanker fleets after they were sanctioned by a majority of the world, helping to keep them afloat and Russian oil moving.
- The results of the Federal Reserve’s stress test on 34 large U.S. financial institutions showed all 34 banks would have enough capital to allow them to continue normal lending to households and businesses during a severe recession. Under different scenarios, the banks remained above the tests minimum capital requirements. Passing the stress test allows the banks to return the excess capital to shareholders in the form of stock buybacks or higher dividends. We expect to see a wave of banks announce an increase in dividends and share buybacks after the market close Monday, which is when banks are able to disclose capital return plans.
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The Week Ahead
It will be a busier week to close out June with month and quarter end rebalancing in the maretks, along with several earnings reports and many economic data releases. On the earnings calendar, notable quarterly results will come from Nike on Monday, General Mills on Wednesday, Constellation Brands, Micron, and Walgreens on Thursday. The economic calendar includes durable goods orders and pending home sales on Monday. On Tuesday, we will see the Case-Shiller home price index, where the record high increases in home prices is expected to have moderated slightly, and the Conference Board’s index of consumer confidence. The final revision of first quarter GDP will come Wednesday morning. Thursday’s reports include jobless claims, and the monthly update on personal income and consumer spending. Wrapping up the week Friday are two manufacturing indices and constructions spending. Throughout the week there will be many Fed officials making speeches as well. OPEC will hold its monthly meeting where it will discuss its plans to proceed with production increases. Many brokerage conference and annual investor meetings will take place as well.