The Dog Days of Summer
By Crest Capital Advisors on August 11, 2023
Dow: 0.62% to 35,281.40
S&P 500: (0.31%) to 4,464.05
Nasdaq: (1.90%) to 13,644.85
Russell 2000: (1.65%) to 1,925.11
10-Year Yield: 4.16%
Outperformers: Energy 3.54%, Healthcare 2.46%, Utilities 0.84%
Underperformers: Technology (2.87%), Materials (1.00%), Consumer Discretionary (0.99%)
US stocks were lower this week, with most major indices adding to last week’s declines (though the Dow Jones Industrial Average managed to eke out a small weekly gain). Big tech, after outperforming during the first 7 months of the year, was once again broadly lower and led the declines in the tech-heavy Nasdaq.
Despite the retreat in stocks, there was very little change to the overall market narrative. Inflation remains a primary concern, but this week’s softer July CPI report bolstered market expectations that the Fed will remain on pause. The tail end of the Q2 earnings season has not presented any new themes to dissuade ‘better-than-expected’, and the broader economic picture remains focused on the likelihood of a soft landing. Despite the overall good news, stocks still retreated.
In this environment, late in the summer as many on Wall Street vacation, forecasters maintain that the stock market is likely to continue to churn along and ‘correct’ in a fairly narrow range. This is typical for this time of year as the various bullish and bearish themes are debated. We already noted the bullish talking points above. But by the same token, bears this week cited higher bond yields, China recovery worries, rising energy prices, a Moody’s bank downgrade, and challenging seasonality as reasons for caution. We don’t see any of these as enduring problems, but the media must ascribe a reason for everything.
Looking ahead to next week, the market will enter the tail end of Q2 earnings season and re-focus again on monetary policy as the minutes from the latest FOMC meeting are released on Wednesday. In the meantime, read on for our thoughts about the recent market malaise.
Don’t Fall For It!
We entered the month of August in a fairly euphoric state of mind….at least in terms of the price performance of the major stock market indices. (To be fair, virtually no investors we speak to were euphoric…almost all of them remain skeptical) Virtually nobody expected to see the S&P 500 up 20.65% through the end of July, let alone the Nasdaq (last year’s red-headed stepchild) up a whopping 37.71%! It was a surprise to all of us…a pleasant surprise…but a surprise nonetheless.
As stocks gained momentum into the early summer months, the FOMO (Fear Of Missing Out) mentality began to build along with it. Traders and hedge funds, mostly short-term focused investors, reluctantly moved away from the sidelines, and back into the game. This additional buying momentum further fueled the markets surge.
The next thing that happened, is the most vocal of the bearish voices began to capitulate.
First, BofA changed their outlook from recession to soft landing. JP Morgan followed suit, with its own report titled “US: The end is not near”. Morgan Stanley’s perma-bear Mike Wilson admits he got the market call wrong. Is this the “all clear” moment everyone was waiting for? Or a contrarian’s dream?
Then, just like that, we entered a new month and stocks started to decline (Investors had gotten complacent and used to things like a 13-day winning streak for the Dow Jones Industrial Average). Instead, we are on a run of the S&P 500 index being down 8 of the last 10 days. It’s gotten to the point where even a 3-5% sell-off, a normal run of the mill squiggle on the road to financial success, somehow feels especially painful. Never mind that we are still up handsomely on the year! And, of course, in order to assign a “why” to the suddenly surprising sell-off, the bearish narratives (the same narratives that have doubted the markets for the better part of the past 2 years) suddenly re-asserted themselves! The Fed! The economy! Credit Markets! Higher Rates!
Aha! It was a head fake after all! Just like the bears have been saying all year. “The rally was fake!” The real reflection of value is only found on the down days. Sell, Mortimer, Sell! This is the type of thinking that permeates the bearish crowds. And the media of course is all too happy to pick it up and run with it. Here’s one of CNBC’s recent headlines…
NO! That is absolutely the wrong reaction. The only thing that changed was random price variables. Nothing fundamentally is different and investors still remain way off sides in terms of exposure to risk assets. As the economy continues to plod along, and inflation continues to come down, the backdrop for corporate earnings remains solid.
We are not down because Fitch suddenly decided to formally acknowledge that which everyone already knows. The US government has a lot of debt.
We are not down because Moody’s made a statement of the obvious about regional banks…that they are having profit pressures as a result of what we’ve all known since March of this year (5 months ago!).
We are not down because the Fed changed course. We are not down because earnings have somehow surprised to the downside.
No, we are down, because the market was long overdue for a corrective pause to refresh…a necessary step to ensure a sustainable path forward towards what we fully expect to be a higher high later this year.
We leave you with this final message. Don’t let short-term, random, price signals sway you from your long-term investment goals. Pullbacks and corrections are healthy and normal. Without the risk, we can’t have the reward. Unlike Charlie Brown in the meme below, you won’t end up flat on your back if you maintain this perspective.
Mission Accomplished
Since the Fed refuses to say it, we’ll say it for them. The war on inflation has been won and it’s time for the Fed to take their foot off the brakes of the economy!
This week’s CPI report, released on Thursday morning, came in at another very low month-over-month rate of 0.2% on both headline and Core (ex-food/energy), and -0.1% on Core Ex-shelter. Used cars and airfares declined and shelter was unchanged. This brings headline year-over-year inflation to 3.2%, marginally lower than the 3.3% economists were expecting. This report now marks the third consecutive CPI print that comes in below 0.2% month-on-month and, in our view, should be supportive of market pricing for lower breakeven and the end of Fed tightening.
In short, CPI year-over-year beat expectations…again, but did rise a tick from last month because of an anomalous year-ago comparable of 0.0% that is now rolling off. Deconstructing the report, it’s all owners equivalent rent (OER) driving the inflation prints now. Without it, CPI was almost unchanged on the month. Core, excluding OER, the best measure of the true inflation signal, outright deflated on the month, and is now at a mere 3% year-on-year.
In the table below, we highlighted the OER calculation in yellow. You’ll note it is the only sub-category that remains too high, but that is simply a function of the heavy lag in this dataset, not because somehow inflation has become entrenched or “sticky”. You’ll also note on the right side column, indicated with the blue arrow, every category is pointing straight down, again except for the OER measure.
We circled in blue what inflation would be if we were to remove the OER component. That’s right, we’d be at a 1.6% annual rate, and a ridiculously low 0.3% annualized over the last 3-months! IF OER was reflecting reality in any way, shape, or form, we’d be hearing the Fed talk about how to bring inflation UP to target! Not whether they should hike again at the next meeting.
And, just for a reminder, if we look at Core CPI inflation using private sector rent indices for shelter instead of the official government data…we get outright deflation. The official OER makes up a whopping 43% of the Core CPI. So, when the talking heads in the media (or Fed officials for that matter) complain that inflation is still too high, remember that nearly half of the input in the measure they’re evaluating is completely wrong!! (Or at least out of date data)
Finally, with this week’s CPI reaction, the bond market is telling the Fed they are done with rate hikes. There’s just a 15% chance of a September rate hike being priced into fed funds futures and a 21% chance of one in November. The Fed is now expected to start cutting rates in early 2024, according to market pricing. We think it may have to come even sooner than that.
“Today’s report further reduces the possibility of a September hike and is consistent with our view that the FOMC will decide that a final hike is unnecessary at the November meeting. We continue to expect unchanged policy for the remainder of the year.”
-Goldman Sachs Economics Research, 8/10/2023
Payroll Anomaly?
We came across an interesting fact this past week and thought it may be worth sharing, particularly with the Fed’s overemphasis on labor market conditions as a signal to guide them in their inflation fight. What we’ve noted, and this is a very rare condition that has only occurred on two other occasions, is that every single monthly payroll report in 2023 has been revised lower in subsequent months. (Conclusion: The jobs market may not be as strong as initially thought.) For all the market fanfare over whether payrolls beat or missed expectations (usually, the difference is just a few thousand jobs in either direction), it’s crazy to see it all get quietly revised away a month later upon the release of the next report. No harm, no foul we suppose…but when literally trillions of dollars are impacted by subtle changes in the jobs report, you’d think the Bureau of Labor Statistics would at least not be consistently wrong in only one direction!
Experts Get It Wrong…A Lot
In the early 1980s, AT&T asked the expert business consultants at McKinsey & Co. to estimate the cell phone market by 2000. The consulting giant came back and said that it would be a “niche” market with a size of 900,000 subscribers.
The recommendation was for AT&T not to do cellular. McKinsey was obviously very wrong. In 2000, about 900,000 cell phone subscribers joined every day! (And the market was well over 100 million users at that time.)
AT&T paid for the mistake dearly. In 1993, it spent $12.6b to acquire McCaw Cellular (the 5th largest ever US corporate acquisition at the time).
Then, we came across an example of perhaps an equally enormous mistake, only this time in the other direction. (Time will tell of course) On June 17th, 2022, McKinsey released a report suggesting the Metaverse may create $5 trillion in value by 2030! Well, we all know how well that worked out for Facebook/Meta. They changed their name, and their primary business focus, and the stock was thoroughly punished for it, declining nearly -77% from peak to trough! It didn’t start to recover again until the company pivoted back to focus on its core businesses.
Here’s the headline…
The moral of the story is this…the next time an expert comes onto one of the financial media channels with a compelling story, no matter how smart they sound, remember to take it with a grain of salt as the experts are frequently wrong!
Earnings Report Card Update
With the majority of earnings season complete (84% complete as we entered this past week), the overall picture is once again ‘better-than-expected’ earnings and sales. (Just like we predicted here) Earnings growth for the quarter is expected to decline -4.2% which is a smaller decline than what was originally expected (-5.7%). Sales are now expected to squeeze out a small gain at 0.2% versus a decline of -0.6%. The energy sector is where the notable weakness is occurring but with oil prices on the rise again and expectations just about as bad as it gets, the sector is likely at trough earnings.
Economic Funnies
Relax, it’s just a summer correction that was overdue…
Crazy Stat(s) of the Week
Here are this week(s) crazy stats!
- The 101 S&P 500 stocks that pay no dividends are up an average of 20.7% YTD, while the 100 highest-yielding stocks in the index are down -3.2% YTD.
- Investors today are earning their highest yields on cash since January 2001! The 3-month Treasury bill briefly touched 5.5% this week before pulling back a bit to settle around 5.43%.
- Apple has bought back $588 billion in stock over the past 10 years, which is greater than the market capitalization of 492 companies in the S&P 500 Index. The company still has over $166b in cash and long-term investments on its balance sheet as of the most recent quarterly.
- According to Edmunds, the share of consumers who financed a vehicle with a monthly payment of $1,000 or more reached a new all-time peak of 17.1% in Q2, up from 16.8% in Q1 and just 4.3% in Q2 of 2019.
Quote(s) of the Week
“There is no place for dogma in science. The scientist is free, and must be free to ask any question, to doubt any assertion, to seek for any evidence, to correct any errors.”
-J. Robert Oppenheimer
Editors Note: Seems many in this country have lost sight that science is not mono-lithic, nor is science ever settled. Science is a process of discovering truth and welcomes open dialogue and discovery.
Calendar of Events to Watch for the Week of August 7th
As the week came to a close, we have ~91% of the S&P 500 having reported Q2 earnings with ~80% posting positive beats in the quarter. Next week marks the last of the bigger earnings weeks for Q2 with notable prints from major big box retailers Home Depot, Target, and Walmart as well as a number of high profile tech leaders such as Palo Alto Networks, Applied Materials, and Cisco Systems.
On the economic front, the major focus will be on Retail Sales on Tuesday, Industrial Production on Wednesday, and Leading Indicators on Thursday. In general though, it’s a fairly light economic calendar.
On the monetary policy front, we’ll get the meeting minutes from the latest FOMC meeting on Wednesday, but the next main event on this front won’t come until later in the month (August 24th – 26th) when the Fed holds it’s annual Jackson Hole conference. This conference has a history of marking headlines as it applies to monetary policy and there is growing anticipation that this one could be an opportunity to formally announce a “pause” in rate hikes.
Monday 8/14 – No major US economic reports due today. Looking overseas, Japan will be out with Q2 GDP, Industrial Production, and Retail Sales.
Tuesday 8/15 – US Retails Sales for July are expected to post 0.4% month-over-month rate, up from 0.2% last month. The July Empire Fed Index is expected to be flat at 0.0, down a tick from last month’s anemic 1.1 reading.
Wednesday 8/16 – July Industrial Production is expected to post a modest 0.3% monthly increase, an improvement from the -0.5% contraction in June. Housing Starts and Building Permits for July will also be out. Finally, the meeting minutes from the latest FOMC meeting will be released and sure to influence markets.
Thursday 8/17 – US Leading Indicators for July are expected to contract again…but at a less negative rate (-0.35% v. -0.7% last month). The Philly Fed regional index is expected to stay in contraction territory at –10.0, up modestly from last month’s -13.5. And as is now usual for each Thursday, the weekly jobless claims data will continue to be scrutinized for any signs of additional labor market weakness.
Friday 8/18 – No major US economic reports due today. Looking overseas, Eurozone CPI inflation for July is expected to come in at 5.3% year-over-year, unchanged from the preliminary reading a few weeks back.
Source: FactSet
