After Sprinting A “3K,” Market Mulls More Powell, Inflation, Delta Q2
TD Ameritrade | Jul 11, 2019 10:42AM ET
(Thursday Market Open) The S&P 500 Index (SPX) hit 3000 for the first time Wednesday on dovish testimony from Fed Chair Jerome Powell, but is there meaning in this big new round number?
Well, it’s great for fodder, and maybe it helps psychologically to see a new first-digit for the SPX for the first time since 2014.
The challenge to that psychological lift probably comes when earnings season starts next week. Expectations on Wall Street are already pretty soft, meaning companies have a low bar for beating projections. Companies that do beat might get a small reward in the stock market, but companies that miss low expectations are likely to get taken out to the woodshed.
That’s one reason why some analysts think the SPX might be approaching the top of its range for the moment. The earnings rewards look like they might be unremarkable, while the punishments look like they could be significant. If we see a couple of big-name stocks miss earnings expectations, that could hurt sentiment across the market.
When you look at the price-to-earnings ratio (P/E), the “P” has been rising much faster than the “E,” for a lot of companies. That potentially raises questions about current market values when you look ahead to an earnings season where many analysts expect average S&P 500 earnings to actually fall year over year.
Even if earnings turn out better than expected, the market faces more tests in the months ahead, including the tariff overhang, Brexit, and, as Fed Chairman Jerome Powell reminded people in his testimony Wednesday, the U.S. debt ceiling debate. Yes, based on Powell’s testimony Wednesday, a rate cut later this month looks extremely likely. That news is now basically built in and it’s on to earnings, a key test to see if this rally can continue.
Speaking of earnings, Delta (NYSE:DAL) reported strong Q2 results early Thursday, easily beating third-party consensus estimates on earnings per share and coming in slightly higher on revenue. The company also raised its fiscal year guidance. Shares rose about 2% in pre-market trading.
The other earnings news this morning didn’t get so much applause, with Bed Bath & Beyond (NASDAQ:BBBY) beating bottom-line estimates but apparently disappointing on guidance. Shares fell 4%.
On the trade front, France and the U.S. are having a skirmish. The U.S. Trade Representative is investigating whether a new 3% French “digital” tax on company revenue “is unfairly targeting” certain U.S.-based technology companies. Some of the companies potentially affected by the tax include Alphabet (NASDAQ:GOOGL), Amazon (NASDAQ:AMZN), and Facebook (NASDAQ:FB). The French Senate approved the tax early Thursday.
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Meanwhile, crude continues to find momentum, with U.S. prices trading above $60 a barrel—a six-week high—amid hurricane concerns in the Gulf of Mexico and a big weekly U.S. supply draw.
Powell continues his Capitol Hill testimony this morning.
h3 Powell Delivers For Stocks/h3For the second time in two weeks, the market got what it wanted from the Fed yesterday.
Back in late June, stocks rallied after the Fed’s meeting when Powell expressed new concerns about the economy and raised hopes of a July rate cut. Then on Wednesday in his “Humphrey Hawkins” testimony to Congress, he renewed those hopes by again talking about economic uncertainty and noting that the big June job gains didn’t mean all was well. It seemed to signal that Powell is ready to cut rates later this month.
The odds of a 50 basis-point cut in July rose from under 4% early Wednesday to more than 26% by the end of the day after Powell spoke. Chances for another Fed easing in September are now above 70%, up from around 60% earlier this week.
We often emphasize here that a single piece of data doesn’t represent a trend, and Powell made that clear in his Q&A with Congress on Wednesday. At one point, a House member asked Powell if strong jobs growth had changed his negative views about the economy. “The straight answer to your question is no,” Powell replied, adding that weakness in overseas economies continues to weigh on the U.S. economy.
Economists’ forecasts for U.S. economic growth arguably back up Powell’s concerns. For instance, the New York Fed Staff “Nowcast” predicts gross domestic product (GDP) to rise just 1.48% in Q2. That improves just slightly to 1.74% in Q3. Compare that to the 3% growth in Q1 and nearly 3% growth for the full year of 2018 and it looks clear that things are slowing down. Softness overseas, which Powell referred to, plays a role, but it’s not the only factor. Trade worries are another major weight.
The New York Fed’s probability model now signals around a 32% chance of a U.S. recession next year. That’s a big leap from 12-month recession odds of just around 10% at the start of 2019. One analyst on CNBC said Wednesday that the New York Fed’s probability data rising above 30% has often been a good, but not perfect, indicator of near-term recession risk.
All this leads to a question many investors might be asking themselves today: If things look so tepid, why did stocks rally to record highs on Powell’s testimony? Yes, rates look like they’ll probably be going down, maybe more than once this year. But the Fed lowering rates isn’t necessarily the best news. The Fed doesn’t ease its policy when the economy is rolling along. A stronger economy would ultimately be a better argument for record highs on Wall Street.
h3 Q2 Results Could Help Finish Story Started By Powell/h3Earnings season isn’t a panacea, but it might help answer some questions that seem more theoretical now. If executives back up Powell’s assertions about economic weakness and earnings come in as bad or worse than analysts expect, it’s possible that might be a wet blanket thrown over the market. At this point, however, it looks like investors are hoping low rates can keep companies interested in making new investments and keeping workers on the job. That also depends on consumer demand, which could be buffeted by lower borrowing costs.
The other thing earnings season can do is help crystalize what executives think of the tariff situation. They were relatively quiet about that on their Q1 calls, but now there are 89 companies in the S&P 500 issuing negative Q2 guidance, and a lot of them probably are doing this partly because of tariff worries. We’re coming to a point where CEOs of multinational companies will almost be forced to comment on tariffs.
Powell pointed to persistent low inflation as another concern, and today marked the release of the June consumer price index (CPI). The core CPI, which strips out food and energy, came in above expectations at 0.3% for the month and 2.1% year-over-year, up from May’s 2%. However, headline inflation of 0.1% in June was only slightly above third-party estimates for a flat number, while the year-over-year headline CPI increase of 1.6% was in line with Wall Street’s expectations.
It seems unlikely that these data would give the Fed any pause about the anticipated rate cut, but Powell might get asked about it as he testifies in Congress today.
More inflation data are due tomorrow with the June Producer Price Index (PPI). At this point, analysts expect PPI to come in flat, with core PPI (stripping out energy and food) rising 0.2%, according to Briefing.com. That’s pretty similar to the previous month and not too remarkable.
Also on the data side, Fed minutes from June came out Wednesday but kind of got lost in the shuffle with Powell providing so much updated analysis during his testimony. We all heard straight from the horse’s mouth on Wednesday, and that continues today with more Powell testimony in D.C. The minutes showed Fed officials backing Powell’s views about economic risks increasing.
From a technical standpoint, there’s some significance in the SPX crossing a major barrier like 3000, but it might be more important if it can close above that, which it didn’t do Wednesday. Sometimes you see a big number get breached intraday and then several days of the market toying with it again but not closing above it. That can’t be ruled out here, but if the SPX can make several closes above 3000, that could help cement that round number as a support level.
Figure 1: A MAN AND A MARKET. Any doubt that a single person can have an outsized effect on the entire market arguably vanishes with a look at this intraday chart of the S&P 500 (candlestick) and 10-year Treasury yield (TNX) over the Tuesday to Wednesday timeframe. Look at the jump in stocks and the drop in yields early Wednesday right after Fed Chair Jerome Powell’s testimony went public. Data Source: Cboe Global Markets, S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
FAANGs Soon Back in the Hot Seat: Feel like taking a summer vacation to steamy Washington, D.C.? Some executives at the “FAANG” companies have no choice, but might wish they were somewhere cooler. Officials from Apple (NASDAQ:AAPL), Amazon (AMZN), Facebook (NASDAQ:FB) and Google (NASDAQ:GOOGL) are scheduled to testify next week as part of House lawmakers’ wide-ranging investigation into big tech companies and potential threats they may pose to competition, according to the Washington Post. It’s been a while since these executives got called out on the carpet by Congress, but this might put them and these issues back in focus.
While Democrats lead the House and some of their standard bearers are calling for more regulation in the technology business, Republicans have also raised concerns about possible competitive threats in the industry. Also, President Trump told reporters last month that, “Obviously, there is something going on in terms of monopoly,” when asked about antitrust issues with large tech firms like FB and GOOGL. Stay tuned, because this sort of hearing can sometimes cause stocks to move, especially if it looks like the executives are turning into punching bags for Congress.
Mixing and Matching Bank Earnings: Though investors often think of the big banks as one entity responding to various economic cues, that isn’t really the case. Sometimes the bank stocks move in sync, but it’s also important to distinguish them, because they’re not a solid bloc. For instance, falling mortgage levels—with the average 30-year mortgage now at around 3.75% vs. 4.52% a year ago—probably meant more for Wells Fargo (NYSE:WFC) than the other banks reporting next week, due to WFC’s huge presence in the mortgage space. If consumer spending slows, that could show up in C’s or JPM’s results due to their massive credit card businesses.
Another thing to consider keeping in mind as bank earnings approach next week is the wide views bank executives have of the economy. The very nature of their business means they tend to keep a close eye on trends that really can make a difference for the entire stock market. These include U.S. trade disputes with China and Europe, immigration, Fed policy, and infrastructure. Commodity price trends are another place bank executives might be able to offer some pertinent thoughts. That’s why if you have time to listen, it might be prudent to consider tuning in and hearing what they have to say on their earnings calls.
Steep Road Ahead? The Fed could be trying to steepen the yield curve a little by keeping short-term borrowing costs low. If that’s its strategy, it seemed to work on Wednesday, though one day is never enough to be a trend. As Fed Chairman Powell testified to Congress and made it clear to investors that the Fed is eyeing a possible July rate cut, the 30-year Treasury note sold off, while 10-year and two-year notes rose slightly. While the 10-year yield didn’t probe lows below 2% the way it did recently, it did come down pretty solidly from its early highs of around 2.1% posted before Powell’s remarks went public, finishing the day at 2.06%.
More significantly, maybe, is that the two-year note did well compared to the 30-year. So the yield curve did steepen slightly on Wednesday, and that could be good news overall for the market. However, we’d probably have to see this continue for a few days for it to look significant, and one negative side effect (which was evident Wednesday) could be pressure on the Financial sector. Meanwhile, the Fed’s signaling seemed to weigh on the U.S. dollar and might have aided crude prices as well, though a big U.S. weekly crude draw also played a role. Energy shares led the leaderboard Wednesday in part due to the crude rally.
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