- Equities mixed but showed some footing after tech-led weakness – U.S. stocks put in a mixed performance on Thursday, though markets displayed what we would characterize as a bit of stabilization, following the declines in recent days stemming from underwhelming earnings reports from some of the bellwether technology names, along with an overall rotation away from growth stocks that have prompted equities to retreat from the recent record highs. After spending the majority of the day in positive territory, the S&P 500 was unable to hold on to the gains and closed moderately lower on the day, while the Dow added 81 points, and small-caps continued their outperformance with a gain of more than 1%. Meanwhile, tech stocks continued to lag, with the Nasdaq finishing nearly 1% lower. Bonds moved higher, pushing 10-year Treasury rates down near 4.25%, while gold was lower and oil prices gained 1%. A slew of earnings reports added to the mix, with better-than-expected results from companies like IBM and Chipotle, while disappointments from Ford and American Airlines are weighing on those shares. Economic data provided some help, as second-quarter GDP came in ahead of expectations.*
- GDP report shows a still-solid economy – The latest GDP report showed that the U.S. economy grew by a healthy 2.8% in the second quarter, ahead of consensus estimates calling for 1.9%. This was a notable pick up from the previous quarter's 1.4% pace of growth, powered by an acceleration in household consumption as well as a notable jump in investment spending (particularly equipment investment).* There are a few key takeaways from this result:
- The resilience in personal consumption is a bright spot, highlighting that consumers are not going into hibernation. Softness in the labor market is starting to emerge, which, along with slower wage growth and depleted accumulated savings, leads us to believe we'll see slower spending growth ahead. That said, we're not yet seeing evidence that consumer spending will turn down in a manner that would drive a broader decline in GDP. With labor-market conditions still in solid shape, we think the consumer will continue to support slower-but-positive economic growth over the balance of the year.
- This pace of growth should give the Fed confidence that the economy is not in immediate need of monetary support. Therefore, we think this will support the central bank holding rates steady next week. At the same time, we don't think this poses any major changes to the expectation of a September rate cut. Friday will bring the latest read on the PCE (personal consumption expenditures) index, the Fed's preferred measure of inflation. A lot is riding on that report, but to the extent it does not show a surprise uptick in consumer price pressures, we think the combination of moderating inflation and still-solid GDP growth supports the "soft landing" outlook that has largely underpinned the rally in equities this year.
- Some perspective on the recent market volatility – The pullback in the stock market in recent days has driven headlines and some anxiousness in overall market sentiment. It's not unreasonable to expect that some weakness could linger as investors evaluate election uncertainties, incoming quarterly earnings announcements, and the prospects of upcoming Fed moves dictated by the balance of high but falling inflation and positive but moderating economic growth. Nevertheless, we think some perspective is warranted around recent market moves. The S&P 500 is off about 4% since early last week, but we'd point out two important elements of that pullback: 1) This decline is from an all-time high. The stock market is up more than 13% so far this year and 20% over the last 12 months.* 2) This dip is largely coming from weakness in big tech, the very stocks that have been sizable outperformers this year. This is underscored by the fact that the Nasdaq is down 7% from its highs, while the Dow and Russell 2000 index (small-caps) are off only modestly from recent highs. This suggests that the dip is not, at this stage, a more marketwide decline and, in our view, is more reflective of some froth coming off of the top of the largest gainers, versus being driven by new risks or concerns about the underlying fundamentals.
Craig Fehr, CFA
Investment Strategy
Source: *FactSet
- Stocks drop on underwhelming earnings - Major equity indexes posted broad declines on Wednesday, with the S&P 500 logging its worst daily decline since December of 2022 and the tech-heavy Nasdaq declining more than 3%. Earnings from two of the Magnificent 7 stocks underwhelmed, weighing on the growth sectors of the market that have driven most of the market gains this year. Shares of Tesla fell 11% after a fourth straight quarter of disappointing earnings, while shares of Alphabet also pulled back, as the race in artificial intelligence (AI) is driving higher spending than analysts expected*. On the other side of the Atlantic, corporate profit disappointments were front and center as well, with shares of luxury goods company LVMH dropping to a six-month low on signs that China growth is weighing on luxury spending*. Shares of Deutsche Bank were also under pressure after the company reported its first quarterly loss in four years and paused share repurchases*. Despite the risk-off sentiment, U.S. small-cap stocks added to their recent outperformance relative to large-cap stocks*. Bonds were little changed, as investors wait for Friday's inflation data.
- Bar of expectations is high for mega-cap tech - Between today and the end of next week, over 50% of the S&P 500 companies will have reported earnings, shifting some of the attention from U.S. politics and macroeconomic data to the health of corporate America. The outlook for earnings remains positive, as S&P 500 earnings growth is expected to accelerate from 6% in the first quarter to about 10% in the second*. However, unlike the past couple of quarters, the bar of expectations is higher for the broader market, and more so for the Magnificent 7 group of stocks that are responsible for the bulk of this year's gains. Analysts project profits at these companies to rise 30%, outpacing the rest of the market, as they have done for the past five quarters*. But given the elevated valuations, investors are sensitive to any blemishes in the results and in forward guidance. To this point, results for Alphabet were strong, but the stock finished down 5% due to higher spending*. We think that AI is poised for rapid growth over the next five to 10 years and can continue to drive earnings for the companies that are spending heavily today to enable its development. However, as comparisons from a year ago for mega-cap tech become harder and earnings growth from the rest of market starts to pick up, we expect to see a broadening in market leadership ahead, providing further fuel for the sector rotation that appears to be underway over the last couple of weeks.
- Broader backdrop remains supportive - On the economic front, the business activity indexes (S&P Global PMIs) released this morning suggest that growth held mostly steady in July and that the current level of activity is consistent with an average pace of expansion. Tomorrow's advanced estimate of second-quarter GDP is likely to convey a similar message, as the U.S. economy is expected to grow 2%*. That would be an acceleration from the prior quarter but also a notable downshift compared with the second half of the last year, which we would describe as normalization after a period of very strong demand. There are plenty of signs that the labor market and economic growth are downshifting in the U.S. But inflation is cooling as well, which should allow the Fed to start cutting rates, potentially just in time to achieve a soft landing. Given the magnitude and speed of the rally in the first half of the year, markets could enter a choppier phase in the near term. But as long as the economy stays out of recession, inflation continues to moderate, and the Fed gradually lets off the brakes, we would view any pullbacks in both equities and bonds opportunistically relative to cash and bonds.
Angelo Kourkafas, CFA
Investment Strategist
Source: *FactSet
- Quiet day for markets after recent big swings: Equities closed just a touch lower on Tuesday, spending the day bouncing around both sides of the flat line, as markets split attention between the progressing political situation and incoming quarterly earnings announcements. While the former has injected a dose of uncertainty, equities have largely maintained their ground thanks to solid fundamentals, on which the latter will provide a fresh look through the lens of corporate performance. After a rather calm stretch through May and June, daily swings have picked up in recent days, with the S&P 500 moving by an average of roughly 1% per day over the previous four trading days. Bond yields were also little changed on Tuesday, with 10-year U.S. Treasury rates up nearly 10 basis points (0.10%) over the last week, but down appreciably (roughly 25 basis points, or 0.25%) in the month of July. Markets looked content to take a breath today amid a confluence of headlines and data that includes the election shakeup, upcoming earnings from big tech companies, and an important inflation report due out Friday that will have potentially meaningful implications for Fed policy decisions in the coming months.*
- Solid start to earnings season: The spotlight swings brightly to earnings results this week. Second-quarter announcements are off to a fairly strong start, which began with the big banks largely beating expectations. Tuesday, announcements from General Motors and UPS kicked things off, with GM delivering better-than-expected profits, while UPS came up short of consensus estimates. The latter can provide some signals of consumer activity, and while quarterly figures came in light, shipping-volume growth did pick up in the U.S., consistent with recent data showing household spending is not drying up. The headliners, however, will be Alphabet (Google) and Tesla, which will report after the market close on Tuesday afternoon. As has been the case over the last several quarters, big tech earnings are likely to set the tone for markets through this earnings season. Overall, consensus expectations are for nearly 10% earnings growth for the second quarter, a healthy pace that, if maintained in coming quarters, would provide validation for the market's rally so far this year, as well as support for equity-market performance over the remainder of 2024.
- What is recent market performance signaling? The rotation in market leadership that kicked into gear last week continued into this week, reflecting an evolving economic outlook and election implications, while also underscoring the importance of proper portfolio diversification across asset classes and sectors. Small-caps have been the standout, rallying more than 11% between July 10 and July 16, and outperforming again on Monday and Tuesday of this week, posting 1%-plus gains each day.** Cyclical sectors and value-style investments have also outperformed in recent days, while mega-cap technology and growth-style investments (the runaway leaders through 2024) have lagged, as highlighted by the 5% pullback in the Nasdaq between July 10 and the end of last week.* This rotation is consistent with our outlook coming into 2024, which was for a broadening of equity-market leadership beyond big tech and AI-related investments and toward segments of the market that would be geared to trends like lower interest rates and an upswing in the economy, following a softer patch of economic growth in 2024. While we think it's premature to call this rotation a fully sustainable trend, we do think this leadership pivot signals an outlook for approaching Fed rate cuts, resilience within the economy, and a healthy pace of corporate profit growth ahead.
Craig Fehr
Investment Strategy
Source: *FactSet **FactSet, Russell 2000 index performance
- Washington remains in focus as Biden drops re-election bid: On Sunday afternoon, President Joe Biden announced he will not seek reelection in November as the Democratic nominee, and he endorsed Vice President Kamala Harris to be the Democratic nominee, though others may enter the race. This latest twist in the political landscape potentially brings more uncertainty about the final outcome of the U.S. election. However, stocks took the news in stride, with the S&P 500 and Nasdaq both gaining over 1% while bond yields ticked modestly higher.* We'd view the positive response as a sign that markets likely don't expect any wholesale changes in policy from the upcoming Democratic nominee. On the other side of the aisle, Donald Trump remains the favorite to win the election according to PredictIt, but his odds are lower after the news. Over the past two weeks, part of the sizable outperformance of small-cap stocks has been credited to hopes of deregulation and more confidence around the start of the Fed rate-cutting cycle. The small-cap rally continued today, with the Russell 2000 Index gaining over 1.5%.* In our view, here are the key takeaways from the weekend developments:
- The change in the Democratic nominee won't dramatically change the policy backdrop. From a market standpoint, the key issues at stake will likely remain taxes and tariffs. The Trump administration proposals point to lower taxes, deregulation and higher tariffs. While markets have welcomed the pro-growth stance, these policies could also pose inflationary risks down the road. On the Democratic side, we don't expect a meaningful deviation from current views on trade and taxes.
- The procedure around the selection of the new nominee and headlines heading into the democratic convention can inject more short-term volatility. Historically, volatility tends to rise about two months before the election but subsides after the election.
- The investment backdrop remains positive for markets, supported by rising corporate profits, continued economic expansion, and the potential for lower yields as the Fed potentially pivots to interest-rate cuts in the months ahead. We'd recommend investors use short-term pullbacks as an opportunity to add to quality investments in line with their long-term goals.
- Fundamentals, not politics, remain in the driver's seat for markets: While political uncertainty can and does drive short-term bouts of market volatility, we'd remind investors that playing politics with your portfolio can be a risky strategy. For example, looking at the previous two administrations, Donald Trump has talked tough on relations with China and imposed tariffs on billions of dollars' worth of imported goods in 2018. While the Biden administration has kept many of the Trump administration tariffs in place, rhetoric has been softer toward China, and there has been a greater willingness to be collaborative with China as a trade partner. Based purely on rhetoric and headlines, it would be easy to assume Chinese stocks underperformed under the Trump administration and outperformed under Biden. However, the opposite is true. Under the Trump administration the MSCI China Index gained 114%, while under the Biden administration the MSCI China Index has declined by roughly 48%.* Over the long run, we believe fundamental forces, such as economic growth, interest rates and corporate earnings, are more powerful drivers of market performance. To that end, we believe conditions will remain favorable for U.S. equity markets in the months ahead, driven by ongoing economic growth, a Fed that is approaching interest-rate cuts, and healthy corporate profit growth.
- Earnings take the spotlight: Speaking of fundamentals, markets will have a number of corporate earnings reports to digest, with roughly 30% of the S&P 500 set to report this week. Expectations are for the S&P 500 to grow earnings by roughly 10% year-over-year in the second quarter, backed by strong profit growth in the communication services, information technology, financials and health care sectors.* Looking ahead to the full year, expectations are for the S&P 500 to grow earnings by just shy of 12% in 2024, which, if achieved, would be the strongest growth rate since 2021.* Unlike 2023, where only a handful of sectors saw strong profit growth, 2024 is expected to see positive earnings growth across every sector except energy and materials.* Healthy profit growth across multiple sectors could lead to a broadening of leadership in the months ahead and help to extend the current bull market.
![Chart shows the average level of the VIX Volatility Index 6-months before and after election day since 1992](/sites/default/files/styles/chart_image/public/acquiadam/2024-07/7-22-2024-Snapshot-Chart1.png.webp?itok=oagdhvMz)
Image Description: This chart shows the average level of the VIX Volatility Index 6-months before and after election day since 1992. Historically, volatility spikes as election day approaches but subsides in the weeks after. Past performance does not guarantee future results.
![Chart shows the average level of the VIX Volatility Index 6-months before and after election day since 1992](/sites/default/files/styles/chart_image/public/acquiadam/2024-07/7-22-2024-Snapshot-Chart1.png.webp?itok=oagdhvMz)
Image Description: This chart shows the average level of the VIX Volatility Index 6-months before and after election day since 1992. Historically, volatility spikes as election day approaches but subsides in the weeks after. Past performance does not guarantee future results.
Investment Strategy
Source: *FactSet