A Week That Had It All: Interpreting the Latest Data
A slew of corporate earnings reports, economic data, a Fed meeting, and the regulatory-induced sell-off in Chinese equities made the last week of July the busiest one this summer. There was a lot of push and pull, with equities finishing slightly lower to where they started the week, but still near all-time highs. We think the fresh datapoints reveal the following about the health of the economy, the corporate sector, and the future direction of monetary policy:
- Shortages are holding back the recovery, but the economy is bigger now than it was before the pandemic.
- Corporate earnings continue to rise at a fast clip, supporting sentiment and valuations.
- The Fed is in no rush to dial back its accommodation, but the countdown to tapering has started.
We believe that the remainder of the year could be choppy given elevated expectations, a slowdown in growth, and regulatory uncertainty in China. However, last week's data provide further assurance, in our view, that the foundation of the expansion and bull market is solid. We'd offer the following additional perspective on last week's market developments.
Second-quarter GDP: More than meets the eye
- The initial estimate of second-quarter GDP showed that U.S. economic activity reclaimed its pre-pandemic peak and accelerated from the first quarter, but at a meaningfully slower pace than expected. Real GDP grew at a 6.5% annualized rate versus the 8.4% forecast1. The drag on growth came from a decline in inventories, residential investment (housing), government spending, and a wider trade deficit as imports rose faster than exports.
- Despite the headline miss, consumer spending, which represents the lion's share of overall demand (about 70%), was stronger than expected, growing at 11.8%1. The reopening of the economy, aided by vaccinations, pent-up demand and a rundown of pandemic savings, powered spending higher. Growth would have likely been even stronger if it weren't for the supply bottlenecks and shortages that are holding back demand. Empty car-dealer lots is one example of the numerous supply issues that the economy faces. The silver lining to the decline in inventories is that retailers will have to restock and rebuild them in the second half of the year, boosting GDP.
- After just six quarters and unprecedented fiscal and monetary support, economic activity is now back above its 2019 peak, fully recovering from not only one of the deepest recessions in U.S. history, but also the shortest2. Growth in the second half of the year will unavoidably slow as the economy transitions from recovery to expansion. However, the business cycle remains young, and over the next 18 months the economy is expected to grow comfortably above the 2.3% average pace that prevailed from 2010 to 20191.
The graph shows U.S. economic activity which is now back above its 2019 peak.
Earnings: Another stellar quarter in the works, but the bar is high and rising
- Last week was the busiest week of the second-quarter earnings season, which spans over two months. About a third of the S&P 500 companies reported results, including the biggest tech names. Like the previous four quarters, companies are topping estimates at record levels (87% of the S&P 500 companies have exceeded estimates by an average of 18%), driven by the strong rebound in demand and elevated profitability levels1.
- The highly anticipated earnings reports from several mega-cap tech companies were solid but not without blemishes, and share prices, excluding Google, declined. Amazon, Apple, Google, Microsoft and Facebook, which together make up 22.5% of the S&P 500, on average doubled their earnings from last year3. Even as some of the pandemic trends reverse, the digital transformation continues, with online advertising spending, cloud computing and smartphone demand rising at a fast pace. Despite the staying power of the tech earnings, comparisons are getting harder in the second half of the year, and the bar of expectations is high after a sharp rally in prices since the middle of May. Outside of tech, earnings of stocks that are more closely tied to the business cycle have been recording the biggest upside surprises, supporting the case for sector and style diversification.
- With large-cap companies delivering strong results, forward earnings expectations continue to rise at a fast pace, even compared with other post-recession recovery years. For perspective, 2021 earnings have been revised higher by 18% since the start of the year, and 2022 earnings by 11%, vs. 9% in 2010 and 8% in 20043. In our view, rising earnings have helped support sentiment and have allowed investors to look through the COVID-19 variant uncertainty. Persistent input cost pressures could pose profitability challenges ahead, but, so far, most companies have been able to pass through price increases and have achieved productivity gains.
Source: FactSet, past results are not a guarantee of future returns
The graph shows forward earnings expectations for the S&P 500 which continue to rise at a fast pace, supporting sentiment and valuations.
Fed policy: "Progress," but not yet "substantial further progress"
- Chair Powell's commentary broke little new ground after the Fed's two-day meeting last week. The central bank made no changes to policy rates or its asset-purchase program, as expected. However, the Fed's statement noted that progress has been made toward the employment and inflation goals, hinting that policymakers are closer to tapering bond purchases.
- Yet, a policy shift is not imminent, as Powell repeated that the economy is still "a ways off" from "substantial further progress," which is the standard that needs to be met to reduce the $120 billion of bonds the Fed is buying every month. All eyes will be on this week's and September's employment reports to gauge how fast the labor market is recovering. We continue to expect that policymakers will announce their intention to start removing some of the extraordinary accommodation over the coming months, with actual implementation at the end of the year or the beginning of next. This shift could trigger some volatility but is unlikely, in our view, to result in significant tightening of financial conditions, which are currently near the easiest on record.
The graph shows an index for financial conditions, which are highly supportive helped by unprecedented central bank stimulus.
China stock rout: Regulatory uncertainty clouds near-term outlook
- China’s regulatory crackdown on mega-cap internet stocks over the last several months, and on the private education sector last week, has dragged the MSCI China Index down 26% from its February peak this year. Previous government actions were mostly focused on anti-monopoly and financial technology regulation, involving a $2.8 billion antitrust fine on Alibaba and the suspension of Ant Group’s $34.5 billon listing. The more recent data-security probe into the ride-hailing company Didi (which raised $4.4 billion in its U.S. IPO last month), along with the sweeping new rules affecting private education companies, shook investor confidence, triggering a 13% three-day decline last week1.
- To compensate for the regulatory risk, investors are likely to assign a higher-risk premium and continue to demand a deeper discount to own Chinese equities. With uncertainty lingering, we think the outlook is likely to stay clouded for a while. However, the stock-market rout could trigger additional steps by China's central bank to ease liquidity. Also, the government could take steps to calm the markets and reassure investors that further actions won't be applied broadly.
- With Chinese equities making up almost 40% of the emerging-market benchmark, the case for improved near-term relative performance for emerging-market equities has weakened1. Yet, we believe that the positive medium- and long-term trajectory for emerging economies remains intact: 1) The higher sensitivity to global trade will likely prove to be an advantage as the economic reopening advances and global growth picks up; 2) Elevated commodity prices relative to recent history benefit commodity exporters (last week a broad basket of commodities reached a seven-year high); 3) Even though the Chinese economy is slowing after having recovered first, it is still expected to grow faster than developed market economies for years to come; and 4) The potential for the U.S. dollar to weaken over time could potentially provide an additional tailwind to international returns.
Source: FactSet, Past results are not a guarantee of future returns.
The graph shows the recent sharp decline of Chinese equities and their divergence with U.S. equities driven by regulatory uncertainty.
Angelo Kourkafas, CFA
Sources: 1. Bloomberg, 2. National Bureau of Economic Research. 3. FactSet, Edward Jones calculations
Weekly market stats
|Dow Jones Industrial Average||34,936||-0.4%||14.1%|
|S&P 500 Index||4,395||-0.4%||17.0%|
|MSCI EAFE *||2,307.08||0.2%||7.43%|
|10-yr Treasury Yield||1.23%||0.0%||0.3%|
Source: Factset, 7/30/2021. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results. * Source: Morningstar 08/01/2021.
The Week Ahead
Important economic data being released this week include construction spending, hourly wage growth, and consumer credit.
Angelo Kourkafas is responsible for analyzing market conditions, assessing economic trends and developing portfolio strategies and recommendations that help investors work toward their long-term financial goals.
He is a contributor to Edward Jones Market Insights and has been featured in The Wall Street Journal, CNBC, FORTUNE magazine, Marketwatch, U.S. News & World Report, The Observer and the Financial Post.
Angelo graduated magna cum laude with a bachelor’s degree in business administration from Athens University of Economics and Business in Greece and received an MBA with concentrations in finance and investments from Minnesota State University.
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