Market bounce continues as sentiment improves

Thoughts

• Equity markets look to extend their three-week winning streak, as the S&P 500® Index nears the best level since April. Investors have again adopted a “risk-on” approach, with growth and small caps beginning to outperform value and large caps. Interest rates reflect investor confusion, with the 2-year yield up 0.33% last week to 3.21%, with the spread between the 10-year and 2-year yields the most inverted since 2000. Confusion is driving investor decisions, as investors contemplate if we are in a recession or a sluggish growth period and if strong data is positive or negative for markets. Confused investors generally lead to directionless volatility.
• Investors are increasingly in a game of tug-of-war over bullish and bearish talking points. Optimists point to likely peak inflation, recovering supply chains, better-than-expected earnings, a healthy jobs market, and conservative positioning among institutions and hedge funds. Pessimists argue that Fed hawkishness is here to stay, economic data is deteriorating, negative estimate revisions given slowing demand and weakening margins, geopolitical tensions, and lack of capitulation among retail investors. Risk, momentum, and sentiment indicators have all materially improved since the market bottom in mid-June.
• The Inflation Reduction Act will be a modest negative for corporate profits, but hyperbolic forecasts of that impact will be proven wrong. Ultimately, the impact on earnings and share repurchase activity will only be marginally to the downside.

News

• Economic data signal a mixed picture, with Friday’s better-than-expected jobs report pushing back against the recession narrative. Payrolls at 528k were more than double the expectation, and total employment now exceeds pre-pandemic levels. The unemployment rate fell to 3.5%, back to the level from before the pandemic and equal to the lowest rate since 1969. Wage gains surprised to the upside, rising 5.2% from a year ago, though the rate remains well below inflation resulting in negative real wages. Despite this, economic sentiment continues to decline, with an ABC News poll showing more than two-thirds believe the economy is deteriorating, the highest level since 2008. After two consecutive quarters of negative growth, the Atlanta Fed’s GDPNow model forecasts a bounce in the third quarter to 1.4% growth.
• Senate Democrats passed their $700+ billion spending plan along party lines, with Vice President Harris casting the deciding vote. While below the initial $1.75 trillion target, the plan includes clean energy tax credits and an extension of health insurance subsidies, paid for with limits on drug pricing, a 15% corporate minimum tax, greater IRS enforcement, and a tax on stock buybacks. The 1% excise tax on share repurchases will begin in 2023, likely resulting in a front-loading of buybacks through year-end. Ultimately, the bill will incrementally incent corporate executives to opt for dividends versus repurchases. This and the 15% minimum tax on profits will have a modest negative impact on earnings beginning next year, perhaps 1%.
• Earnings season has largely concluded, with over 85% reported earnings growth of 7% on 14% sales growth. Both metrics were solidly above the expectation coming into the quarter, though the magnitude of the beats was below what was seen in recent quarters. Revisions for future quarters have turned negative, with the one-month earnings revision ratio at the weakest level since April 2020. Estimates for 2023 are being revised lower, though the 8% expected growth rate still strikes many as optimistic given slowing demand and margin pressure.

What to Watch

Inflation data will be closely watched, with CPI on Wednesday and PPI on Thursday. Other notable releases include NFIB Small Business on Tuesday and consumer sentiment on Friday.