Markets continue to rally as bear arguments fade

Thoughts

• Equity markets continued to steadily move higher, with the S&P 500® Index gaining for the third-straight week and the ninth time in the past 11 weeks, bringing the Index to within 4% of a record high. The month of July is set to close with a 3% gain, delivering the sixth consecutive winning month, and bringing the S&P 500 to 28% above the October low. Bulls continue to point to signs of a soft landing, a strong consumer, improving inflation, and a peak in Fed policy, while the bear argument continues to break down as inflation and economic data beat expectations. Interest rates have stabilized as the Fed Futures curve predicts only a one-in-three chance of an additional hike, with a cut expected by next Spring.
• Signs are beginning to point to capitulation among bearish institutional investors, economists, and Wall Street strategists as market returns and economic data continue to defy expectations. Morgan Stanley increased their year-end target by 15% to 4,600 from 4,000, while a noted bear, Morgan Stanley conceded that they have been too bearish. JPMorgan data show capitulation among hedge funds, with long/short funds adding risk at the fastest pace since 2019. Year-to-date, money market funds have added $850 billion versus $250 billion for equities and $215 billion for fixed income, bringing the group to a record $7.9 trillion, and providing dry powder for further moves in equities.
• The earnings picture has been mixed, with better-than-expected gains among domestic companies and underperformance from companies with international exposure. But the challenges companies have endured – stubborn inflation, weak markets, and sluggishness internationally – are no longer headwinds. Now, we’re not only seeing tailwinds heading into 2024, but we’re getting less disruptive reactions in the stock market following earnings reports. These are very encouraging signs that a lot of the emotion that was driving markets has subsided.

News

• Earnings continue to beat expectations, with 80% of companies beating earnings estimates and 64% topping revenue estimates. Earnings are on pace to fall by 7%, marking the largest decline since the beginning of the pandemic. Domestically focused companies are seeing modest earnings growth, while foreign-focused companies are seeing a decline of greater than 20%, notably in the energy, materials, and health care sectors. Despite the market tailwind, companies that are beating estimates are not being rewarded, with companies beating seeing a price decline in the two days prior and two days after the release. This compares to an average gain of 1% over the past five years. Interestingly, companies that miss are only seeing a 0.7% decline, compared with the long-term average of a 2.2% drop.
• Economic data continues to surprise to the upside, with second-quarter GDP rising at an annualized rate of 2.4% versus the consensus estimate of 1.5% and 1.8% in the first quarter, pushing back on the idea that we are heading for a recession. Consumer confidence surged to the best level in two years at 117, with inflation expectations at the lowest level since the beginning of 2021. Inflation data continue to surprise to the downside, with the PCE deflator at 3.0% from a year ago, core at 4.1%, and the GDP price index at 2.2% annualized. The Citigroup Economic Surprise Index touched 82 on Thursday, the best level since March of 2021. Bearish economists wonder if the upside to data and loosening financial conditions places upside pressure on Fed policy.
• The FOMC (as expected) voted to hike the Fed Funds rate by 0.25% to 5.25-5.50%, the highest level in 22 years. Chair Powell was seen as taking an incrementally dovish tone at his press conference, noting that the group will take a “meeting-by-meeting” approach going forward, though noting that inflation “has a long way to go” to hit the 2% target. Equity markets reached the highest level since April as investors increasingly bet on a soft landing. The tug-of-war between bulls and bears has been dominated by the bulls in recent weeks, with strong macro data, easing inflation, the perceived peak in Fed policy, and strong technical indicators. The bears’ focus on economic and earnings recessions is fading as data exceed expectations. The FOMC meeting resulted in a 0.25% rate hike to 5.50%, though Chair Powell’s commentary was viewed as incrementally dovish.

What to Watch

• Earnings will be in focus this week, with over 160 companies representing nearly one-third of the S&P 500 set to report. Economic releases include manufacturing ISM and PMI, along with JOLTS job openings on Tuesday, productivity, durable goods, and services ISM and PMI on Thursday, and the monthly payroll report on Friday.