VIDEO: Making Sense of Conflicting Signals
Welcome to my latest video presentation. Below is a condensed transcript; the video contains additional details and several charts.
The U.S. economy has posted two consecutive quarters of negative growth, inflation remains stubbornly high, and the Federal Reserve has hiked the federal funds rate four times so far this year.
And yet, July turned out to be the best month for stocks since November 2020. The S&P 500 jumped 1.4% last Friday, bringing its gain for July to 9.1%. That’s the best single month performance since the first announcements about an effective coronavirus vaccine.
So what gives? Well, driving stocks higher have been better-than-expected quarterly earnings results, positive guidance from the management of bellwether large-cap stocks, and expectations that slowing economic growth will prompt the Fed to ease up on tightening. Let’s make sense of the conflicting signals.
Last week witnessed the second consecutive weekly gain for the major U.S. and overseas stock indices. The tech-heavy NASDAQ racked up the biggest gain at 4.7%, as key Big Tech players offered a positive assessment of future growth prospects. The Dow Jones Industrial Average and the S&P 500 gained 3.0% and 4.3% for the week, respectively.
The MSCI EAFE index of international stocks rose 0.9% for the week, as the euro zone’s economic growth in the second quarter surprised on the upside. Despite the geopolitical battle with Russia over energy supplies, the Europeans are making huge strides in finding alternate sources.
In the U.S., the Bureau of Economic Analysis (BEA) reported last Thursday that gross domestic product (GDP) growth shrank by 0.9% year over year, the second straight quarterly contraction and technically constituting a recession.
However, many analysts have refrained from declaring a recession, largely because jobs growth and consumer spending remain strong. What’s more, the GDP numbers are likely to be revised.
Inflation: set to fall in 2023?
The BEA reported last week that the U.S. personal consumption expenditures (PCE) price index jumped 6.8% year-over-year in June, the highest reading since January 1982 and above the 6.3% posted in each of the previous two months.
Prices for goods increased 10.4% and prices for services 4.9%. Food cost rose 11.2% and energy spiked 43.5%. Excluding food and energy, PCE “core” inflation accelerated to 4.8% from 4.7%, above the consensus forecast of 4.7%.
However, the International Monetary Fund noted that it expects U.S. inflation to moderate in 2023, as slowing economic growth takes pressure off overburdened supply chains.
To combat inflation, the Fed last week boosted interest rates by 0.75%. A crucial signal during the Fed’s latest round of tightening has been the significant move downward in Treasury bond yields. This yield action represents market sentiment that inflation and economic growth may be slowing, which would prompt the central bank to move less aggressively in the future.
Since their mid-June highs, the two-year yield has declined by about 50 basis points (bps) and the 10-year yield by 75 bps. The decline in yields has in turn supported the robust stock market performance in July, particularly in growth sectors.
Also supporting strong equity performance has been healthy earnings growth for the S&P 500. For the second quarter of 2022, with 56% of S&P 500 companies reporting actual results, 73% have reported a positive earnings surprise and 66% have reported a positive revenue surprise.
For Q2 2022, the blended earnings growth rate for the S&P 500 is 6.0%. These numbers come from research firm FactSet and they’re up to date, as of market close Friday, July 29.
The energy sector is reporting the highest year-over-year earnings growth of all 11 sectors, at a whopping 290.3%. Higher oil prices are contributing to the earnings bonanza for this sector. The average price of oil in Q2 2022 ($108.52) was 64% above the average in Q2 2021 ($66.17).
OPEC Plus is scheduled to conduct its next meeting on Wednesday. The cartel has indicated that it expects growing energy demand to strain its production capacity, which suggests high oil prices are here to stay. That’s the bet oil traders are currently making, despite fears expressed by some analysts of destruction demand caused by the economic slump.
Amid these crosscurrents, how should you trade? If you seek growth with mitigated risk, I bring your attention to my colleague Dr. Stephen Leeb, the chief investment strategist of The Complete Investor and Real World Investing.
I first started working with Steve in 1990. Over the past three decades, through peace and war and bull and bear markets, Dr. Leeb has proven uncannily prescient…and he has made a lot of money for his followers.
Now, as we face high inflation and historic commodity demand, Dr. Leeb recommends you buy a small-cap stock that’s positioned to dramatically profit from rising prices. Click here for details.
John Persinos is the editorial director of Investing Daily.