Does "Boring" Data Suggest an Exciting Next Year? Plus Meet the Interns Returns

Does "Boring" Data Suggest an Exciting Next Year? Plus Meet the Interns Returns
[VIDEO] In this week’s video we bring you our annual Meet the Interns conversation with our summer interns and what they’ve learned during their summer at TEN. [ARTICLE] After an epic reversal off the June lows, we look at what likely lies in the near-term but also what the most recent earnings season and credit spreads suggest lies ahead over the next year.

Five Things You Should Know

1. Equity Markets – were mixed this week with U.S. stocks (S&P 500) up 0.35% while international stocks (EAFE) fell -1.08%.
2. Fixed Income Markets – were mixed with investment grade bonds (AGG) down -1.11% while high yield bonds (JNK) rose 0.40%.
3. Labor Market Update – the economy added 528K jobs in the month of July, crushing expectations of a 250K increase, and far above June’s job report of 398K added. The unemployment rate has moved down to match a 50-year low of 3.5%. The private sector added the lion’s share of jobs, as the public/government sector still lagged 597K jobs below pre-pandemic levels. Markets responded lower as a hot labor market could spark another round of aggressive rate hikes from the Fed.
4. US/China Relations Rocky – despite fierce threats from China, the U.S. government reaffirmed support of Taiwan as a democratically elected government when House Speaker Nancy Pelosi visited the island nation this week, marking the highest-ranking American politician to visit the island in 25 years. Among other threats, China quickly responded by firing 11 missies into the sea around Taiwan and suspended, “all contact with United States on major issues”, including climate and military cooperation.
5. Key Insight – [VIDEO] In this week’s video we bring you our annual Meet the Interns conversation with our summer interns and what they’ve learned during their summer at TEN. [ARTICLE] After an epic reversal off the June lows, we look at what likely lies in the near-term but also what the most recent earnings season and credit spreads suggest lies ahead over the next year.

Insights for Investors

After one of the worst two weeks stretches in S&P 500 history in mid-June, which dragged the index into an official bear market, pessimism was running rampant, and projections of doom were everywhere.

The market’s next move? A 12.5% rip higher.

Lesson learned? As we discussed last week (here), markets act in very unpredictable ways over the near-term and usually in whatever way will surprise investors most.

Does this recent move mean that volatility is now behind us? Probably not. It wouldn’t surprise me at all to see the market consolidate a bit over the next few weeks, and “market technicals” also suggest this is a reasonable probability.

However, as we’ll look at below, it is hard to reconcile predictions for a severe recession with recent corporate earnings resilience, as well as continued improvement in credit spreads.

First up, better than expected corporate earnings.

Tom Essaye noted the impact of earnings season on the recent market gains stating, “earnings season was not as bad as feared. With most of the largest S&P 500 companies already reporting, it looks like 2023 expected S&P 500 EPS will stay in the $230-$240 range for now. That’s obviously a re- duction from the previous $245-$250 consensus, but it’s a lot better than the worst fears of $210-ish (or lower).”

Similarly, Goldman Sachs pointed out that, “US earnings results have generally remained resilient in 2Q 2022 despite a strong US dollar weighing on revenues. With 56% of companies having reported, 52% have beaten consensus earnings estimates by more than one standard deviation, above the historical average of 47%. While corporate earnings strength may moderate given higher inflation and rates, we continue to favor companies that can maintain profitability and stable earnings growth.” (See accompanying chart).

A second catalyst for recent market action, as well as positive signal moving forward, is the rapid improvement in credit spreads.

Bespoke put out a great report recently calling out this improvement, and what such moves have historically meant to markets. It stated, “Whether this is the start of a larger rally or not is an open question, but one thing is certain: if credit spreads are falling sharply, equities have a tailwind.”

They continued saying, “Following similar declines as the one currently underway, the S&P 500 was higher in every prior instance over the following week, six months, and year, with >20% average returns over the next year.” (See accompanying chart).

Lastly, Brian Wesbury, Chief Economist of First Trust, highlighted a solidly positive data point this week, “…came from the prices index, which posted the largest monthly drop since 2010, a signal that inflation pressures might have peaked.”

Of course, there is more to slaying the inflation “beast” than just commodity prices as we discussed before, namely the growth of M2 (monetary supply). For those so interested, I’ve included Wesbury’s most recent article below that discusses the positive trend on that front while also being honest about the tough situation we all find ourselves in as investors in the current macro environment.


Have a wonderful weekend,

Tim and the team at TEN Capital

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Monetary Muddle
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 8/1/2022

The Federal Reserve raised short-term interest rates by three-quarters of a percentage point (75 basis points) on Wednesday. The day before, the Fed had released M2 money supply data for June and it fell slightly, the second decline in three months. At his press conference after the rate hike, Fed Chairman Jerome Powell was vague about the Fed’s future intentions on rates, but was not asked one single question about the money supply.

For now, with the federal funds rate at 2.375%, the futures market is leaning toward a rate hike of 50 bps in September. The Fed has apparently abandoned “forward guidance” partly because it has already pushed rates close to what many Fed members said is “neutral.”

Meanwhile, the 10-year Treasury yield has fallen from north of 3.4% to under 2.7% suggesting the market thinks the Fed will either slow down rate hikes, or maybe even cut them next year. Unless, inflation falls precipitously, this makes no sense. “Core” PCE inflation is closing in on 5% and a “neutral” interest rate should be at least that high, or higher. The Fed has never managed policy under its new abundant reserve system with inflation rising this fast. No one, even the Fed, knows exactly how rate hikes will affect the economy under this new system. (See MMO)

Many think the economy is in recession already, because of two consecutive quarters of declining real GDP. But this is a simplified definition. Go to NBER.Org to see the actual definition of recession. A broad array of spending, income, production and jobs data rose in the first six months of 2022. GDP is not a great real-time measure of overall economic activity for many reasons. Jerome Powell does not think the US is in recession, and neither do we. What we do know is that inflation is still extremely high and the only way to get it down and keep it down is by slowing money growth.

And that does look like it’s happening. So far this year, M2 is up at only a 1.7% annual rate, after climbing at an 18.4% annual rate in 2020-21. By contrast, M2 grew at a 6.2% annual rate in the ten years leading up to COVID.

Slow growth (or even slight declines) in M2 is good news. The problem is that the Fed never talks about M2 and the press never seems to ask. Moreover, slower growth in M2 may be tied to a surge in tax payments – when a taxpayer writes a check to the government, the bank deposits in M2 fall. Data on deposits at banks back this up. However, banks have trillions in excess reserves and total loans and leases are growing at double digit rates. At this point, it is not clear that the new policy regime can persistently slow M2. Will higher rates stop the growth of loans? This looks to be happening in mortgages, but it appears to be demand-driven, not supply-driven.

The bottom line is that the Fed seems determined to bring inflation down but thinks raising short-term interest rates, all by itself, can do the job effectively, even at the same time that it is willing to hike more gradually when inflation is well above the level of rates. This is not a recipe for confidence in the Fed. Expect rates to peak higher than the market now expects and keep watching M2.

Data, Just the Data

Data points this week included:

• U.S. Jobless Claims – rose by 6K to a claimant count of 260K for the week ending July 30^th. This was slightly above market expectations of a 5K rise in claims. The four-week moving average has increased to 254.7K.
• U.S. ISM Manufacturing Index – has fallen slightly lower to 52.8 in July after a reading of 53 in June. This is the 26^th consecutive month of factory expansion but marks the weakest growth rate since June 2020. New orders, employment, production, and supplier deliveries have all fallen to 48, 49.9, 53.5, and 55.2, respectively. Demand sentiment is optimistic, but there is concern about a softening economy and excess inventory.
• U.K. Manufacturing PMI – has come in lower at 52.1 in July after an earlier forecast of 52.2. This reading still signals low factory growth since 2020, with output contracting for the first time in two years. New orders have declined thanks to rising cost of living, weak demand, and lower intakes of export business.
• U.K. PMI Composite – came in at 52.1 in July which was slightly lower than the June reading of 53.7. This again marks the slowest expansion rate since February 2021. New orders slightly increased, but export sales declined thanks to new work reduction. Input price pressures and customer demand contributed to lowest rise in prices charged since earlier this year.
• Eurozone Retail Sales – dove (1.2%) lower MoM in June marking the largest decline this year. High prices, borrowing costs, and low consumer confidence all put downward pressure on sales. Sales for food, drink and tobacco products fell (0.4%), with auto fuel falling (1.1%). YoY, retail sales have slumped (3.7%).