2 Major Catalysts: Momentum Builds
2023.07.12 16:25
Investors are facing two major potential catalysts over the next month – inflation in the near-term and Q2 earnings in the longer-term.
The next big domino to fall will be this week’s June reading. The overall disinflationary trend is continuing, pulling the headline rate all the way down to 3% and the core rate to 4.8%, the lowest it’s been in more than a year and a half. A big part of the decline is due to a high base effect rolling off the 12-month measurement period. After this, the inflation rate is likely to begin moving modestly higher again. The n rate is likely to keep hovering around the 4-5% range, which won’t be nearly low enough to get the Fed thinking about pausing. While the current environment is in a much better place versus when inflation was around 9%, we’re probably looking at 2025 before inflation gets close to a sustainable 2% rate. The markets have pretty much priced in an additional 1-2 more rate hikes and I don’t think anything we see on the inflation front this week will change that, but it is having the effect of lifting stock prices and dropping yields. This could help the markets maintain the current low volatility, general optimism mood through most of the summer.
3-Month United States Market View
The Q2 earnings season will effectively kick off later this week with JPMorgan Chase (NYSE:), Citigroup (NYSE:), Wells Fargo (NYSE:) and BlackRock (NYSE:) all reporting on Friday. We’ll probably hear the phrase “earnings recession” a lot over the next several weeks with earnings expected to be down around 7-9% over the same quarter last year. With the S&P 500 trading at 20 times next year’s earnings and the trading at 27 times, there’s not a lot of room for error here. If 2022 brought valuations back down to earth, 2023 has reflated them all over again. I suspect we’ll hear plenty of mentions of AI and that could lead to some optimism around forward guidance. Any signs of breakdown in the macro backdrop and the blowback could be significant.
In terms of equities, we’ve seen the tech rally flatten out over the past few weeks and small-caps start to keep pace with the S&P 500 again. If this were more of a cyclical or reflation rally, I think we’d be seeing small-caps doing a little better, but current market breadth looks a lot better than it did a couple of months ago. Two of the biggest beneficiaries of the tech rally fizzling out have been industrials and transports. When these sectors start outperforming, it signals that investors could be buying into the economic recovery narrative. I think this is probably consistent with the short-term view of the market, but this could run into trouble later in the second half of the year.
