Summertime...
Might a summer storm lie ahead for investors?
... and the living is easy. This incredibly narrow market has been frustrating, but Growth vs. Value, small vs. large caps, and banks vs. the Nasdaq 100 are nearing past inflection points indicative of a change in leadership. Further, high vs. low beta stock performance falls in the 96th percentile, a strong mean reversion signal. There’s been some breadth improvement and more would be welcome. This week, both the Dow Jones and the Dow Jones Transportation Average broke out to their highest levels since spring ’22, while key index constituents such as Apple and Microsoft hit all-time new highs. After a consensus-busting first seven months, the seasonally challenging month of August is just a week away. Fundstrat reports that defensive sectors are strengthening, particularly Health Care, Consumer Staples and Utilities. Poised for consolidation, dry power is aplenty. The sum of commercial bank deposits and money market mutual funds reached a record $22.8 trillion the first week of July, just as a Goldman Sachs poll found institutional investors “deeply bearish.”
It's hard to get too bearish when the economy keeps beating consensus. “Soft landing” expectations have picked up, and consensus now sees a recession as a mid-2024 event, and mild at that. After 3.5% annualized in Q1, domestic demand growth in Q2 is tracking at a still strong 2.6%. Seasonally adjusted weekly credit card spending, housing demand and industrial freight indicators reflect a consumer who continues to spend (more below), a manufacturing sector that’s bottoming (more below), and a new-home and housing construction market that’s picking up (more below). In fact, thanks to elevated construction backlogs, residential investment looks to turn additive to GDP. This and factories rushing to rebuild inventories bode well for manufacturing, as does strengthening auto and aircraft demand and a weaker dollar. After eight straight months of contraction—June’s ISM hit a 3-year low—an improving manufacturing sector could help close its historic gap relative to services. This would bolster the soft landing/mild recession narrative. China remains a drag (more below). But its importance to the U.S. has diminished. Other Asian countries and neighboring Mexico are stepping up to fill the void. Goldman Sachs’ economists are projecting an export rebound in East Asia, led by Korea, and “friend-shoring” has made Mexico our largest trading partner.
Deutsche Bank doesn’t want us to forget “long and variable lags.” It notes of 13 hiking cycles since ’72, only ’80-’81 turned into a recession less than 19 months after the initial rate increase. A recession now (16 months from the first hike) would still be very early. Three other cycles saw the economy enter a downturn 19-21 months after the first hike, which would take us to Q4, while the next three came 25-28 months later, the equivalent of April-July ’24. That’s still only 7 of 13 cycles—the final five translate to spring/summer ’25 and ’29. How’s that for variable? Stocks historically have risen through a pause and until the first cut. Still, with the S&P challenging cycle highs, a technical correction arguably is overdue. Triggers could include a disappointing earnings season (early in, it’s going OK), inflation numbers that surprise to the upside or an unexpected crisis caused by CRE defaults. With full-year EPS declining on margin compression, market returns this year have been all about P/E multiple expansion. But early reports indicate margin pressures may be starting to ease—guidance will be key. Have you enjoyed a summer vacation yet? Not me. I need to get my tan on!
Positives
- The consumer reigns supreme Despite decelerating in June, an upwardly revised May lifted retail sales growth from 0% to 0.4% on a 3-month moving average basis. June’s retail sales control group—a measure of underlying consumer spending that excludes gas stations, food services, auto dealers and building materials stores—expanded by 0.6% m/m, double the expected 0.3%.
- Immaculate disinflation A UBS survey found the percentage of households looking for a rental fell to 9% in Q2, vs. an average 12% in ’21 and ’22. In just over a year, Zillow’s measure of rents has slowed from +16% y/y to +4% and is on track to decline in ’24. Rents account for more than 40% of core CPI.
- Manufacturing making a bottom Early Philly Fed and New York Empire bellwethers improved marginally and expanded a second straight month in July, respectively, while industrial rail volumes, container exports and steel production have all rebounded since spring. In a shout-out to AI, construction of computer, electronic and electrical industries facilities also has exploded, with an estimated 50 newly announced projects that will require $220 billion in capex either underway or breaking ground.
Negatives
- Short and invariable lags Existing home sales fell again in June to near global financial crisis lows, a victim of rapid Fed rate increases that saw mortgage rates more than double in a year. The run-up in rates both deepened a shortage of homes for sale as homeowners with low-rate mortgages aren’t selling and caused prices to climb to record highs (in a rarity, the median home existing home price now matches the median price for new homes). Frustrated buyers are flocking to new homes instead, lifting sales to a 15-month high. In the rush to meet demand, multifamily units under construction in June matched May 1973’s record high, pushing builder confidence to a 12-month high.
- Long and variable lags Conference Board leading indicators extended their uninterrupted downtrend to 15 months in June, dropping the index to a 3-year low. At -7.8%, its y/y change is commensurate with National Bureau of Economic Research recession readings.
- Can’t count on China Its economy only grew at a below-consensus 5.5% annualized pace in the first half, with consumer spending weakening notably in June and property investment contracting. Moreover, a key measure of inflation turned negative, hinting at potential deflation that led some to draw parallels with the bursting of Japan’s bubble which preceded a lost decade. Bank of America cautioned the slowdown could cut into growth in the eurozone, which trades heavily with China.
What else
The consumer reigns supreme With household net worth-to-disposable income near all-time highs, household debt-servicing costs close to historical lows and real incomes on the rise, Americans are on the move—overseas travel is setting records, and more people are moving through airport security lines this summer than in 2019. Not surprisingly, airline and cruise ship stocks are surging and home builders that cater to first-time and move-up buyers are performing as well or better than luxury builders.
3 strikes and we’re out!? 23 years ago, a flurry of summer strikes stalled the economy, with GDP growth plunging from a 7.5% annualized rate in Q2 to 0.4% in Q3. Could we see a repeat with SAG-AFTRA (160k workers), Teamsters-UPS (340k) and UAW (150k) on the docket this summer?
The WFH conundrum Bank of America shares that the U.S. has 1 billion square feet of empty office space, the equivalent of 48k floors that would be tall enough to reach the International Space Station.