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Jul 10, 2023

By Pete Biebel, Senior Vice President, Senior Investment Strategist
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With the holiday week in the rearview mirror, the stock market drives into this week on a mission to get its bearings and resume its cruise down the road. Before the distraction of the Independence Day break, stocks had been on a steady route northward. Both the S&P 500 Index (SPX) and the NASDAQ Composite Index (COMP) closed at their highest levels of the year on Friday, June 30, though they were actually just getting back to their mid-month highs following a brief southerly detour.

Through the commotion of the holiday week, the major averages all gave back a sliver of their recent gains. SPX lost a bit more than 1% over the three-and-a-half session week, while COMP fell a bit less than 2%. The indices saw little net change through Monday’s abbreviated trading and Wednesday. The bulk of those losses came on Thursday morning following the Private Sector Payrolls report from ADP. The report indicated that payrolls swelled by nearly 500,000 jobs in June – more than double the expected increase. That news was compounded by the Unemployment Claims data, which indicated that Continuing Unemployment Claims had declined to its lowest level in five months. Both SPX and COMP hit their lows of the week that morning. The averages were able to recover most of the loss through the balance of the day and Friday morning before a wave of selling Friday afternoon erased much of that recovery.

The bearish reaction to the employment numbers is an indication that market participants are becoming more concerned about the potential for not only an interest rate hike at the U.S. Federal Reserve’s (Fed’s) July meeting, but also the possibility of another hike in September. That view was reflected in the bond market as well. Rates across the U.S. Treasury yield curve spiked to levels near or slightly above their highs of the year reached about four months ago. As a result, interest rate-sensitive sectors were among the poorest performers for the week. Currencies and commodity sectors outperformed, driven in large part by weakness in the U.S. dollar.

As we resume the journey post-holiday, our path over just the next two or three weeks will likely have a significant impact on the market’s course over the coming months. Unfortunately, without GPS to guide us, we’ll have to rely on old fashioned dead-reckoning. Fortunately, we’ll have several prominent signposts in the next few weeks to help determine the appropriate course.

One such hint will be revealed over just the next few days when we can assess the market’s reaction to the updates on both the Consumer Price Index (CPI) and the Producer Price Index (PPI) for the month of June. Core CPI is expected to tick lower on both the month-over-month and year-over-year numbers. A big surprise one way or the other should spark a reaction in the market. The degree to which that reaction deviates from what would be expected (given the data) should be telling.

Later in the week, we’ll get the first of the quarterly reports in the new earnings season. The first couple days will likely be inconclusive, but the following couple weeks have hundreds of announcements scheduled. By the end of the month, companies representing about two-thirds of the S&P’s market capitalization will have reported. Overall S&P 500 earnings are expected to fall by 6% to 7% compared to the year-ago level. Total revenue of S&P 500 companies is expected to show zero year-over-year growth for the first time in 2 ½ years. Net profit margins are also expected to contract. By three weeks from now the market will have deduced whether earnings are generally stronger than expected (as was the outcome in the first quarter) or, in the case of earnings misses and reduced guidance, estimates for future quarters need to be reduced.

We should also be alert for any potholes in the road caused by the Fed’s balance sheet reduction. The liquidity injections during the pandemic and last Spring’s banking crisis are long gone. With already stricter lending standards, the Fed’s continuing monetary tightening could exacerbate a potential credit crunch. Watch for worsening conditions among commercial real estate borrowers and lenders as well as among credit card debt and auto loans.

Economic data and earnings reports, along with the Fed’s policy announcement, are all events with the ability to roil markets. One potential hazard in the road ahead is a sudden increase in volatility. Stock market volatility has been unusually low and seems overdue for a spike. Several of the key contributors to the market’s buying pressure in recent months have been systematic strategies like momentum buying, trend following and risk parity funds (which are forced to allocate more funds to stocks as market volatility decreases). All those strategies will become forced sellers if/when trends reverse and/or volatility increases. The market is in a vulnerable position where a sharp reversal is likely to morph into a very steep reversal. In other words, in the event of a sizable market decline, the mechanical selling could snowball.

On the brighter side, investors can also watch for signs of improvement in small-cap stocks. As a group, small-caps have woefully underperformed their larger-cap peers this year. On a fundamental basis, the Russell 2000 Index of small-cap stocks (RUT) seems to represent a much better value than SPX or COMP. If the market’s journey through the summer months is going to be a pleasant Sunday drive, then we should begin to see much better participation among the smaller companies. After topping out within a few points of the 1900 level several times in the past five weeks, RUT ended last week near 1865. Sustained trading above that 1900 level would be a very encouraging sign for the overall market.

SPX closed Friday at 4399, a mere 10 points below where it ended the week three weeks ago. While it is no longer as overbought as it was then, it’s still a bit extended. Without a big shock, another few weeks of sideways to lower price movement seems likely, though as noted above, there are plenty of potential big shocks on the calendar. As long as the index doesn’t fall much below 4250, there should be no cause for alarm. We should start to get worried if SPX drops much below 4230. Fasten your seatbelts if SPX takes out the 4200 level.

The next few weeks should bring plenty of excitement beginning this week with the CPI and PPI numbers as well as the first of the Q2 earnings reports. The road will likely get a little bumpy, but if the market can get through this stretch without a significant drawdown, then it should mean that the journey through the balance of the year should be pleasant.

Economic Calendar (7/10/23 – 7/14/23)



Monday 7/10/2023 Consumer Credit, May, M/M



Tuesday 7/11/2023 NFIB Small Business Optimism Index, June



Wednesday 7/12/2023 Consumer Price Index, June, M/M



Consumer Price Index, ex-Food & Energy, June, M/M



Consumer Price Index, ex-Food & Energy, June, Y/Y



Fed Beige Book

Thursday 7/13/2023 Initial Jobless Claims



Continuing Claims



Producer Price Index, June, M/M



Producer Price Index, ex-Food & Energy, June, M/M



Producer Price Index, ex-Food & Energy, June, Y/Y



Friday 7/14/2023 Import Prices, June, M/M



Expert Prices, June, M/M



Consumer Sentiment, July




Links to previously published commentaries can be found at benjaminfedwards.com/Latest Investment Insights/Weekly Market Commentary/Market