Ten Out of Ten

Jul 24, 2023

By Jack Kraft, CFA, Investment Strategist
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U.S. equities ended last week mixed as investors digested key earnings reports with the start of second-quarter earnings season. The Dow outperformed, gaining 2.1% and chipping away at its year-to-date underperformance compared to its peers. The price-weighted index notched its 10th straight gain on Friday for its longest win streak since 2017. The S&P 500 added 0.7%, while the tech-heavy Nasdaq lost 0.6%. Meanwhile, small- and mid-cap companies outperformed large caps (measured by the S&P 500) for the second week in a row, with the Russell 2000 adding 1.5%.

A positive sign in the markets last week was the broadening out of gains from the mega caps that have dominated year-to-date performance. This was most notable by sector outperformance, with six of the 11 S&P 500 sectors finishing last week in positive territory. Energy, Health Care and Financials all gained at least 3.0%, while Technology and Communication Services—two of this year’s biggest winners—lost ground. Bank earnings seemed to be positive, with KBW Nasdaq Bank Index surging 7.1% last week. The main takeaways from financial corporate earnings reports included capital market strength, strong deposit bases in money centers and slower deposit flights. In other earnings, mega caps had mixed results with Tesla and Netflix failing to live up to the high hopes set for them.

As equities continue to climb higher into the second half of the year, investors are becoming increasingly aware of lofty valuations. This is because the 19% year-to-date gain in the S&P 500 can almost all be attributed to valuation expansion rather than earnings growth. The price-to-earnings (P/E) multiple has jumped from 17x to 20x, which is above the pre-pandemic peak of 19x. In more simple terms, that means investors are paying a premium for the same amount of earnings that the S&P 500 was producing at the start of the year.

According to Goldman Sachs, the 20x P/E valuation ranks in the 87th percentile going back to 1980. Part of this run-up in valuations can be accounted for by the outperformance of the mega-cap stocks amid hype about artificial intelligence, optimistic growth expectations for 2024 and falling inflation. The seven largest stocks in the S&P 500 are trading at a forward price to earnings of 32x, while the remaining 493 firms trade at a more reasonable level of 17x. This level is still below its pre-pandemic valuation peak of 19x; however, interest rates were much lower during that period with a 10-year U.S. Treasury bond yielding less than 2%, compared to today’s rate of 3.8%.

Economic data was in focus as investors continue to debate the future probability of the U.S. economy, avoiding a recession. Housing data remained strong with builder confidence rising for the seventh straight month and June housing starts and permits remaining near their highest level in a year. June retail sales were softer, while May’s figures were adjusted upward. However, the control group sales surpassed expectations, providing evidence of a resilient consumer. This encouraging data, along with a strong labor market and encouraging inflation data earlier this month, has investors pricing in a move higher in interest rates by the U.S. Federal Reserve (Fed). In fact, at the Federal Open Market Committee (FOMC) meeting next week, CME Group’s Fed-watch tool is pricing in a 99% chance that the Central Bank will lift its interest-rate range to 5.25% – 5.50%. Economists will be looking for any insight from Fed Chairman Jerome Powell’s press conference on Wednesday as the Central Bank edges closer toward its peak federal funds rate.

Looking ahead to this week, the main focus will be on the Fed’s policy meeting. The economic calendar will also garner attention with the release of second-quarter GDP on Thursday. On Friday, the Personal Consumption Expenditures (PCE) Index, which is the preferred gauge for inflation by the Fed, is expected to show a 0.1% increase in June. Elsewhere, key data about the consumer will be released, with personal income and personal spending hitting the tap on Friday as well. Earnings season will also be in full swing with second-quarter reports from some of the world’s largest companies, including GOOGL, MSFT, META, INTC, XOM, V, VZ, CMCSA, F, GM, KO, BA, ABBV, BMY, and DPZ.

U.S. Economic Reports & Fed Speakers
9:45 AM S&P “flash” U.S. manufacturing PMI July 46.7 46.3
9:45 AM S&P “flash” U.S. services PMI July 54 54.4
9:00 AM S&P Case-Shiller home price index (20 cities) May -1.60% -1.70%
10:00 AM Consumer confidence July 112 109.7
10:00 AM New home sales) June 717,000 763,000
2:00 PM FOMC decision on interest-rate policy
2:30 PM Fed Chairman Powell press conference
8:30 AM Initial jobless claims 22-Jul 236,000 228,000
8:30 AM Durable-goods orders June 1.20% 1.70%
8:30 AM Durable-goods minus transportation June 0.70%
8:30 AM GDP (advanced report) Q2 1.70% 2.00%
8:30 AM Advanced U.S. trade balance in goods June -$97.5B
8:30 AM Advanced retail inventories June 0.80%
8:30 AM Advanced wholesale inventories June 0.00%
10:00 AM Pending home sales June -0.50% -2.70%
8:30 AM Personal income (nominal) June 0.50% 0.40%
8:30 AM Personal spending (nominal) June 0.50% 0.10%
8:30 AM PCE index June 0.10%
8:30 AM Core PCE index June 0.20% 0.30%
8:30 AM PCE (year-over-year) 3.80%
8:30 AM Core PCE (year-over-year) 4.20% 4.60%
8:30 AM Employment cost index Q2 1.10% 1.20%
10:00 AM Consumer sentiment (final) July 72.6 72.6


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