Week #30 — Market Review for July 24-28, 2023

Summary

The major US stock indices ended the week higher due to positive data that improved the chances of averting a recession in the U.S. economy. This uplift was further bolstered by strong earnings from two tech behemoths. Meta Platforms Inc. reported strong results for the second quarter and gave an optimistic outlook for the current period. Google parent, Alphabet Inc., reported second-quarter revenue that exceeded analysts’ expectations, boosted by advertising on the company’s flagship search business, which is withstanding new competition from artificial intelligence chatbots. Together, these companies accounted for about half of the weekly rise in the S&P 500 and Nasdaq Composite.

The robust GDP data, coupled with indications of cooling inflation pressure from wages, boosted hopes for a ‘soft landing’ scenario. Ongoing strong macroeconomic data have led to revised forecasts. An increasing number of economists are now projecting only a slowdown in the second half of the year, with the most prominent forecast coming from the Fed. Meanwhile, forward-looking housing market data indicates further improvement and sales growth.

According to data from the CME Group, the likelihood of a rate hike at the Fed meeting on September 20 increased to 20% — slightly higher than the 16% figure from the previous week. The trajectory of future Fed rates, as anticipated by investors, points towards steady rates until next May. Just a week ago, the beginning of monetary easing was expected to commence in March.

Throughout the week, the situation with company reporting was positive for the broad market – the earnings per share (EPS) data turned out to be better than the average figures of previous years, and forecasted earnings were revised upwards.

Market News and Statistics

Several important macroeconomic indicators and economic news were published during the week:

·?????According to a survey by the National Association for Business Economics (NABE) and estimates from the Congressional Budget Office (CBO), the US economy is expected to avoid a recession despite factors like higher interest rates and an uptick in unemployment. The NABE survey showed that 71% of business economists believe the chances of the US entering a recession in the next year are 50% or less. This shift in sentiment was driven by the robust labor market and the pullback in key consumer price metrics.

The CBO's estimates indicate the Gross Domestic Product (GDP) is projected to rise at a 0.4% annual rate in the second half of 2023, steadily improving in 2024 and into the following year. This is despite the anticipation of a slowdown in consumer spending due to higher borrowing costs and a drawdown in Americans' pandemic-era savings.

The labor market's resilience and the services sector's performance have allowed the economy to continue expanding. However, consumer spending, which has sustained the economy despite a downturn in manufacturing, is expected to contract slightly in the fourth quarter due to tighter lending standards, higher interest rates, and less pandemic-related savings.

·?????US home prices rose for the fourth consecutive month due to increased demand and limited inventory. S&P CoreLogic Case-Shiller reported that prices increased by 0.7% in May compared to April. Home buyers have been contending for the few available properties, causing bidding wars in some regions. As of mid-July, the total number of homes listed for sale was 16% less than the same period last year, as per Redfin Corp. data.

The housing market experienced a slowdown over the past year as increased borrowing costs deterred some potential buyers. On a year-over-year basis, national prices were down by 0.5%, compared to a 0.1% decrease in April. Despite a decrease in home prices in the US after June 2022, the last month of the decline was January 2023. May's data suggests a positive outlook for the coming months.

The cities with the most significant price gains have recently shifted from warmer climates to northern cities, with Chicago (+4.6%), Cleveland (+3.9%), and New York (+3.5%) experiencing the largest year-over-year price increases among 20 cities.

·?????US new-home sales fell in June for the first time in four months, suggesting that high borrowing costs and elevated prices are slowing the housing market. Purchases of new single-family homes decreased by 2.5% to an annualized rate of 697,000, below economists' median estimate of 725,000. Despite the drop, sales have bounced back over the past year due to a limited supply of existing homes, leading to a rise in homebuilder sentiment and increased applications for single-family projects. The median sales price of a new home fell to $415,400 from the previous year, but remains significantly above pre-pandemic levels.

·?????US pending home sales unexpectedly rose in June for the first time in four months, overcoming challenges from limited supply and financing issues in the resale market. The National Association of Realtors' index of contract signings for previously owned homes increased 0.3% to 76.8, contrary to economists' predictions of a 0.5% drop. The existing-home market has faced difficulties due to high mortgage rates causing homeowner hesitancy, limiting available homes. High prices and borrowing costs have also discouraged potential buyers. Despite these challenges, NAR's chief economist, Lawrence Yun, expressed optimism, stating that the housing recession is over and any significant decline in mortgage rates could stimulate buyer activity later in the year. The pending-home sales report is seen as a predictive measure of existing-home sales, with houses typically going under contract a month or two before sale.

·?????Freddie Mac data showed that mortgage rates are still hovering near this year's maximum, indicating possible stabilization. Meanwhile, the rates grew a bit (5 to 10 basis points) over the last four weeks.

·?????Economic growth in major developed economies is showing signs of a slowdown, according to the flash PMI surveys. Business activity growth in the US, UK, Eurozone, and Japan is weakening, with the most robust growth rates earlier in the year faltering due to a persisting manufacturing malaise and declining demand for services.

Inflation signals are mixed, with lower inflation in Europe but stickiness around the 3% mark in the US. The extent of inflation's movement towards the central bank 2% targets will be influenced by labor markets. Despite robust job growth and labor shortages keeping wage growth high, there is a cooling demand for staff, pointing to possible further challenges due to declining business confidence and order books in the G4 economies.

Manufacturing output in the G4 economies has contracted for three consecutive months and the service sector is losing growth momentum. Economic activity in Europe, the US, and Japan has slowed, with Europe seeing the steepest decline.

·?????US consumer confidence reached a two-year high in July, driven by a robust job market and easing inflation. The Conference Board’s index rose to 117 from 110.1 in June, surpassing economists' estimate of 112. Both the group's gauge of current conditions and a measure of future expectations improved significantly.

Notably, increased confidence was seen across all age groups and income brackets. Recent economic data has renewed hopes of the US avoiding a recession, with the job market remaining steady and key inflation metrics showing progress. Wage growth is also keeping pace with inflation, supporting consumer spending.

·?????The International Monetary Fund (IMF) has raised its 2023 global economic growth forecast to 3%, up from its 2.8% projection in April, thanks to averted crises in the US and European banking sectors and the avoidance of a US default. This growth, however, remains a slowdown from the 3.5% growth in 2022.

The IMF maintains its global growth expectation for 2024 at 3%. Despite this, it cautioned that the growth outlook is weak compared to the pre-pandemic average of 3.8% and stressed that the balance of risks remains tilted downwards.

Potential threats to the economy include higher interest rates, intensified conflicts such as the one in Ukraine, and climate disasters. Other risks mentioned include a slower recovery in China, debt distress in emerging economies, and geoeconomic fragmentation spurred by Russia's invasion of Ukraine and tension between the US and China.

The IMF expects inflation to slow down to 6.8% this year, compared to the 8.7% in 2022. However, it also raised its projection for cost-of-living increases in 2024 to 5.2%. The Fund stressed the priority of achieving sustained disinflation and enhancing financial supervision and risk monitoring.

Among large economies, the IMF forecasts the US to grow by 1.8% in 2023 before slowing to 1% in 2024. China is expected to expand by 5.2%, although its recovery is noted to be slowing down. The UK, Russia, and Brazil have all seen their growth forecasts boosted, while Germany is projected to contract by 0.3%. Saudi Arabia's forecast was reduced to 1.9%, reflecting oil-output cuts.

·?????Europe's largest economy appears to be stuck in a recession, according to Ifo President Clemens Fuest, as evidenced by poor business sentiment readings. The Ifo's business climate index and expectations gauge have both declined. The cause of the downturn, which started over the winter, can be attributed to Russia's invasion of Ukraine and the underperformance of Germany's manufacturing industry. Despite this, economists believe growth has resumed, albeit at a slow pace. Additionally, S&P Global's business survey pointed out recession risks persist, noting the fastest decline in new orders and backlogs in manufacturing since Covid-19 began in 2020.

Furthermore, the International Monetary Fund predicts that Germany's economy will be the only one in the Group of Seven to contract this year due to the aftermath of the war in Ukraine. The forecast shows a 0.3% fall in Gross Domestic Product, with officials attributing the downturn to the lingering energy crisis that sparked a recession last year. The current economic weakness is rooted in manufacturing, impacted by the energy squeeze, reduced demand from China, and tighter monetary policy. Future forecasts from the IMF could paint an even bleaker picture if the slump persists.

·?????Despite exiting its winter recession, Germany's economy appears to be in a stagnant state, with doubts remaining over the overall health of the region's largest economy. Gross domestic product (GDP) remained unchanged from the previous quarter, falling short of the anticipated 0.1% growth. Although revisions of prior quarters' data indicated a less deep slump than originally estimated, the outlook remains bleak.

·?????The Federal Reserve has decided to resume raising interest rates, marking the 11th increase since March 2022. The quarter percentage-point increase has lifted the target range for the Fed’s benchmark federal funds rate to 5.25% to 5.5%, the highest in 22 years. This move aims to curb inflation, which hit a 40-year high in 2022.

The Fed did not make any substantive changes to its policy statement, leaving the door open for another potential rate hike. However, Jerome Powell, the Chair of the Federal Reserve, indicated a willingness to skip the September meeting hike if inflation data continues to be soft.

A recession forecast was previously issued by the Fed’s staff economists due to the failures of a few US regional banks. However, given the recent strength of the economy, they are no longer predicting a downturn, instead expecting a slowdown in growth later in the year.

Upcoming economic reports, including two jobs reports, consumer price inflation data, and employment cost data, will be key in guiding the Fed's decisions regarding further rate increases.

·?????US economic growth exceeded expectations in Q2, fueled by robust consumer and business resilience despite high interest rates. The Gross Domestic Product (GDP) grew at a 2.4% annualized rate, up from a 2% pace in the prior quarter. Consumer spending also saw a 1.6% increase, surpassing projections. Furthermore, the Federal Reserve's preferred underlying inflation metric rose at a lower-than-expected 3.8%. A strong labor market, healthy consumer spending, and easing inflation have increased optimism of avoiding a recession.

·?????The European Central Bank (ECB) has decided to halt interest payments on the money banks are obliged to hold at the institution as a minimum reserve, a move that could lead to billions in lost interest income for lenders. Banks in Europe are required to hold around 165 billion euros as minimum reserves at the ECB. Previously, the central bank paid an interest of 3.25% on these reserves, amounting to annual income of approximately 5.4 billion euros ($6 billion). This income is now at risk following the ECB's decision. The announcement led to a reversal of gains in European bank stocks, with Deutsche Bank AG experiencing one of the steepest drops, down 4.7%. The ECB has stated that this move will maintain the effectiveness of monetary policy and improve efficiency by reducing the overall amount of interest paid on reserves.

·?????The European Central Bank (ECB) has raised interest rates by a quarter-point for the ninth consecutive time, bringing the deposit rate to 3.75%, in line with economists' expectations. However, future decisions on rates remain uncertain as the ECB's rate hiking campaign approaches its conclusion. There are 50% odds of another quarter-point increase in September, with short-dated German bonds leading gains following the announcement.

The economic outlook for the Euro area has been worsening, primarily due to weaker domestic demand. Germany, the bloc's top economy, is having difficulties emerging from a recession, and there's a significant decrease in the demand for corporate credit. Despite falling inflation and rising incomes, the ECB officials express concerns about the current rate of consumer price gains.

ECB President Christine Lagarde stated that the officials have an open mind regarding their next step. While a pause in rate hikes is possible in September, it would not necessarily be for an extended period. Officials will continue to follow a data-dependent approach to determine the level and duration of restriction. Future decisions will ensure that key ECB interest rates will be set at restrictive levels for as long as necessary.

Inflation is still predicted to exceed 2% by the end of 2025. In the face of these economic conditions, the ECB is expected to tread carefully with further rate hikes. Policymakers anticipate that the peak, once reached, will be maintained for an extended period. September will bring a new set of quarterly economic projections for ECB officials, providing clearer insights into future actions.

·?????Several key indicators suggest that the US economy could avoid a recession as inflation and labor costs appear to be cooling down. The employment cost index (ECI), a broad measure of wages and benefits, rose 1% in Q2, marking the slowest advance since 2021, according to the Bureau of Labor Statistics. Additionally, the Federal Reserve's preferred inflation gauge, the personal consumption expenditures (PCE) price index, saw a 3% year-on-year increase in June, the smallest increase in over two years.

Moreover, the PCE report also indicated that inflation-adjusted consumer spending rose in June, marking the highest increase since the beginning of the year. This data supports the message from Thursday's data indicating that the US economy expanded at a healthy rate in Q2.

These figures inspire hope that the Federal Reserve can achieve a 'soft landing', i.e., moderating inflation without substantial job losses, even amidst the steepest interest-rate hikes in a generation. Fed Chair Jerome Powell hinted that the ECI data, along with upcoming consumer price reports, would influence the central bank's decision about whether to continue raising rates later in the year.

·?????US consumer sentiment rose to its highest level since October 2021 in July as inflation continued to ease. According to the University of Michigan's final July reading, the sentiment index increased to 71.6, a downward revision from the preliminary 72.6, up from 64.4 in June. Consumers anticipate a 3.4% (in line with early data) annual rise in prices over the next year, a slight increase from the 3.3% expected in June. Over the next five to ten years, they still expect costs to rise by 3.0%, which is better than the 3.1% anticipated in early July.

Joanne Hsu, the director of the survey, pointed out a re-emerging divergence between high- and low-income consumers. She noted that if this trend continues, it would restore the typical pattern where higher-income consumers have more positive sentiment. The future months will reveal if the recovery in sentiment will be shared across the income distribution.

·?????The Bank of Japan (BOJ) has surprised financial markets by relaxing its control over bond yields. The BOJ has decided to treat its 0.5% ceiling on 10-year bond yields as a reference point, not a rigid limit, effectively doubling the movement range for yields to 1%. This move has been interpreted by some as a preliminary step towards policy normalization. The yen and Japan's benchmark bond yield, which surpassed the previous 0.5% cap, strengthened in response to these policy adjustments.

US stock market

The major US stock indices ended the week higher due to positive data that improved the chances of averting a recession in the U.S. economy. This uplift was further bolstered by strong earnings from two tech behemoths. Meta Platforms Inc. reported strong results for the second quarter and gave an optimistic outlook for the current period. Google parent, Alphabet Inc., reported second-quarter revenue that exceeded analysts’ expectations, boosted by advertising on the company’s flagship search business, which is withstanding new competition from artificial intelligence chatbots. Together, these companies accounted for about half of the weekly rise in the S&P 500 and Nasdaq Composite.

Sector ETFs displayed mostly positive dynamics. The jump in Communication Services was due to META and GOOGL, which account for almost half of the ETF holdings share.

The Fear & Greed Index remained in the 'extreme greed' territory, edging lower to 78 from 82 a week ago. I’d like to remind you that, historically, such high values of the indicator coincide with local maximums and are followed by market corrections. The latest sizeable pullback we saw was from February to mid-March.

U.S. stocks, tracked through SPY (an ETF for the S&P 500 index), continued their relentless rally to overcome the levels at the beginning of 2022.

The S&P 500 is now about 4% away from reclaiming its all-time high of 4,796.56, which was reached in January 2022. I still think that in the absence of negative news, the stock market momentum could help to overcome that level in several weeks.

The earnings season continues – according to Refinitiv, 165 companies in the S&P 500 Index have reported their Q2 2023 earnings to date. Thus, the total percentage of companies that have already reported their earnings stands at 51% (+33 pp. over the week). Among them, 78.7% have surpassed analysts' earnings expectations (last week, this figure was 73.0%). This is higher than both the long-term average (66.4%) and the average of the last four quarters (73.4%). This figure has shown a considerable increase compared to the previous week.

Over the week, the projected earnings growth for the quarter was significantly improved - now a decrease of 6.4% YoY overall and a decrease of 0.3% YoY excluding the energy sector are expected. A week earlier, these figures were -7.9% and -2.2%, respectively. Thus, the latest revision of forecasts suggests an ongoing improvement in expectations regarding companies' financial results for the current quarter.

From July 31 to August 4, another 169 companies from the S&P 500 index will present their results. After this, the earnings season would be mostly over. Overall, among all stocks, the most anticipated earnings reports will be from Amazon, Apple, and AMD.

Global Markets

Global stock once again turned to 'risk-on’ mode, a situation where investors prefer risky assets.

Chinese stocks posted the best week since early January (in dollar terms), driven by stimulus hopes and changing authorities’ stance regarding the stock market.

First, in an effort to stimulate economic growth, the Chinese government introduced new measures to enhance consumer industries and assist small businesses in obtaining funding. These strategies include plans to increase growth in the light industry sector, which encompasses products such as household goods, food, paper-making, plastic products, leather, and batteries. The aim is to increase the sector's value-added growth to an average of about 4% by the end of next year, up from just 0.4% in the first half of this year.

Second, Chinese authorities have asked major tech companies, including Tencent Holdings Ltd. and Meituan, to provide successful case studies of their startup investments in consumer, telecom, and media companies. This could signal that the government is preparing to allow these tech companies more freedom in backing such deals after a clampdown nearly halted such activities two years ago.

Third, the China Securities Regulatory Commission (CSRC) has reportedly sought advice from securities firms on possible ways to boost the nation's stock market and restore investor confidence. Some of the proposals include a cut in the stamp duty on stock trading and a reduction in initial public offerings to improve liquidity. However, the CSRC has not yet provided any details about its plans. This move indicates that authorities are keen to fulfill a previous promise by the Politburo to invigorate China's $10 trillion stock market and improve investor sentiment.

Global stocks, reflected through ACWX (an ETF based on the MSCI All Country World ex USA Index), climbed to a new year maximum.

Foreign Exchange Markets

The dollar index gained 0.6% for the week. For your information, the euro, yen, and pound constitute about 83% of the dynamics of the dollar index.

Commodities Markets

The major commodities ended the week in mixed directions.

Debt Market

According to CME data, the implied Fed Funds rates curve (for the period until November 2024) shifted upwards by an average of 6 basis points. The robust U.S. economy suggests that a slightly longer period of high rates might be necessary to curb inflation.

Only the long-term part of the U.S. Treasury yield increased by 12 basis points, reflecting potential challenges in bringing inflation back to the target 2%.

This tendency can be observed from expected forward inflation 5 to 10 years from now, derived from inflation-adjusted Treasury securities. This figure is currently at 2.48%, its highest level since April 2022.

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