Weekly Thoughts: July 1, 2023

The S&P had a calm week to end Q2 with a return of -0.08%, although on Friday it did manage to set a new intraday all-time high of 5523.64 before reversing to close at the 5460.48 level. The catalyst for the pop on the open was in line May PCE data, both index and core. The in-line numbers reiterated the recent data that the inflation scare of Q1 was merely an interruption of the disinflationary fall from the over 9% CPI high in July 2022. For investors that question why stocks struggled to close at a new high and follow through with more fervor, one must keep in mind we ended the first half with gains of 14.48% and the Nasdaq +18.13%. The news was welcome but only allowed markets to digest higher levels and avoid a retracement of recent gains.

Breadth is poor for US stocks. The modest improvement of a widening of performance beyond the large cap blue chip winters reversed in recent weeks. The equal weight S&P, RSP, is up +4.11% YTD, over 1000bps below the cap weighted index. Focusing on Q2, Bespoke Investment Group completed an analysis of the Russell 1000 and broke it up into 10 deciles. While the R1000 returned +3.22% for the quarter, the average stock in the index was DOWN 4%. Nine out of ten deciles were lower. Only the largest 100 stocks were up as a group and even that bucket returned a mere +0.76% in Q2. Thus, it was a group of the largest of the large, the NVidia’s & Microsoft’s & Amazon’s of the market that captured the returns. This market has been ruled by intense momentum in a select group of stocks.

We are in the camp that after a stellar bull run over the last 20 months, for the market to continue higher, a broadening is necessary. Bullish prognostications are currently predicated on inflation to continue the recent improvements and while a growth slowdown is acknowledged, recession avoidance is the base case. Even if that comes to pass, a healthy market will see the stocks left behind join the rally or perhaps take leadership. This is not just a “because they have to” wish, there are many companies with improved cash flow and free cash flow yield that are primed for better performance. While the current market leaders and performers have obviously delivered stellar earnings and cash flow growth, the rallies have been extended to such a degree that as a group, some of the names may be a bit over their skis from a valuation standpoint.

Perhaps the coming Q2 earnings season will serve as a catalyst to initiate a turn in investor focus. It would also be helpful for management teams to provide specifics on how they are using or planning to use AI to boost their productivity. The AI winners are selling products, and the Capex firms are investing enormous sums of money, but at some point, investors will begin to demand earnings on the invested capital. Of course, as always, the key moment in earnings reports is the forward guidance outlooks management provides. As stocks prices rise, often merely beating earnings and revenues but leaving forward guidance flat leads to an immediate negative reaction in the market. On a stock-by-stock basis, over the following few trading sessions, investors endeavor to decipher if the reaction was warranted.

The second quarter begins with a holiday shortened week as the July 4th celebration falls on Thursday. However, traders & investors will return to an important Friday session due to the release of the non-farm payroll report and unemployment rate for June. The expectation is for a “steady as she goes” result with payrolls growing in the 175,000 to 200,000 range. We are keenly watching for revisions in previous months as our expectation is the strong May result of 272,000 will be trimmed. The headline unemployment rate is predicted to remain flat at 4.0% and hourly wages to rise 0.3%, a tick lower from last month’s 0.4%.

To all our clients, readers & friends, we hope you enjoy the holiday celebration with your families & friends.