Before The Bell
The U.S. equity market has moved steadily to the upside over the past two weeks. This followed an uneven month of trading in September and the first few trading sessions of October. Powering stocks higher was an exceptionally strong start to the third-quarter earnings season. The big banks, including JPMorgan Chase (JPM) and Goldman Sachs (GS) set the tone last week with strong quarterly results and encouraging outlooks, the latter of which was greeted positively by investors, who have been concerned about inflation, the possibility of slowing domestic growth, and the effects of the COVID-19 Delta variant strain. The rally on Wall Street has the large-cap Dow Jones Industrial Average and the S&P 500 Index trading just below their record highs. In general, investors have shown a greater appetite for risk following the stout results from Corporate America.
The impressive earnings results, including a notable bottom-line beat from mega-cap electric vehicle producer Tesla (TSLA) after yesterday’s closing bell, have put wind in the sails of the market bulls and offset, at least for the moment, concerns about inflation, legislative gridlock in a highly partisan Capitol Hill, which has delayed the passage of a $1 trillion-plus infrastructure package, slowing growth in China, and a possible emerging debt crisis in that country’s highly leveraged property market.
The story within the story of the notable move higher for equities since the commencement of earnings season has been the interplay of growth versus value stocks. This market dynamic has been mostly driven by inflation concerns, with Wall Street eyeing Treasury market yields on both a daily and intra-day basis. When government bond yields are on the rise, which was the case yesterday with the benchmark on the 10-year Treasury note moving above 1.65%, investors look away from the higher-growth names and at the value-oriented cyclical areas. Last week the opposite rang true when yields pulled back on positive jobless claims data and a surprisingly strong retail sales report. Selective weakness in the technology sector yesterday, along with a down day for the communication services stocks, was the primary reason why the NASDAQ Composite fell seven points, while the Dow 30, the S&P 500 Index, and the small-cap Russell 2000 booked respective gains of 152, 17, and 14 points.
With energy prices continuing to rise—the product of a short supply and growing demand for fuel as the global economy reopens further—and supply-chain bottlenecking causing disruptions for many industries and the resultant higher producer and consumer prices, we still think the value-oriented names in the cyclical industries (i.e., energy, materials, and financials) should be given a closer look. These groups have historically performed better than the growth sectors when inflationary pressures emerge. On point, the Federal Reserve’s latest Beige Book summation of economic conditions (released yesterday afternoon) showed that U.S. economic output slowed to a modest to moderate rate this fall, as companies continue to deal with supply-chain disruptions, elevated prices, and a shortage of available workers. Many businesses said they anticipate higher prices and supply shortages may last another year or so. On point, Secretary of Commerce Gina Raimondo recently said: “The semiconductor situation is going to take a long time to fix.”
In addition to another heavy slate of earnings reports this morning, investors will get some important releases from the business beat. At 8:30 A.M. (EDT), the Labor Department reported that initial weekly jobless claims came in at 290,000, a pandemic-era low; continuing claims also fell. The equity futures, which were lower leading into the report, are still indicating some modest profit taking at the start of today’s session. Later this morning, we will get the existing home sales figures for September and the latest report on the leading economic indicators.
To date, the third-quarter earnings season, as noted above, has been a major catalyst for stocks, with the backdrop of the Federal Reserve’s highly accommodative monetary policies. Moving forward, it will be interesting to see if this momentum will continue as the focus moves away from the banking and financial sectors and to other industries where bottlenecking in the supply chains and disruptions may pressure those companies’ earnings and more likely dampen near-term outlooks some. The consumer staples companies, most notably the grocery and meat processors, may have a harder time passing some of the elevated operating costs to the consumers via pricing hikes. A number of the consumer foods companies, including Kellogg Company (K), McCormick & Company (MKC), and J.M. Smucker (SJM), have warned about higher ingredients, fuel, and logistics costs pressuring near-term operating margins. (Our analysis on the Food Processing Industry can be found in Issue 10 of The Value Line Investment Survey.) So far the non-banking earnings results have been good, save for a few key misses, including International Business Machines (IBM) yesterday afternoon. This morning, Verizon Communications (VZ) and Abbott Laboratories (ABT) are adding to the string of positive quarterly reports.
– William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
