The major equity averages continued their upward move yesterday. A better-than-expected round of earnings results from the big banks and financial services companies, including Charles Schwab (SCHW), gave a boost to stocks. The continued retreat in Treasury market yields, which saw the rate on the 10-year note fall below 3.80% during yesterday’s session, also helped equities move higher. The Dow Jones Industrial Average led the way, finishing higher for the seventh consecutive session after recording a gain of 367 points, or a little over 1%.
The latest results have assuaged concerns about the big money center banks, which surfaced after the regional banking crisis in mid-March resulted in the collapse of three lenders. The mostly stronger profit margins for the banks, along with the absence of unusually large buildups in loan-loss reserves, which are capital accounts created to provide capital for potential loan defaults, were greeted positively by Wall Street. However, Goldman Sachs (GS) delivered mixed results today, with second-quarter profits plunging 58% year over year, on a poor performance from its fixed-income trading operation. The stock is down nominally in pre-market action.
This morning, we received the latest report on residential construction activity. At 8:30 A.M. (EDT), the Commerce Department reported that June housing starts and building permits came in at an annualized rate of 1.43 million and 1.44 million units, respectively. Those figures fell short of consensus expectations and were down on both a sequential and year-to-year basis. This was likely the result of mortgage rates reaccelerating in the late spring/early summer period. These uninspiring figures also followed some lackluster economic data yesterday, with industrial production falling 0.5% and retail sales climbing just 0.2% last month. Both figures came in worse than expectations. Yesterday, we also learned that homebuilder sentiment remained positive, but some builders are worried about the recent uptick in mortgage rates. The equity futures, which were positive heading into the housing data, are still presaging a modestly higher opening when trading kicks off stateside.
In general, the market is moving higher on the combination of falling Treasury market yields, a weakening U.S. dollar, and better-than-expected earnings to start the second-quarter reporting season. It should be noted that better-than-feared earnings in the first quarter gave a big boost to equities and could do the same over the next fortnight. That said, the recent rally has pushed equity valuations higher, with the price-to-earnings ratio for S&P 500 companies now above 19 and tracking higher than its 10-year average of 17.4. This frothy valuation leaves stocks susceptible to selling on any disappointing news. The stock of technology giant Microsoft (MSFT) finished yesterday at a record high price after the company unveiled pricing for its burgeoning artificial intelligence (AI)-driven products.
We continue to recommend that those looking to increase their equities exposure in this current environment would be wise to look at the stocks of high-quality companies that have demonstrated a history of producing steady earnings and cash flow growth. These stocks are likely to be less vulnerable to falling on unforeseen earnings misses. There also are a number of stocks in the cyclical sectors that are trading at less-expensive valuations, and that group could benefit from a “soft landing” for the U.S. economy that avoids a significant recession. The resilient consumer sector, along with still-healthy labor market conditions (initial weekly unemployment claims, which will be released tomorrow morning, have been on a downward trend), have raised hopes that the Federal Reserve can orchestrate a “soft landing” for the economy as it nears the end of its most restrictive monetary policy course in 40 years.
Speaking of the Fed, the central bank kicks off its two-day monetary policy meeting next week. The expectation is that the Federal Open Market Committee (FOMC) will raise the federal funds rate by a quarter point, to 5.25%-5.50%, after pausing at its June meeting. The expected increase has been priced into the market, so we think the market action will be driven by the Fed commentary about possible future interest-rate actions. The Fed has noted that it plans to be “data dependent” in formulating monetary policy, so the recent moderation in inflation at the consumer and producer levels is adding to the Wall Street narrative that the Fed is close to ending its tightening course and that is pushing Treasury market yields lower and providing additional support for stocks. - William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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