The main catalyst behind the overall rally we are witnessing this week in the U.S. stock market has been second-quarter earnings season. And that is likely to be so again today, as the Federal Reserve is in a quiet period ahead of next week’s two-day monetary policy meeting. The futures are pointing to a modestly higher opening to stock trading stateside, with the tech-heavy NASDAQ Composite once again in positive territory.
It is not that Corporate America is delivering particularly strong results so far, as reflected by the releases from the big banks over the last week, but the reported figures in many cases have beaten lowered expectations. With the market already pricing in a lackluster earnings season, the positive surprises have brought more people back into the market and into riskier assets, especially in the sectors that were pummeled earlier in the year. In general, it is a case of “less bad than feared” on Wall Street right now.
Meantime, the big economic news came from overseas this morning. At 8:15 A.M. (EDT), we learned the European Central Bank (ECB) raised its benchmark short-term interest rate by a half-percentage point in an effort to combat inflation; the consensus was for a quarter-point hike. This also may provide some support to the euro, which has struggled against the U.S. dollar and is now near parity (one euro approximately equal in value to one dollar on the foreign exchange market) with the greenback. It was the first interest-rate hike by the ECB in 11 years, signaling a more-aggressive monetary policy tightening stance than expected.
On the earnings front, we received some important reports since the close of trading yesterday. Among the headlines were second-quarter results from Tesla (TSLA). The electric vehicles maker delivered mixed results, with earnings beating expectations, but revenues coming in a bit lighter than anticipated. It is also worth noting that the electric car maker’s profit margins contracted, which Tesla founder Elon Musk said would be the case during the quarter due to COVID-19 mandated shutdowns in China and global supply-chain disruptions. Shares of Tesla are pointing to a higher opening today. Meantime, insurance giant Travelers (TRV) reported strong results, with revenues coming in well above forecasts. The Dow-30 component’s stock is up nicely in pre-market action on the report. Shares of domestic air travel leaders American Airlines (AAL) and United Airlines (UAL) are looking at lower starts after each reported quarterly results.
The technology group has been among the best performers in recent days and has served as the primary impetus for the market’s rally. The interest in technology stocks has been driven by better-than-expected results from some of the industry’s heavyweights, including Netflix (NFLX) and International Business Machines (IBM), as well as growing sentiment that the economy may be headed into a recession down the road. The higher-growth technology companies are viewed as more likely to perform better than the cyclical value-oriented names in a period of slowing economic growth.
We did get some more data on the U.S. economy this morning and at first blush none of the reports quelled the fears that the pace of expansion is slowing. At 8:30 A.M. (EDT), the Labor Department reported that initial jobless claims for the week ending July 16th came in at 251,000, which was up 7,000 from the prior week. That, along with another weak reading on manufacturing activity in the greater Philadelphia area (the index fell nine points, to -12.3, this month), adds to the narrative that the U.S. economy is slowing. It should be noted that the Treasury yield curve remains inverted, which occurs when the yields on short-term Treasury notes exceed those of longer-duration government debt. This has historically been a reliable predictor of a recession down the road. Some of the recent data coming from the housing, homebuilding, and mortgage banking areas have been very weak for an area that is the second-largest contributor to the gross domestic product after the consumer.
The Federal Reserve has its work cut out for it in the attempt to slow stubbornly high inflation, without producing a “hard landing” for the economy. The consensus is that the central bank will increase the benchmark short-term interest rate by 0.75% at next week’s Federal Open Market Committee (FOMC) meeting. Our sense is that Wall Street believes that the “soft landing” scenario” is unlikely. Thus …
We don’t think this is the time to throw all caution to the wind again. There is still a lot of earnings news to come, and with the Federal Reserve aggressively tightening the monetary reins into a period of slowing economic and earnings growth, a recession is looking like a possibility down the line. We recommend that investors keep a mixture of equities, bonds, and cash in their portfolios and still give greater attention to the stocks of the higher-quality companies. For those looking to increase their exposure to the technology sector, there are many companies that have historically produced steady earnings gains and generate significant cash flow, the latter of which may allow them to weather any economic headwinds.
– William G. Ferguson
At the time of this article’s writing, the author did not hold any positions in the companies mentioned.
