One of the stock market's most consistent trends 👯♀️
Plus a charted review of the macro crosscurrents 🔀
📈 Stocks rallied to new all-time highs, with the S&P 500 setting a record intraday high of 5,655.56 on Friday and a record closing high of 5,633.91 on Wednesday. For the week, the S&P gained 0.9% to end at 5,615.35. The index is now up 17.7% year to date and up 57% from its October 12, 2022 closing low of 3,577.03. For more on the stock market, read: Keep your stock market seat belts fastened 🎢
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Second quarter earnings season kicked off on Friday with the nation’s largest banks announcing financial results for the April-June reporting period.
Over the next few weeks, all of the big publicly-traded companies will tell us how they did in Q2 and provide guidance for what they believe is to come in the next few quarters. (Bloomberg’s Esha Dey and Jess Menton have a great roundup of the narratives to watch in the earnings announcements.)
Will we get the bad news that puts an end to the market rally and send prices spiraling lower? Maybe. But that seems unlikely.
If a company’s financial performance is way out of line with analysts’ expectations, they’ll usually make an announcement before releasing quarterly results or they’ll have insiders signaling to analysts to revise their estimates.
So with that in mind, don’t be surprised if earnings season follows the oft-repeated pattern of most companies beating earnings estimates. It’s one of the most consistent trends in the stock market.
As the chart below from Deutsche Bank’s Binky Chadha shows: In every single quarter since 2006, no less than 60% of S&P 500 companies have reported quarterly earnings per share (EPS) that beat analysts’ expectations.
Also, don’t be surprised if those EPS results beat estimates by a margin of around 5%.
By the way, my favorite anecdote related to all of this comes from DataTrek Research co-founder Nicholas Colas (via the May 1, 2023 TKer):
…It took me many years to develop a ‘hack’ that eventually landed me consistently on the Wall Street Journal’s list of analysts with the most accurate earnings estimates. Over time I realized that companies always beat the consensus of analysts’ estimates by about 5%. So, a week or two before an earnings announcement I would set my estimate to 5% above the Street’s number…
Why does all of this happen? This is actually a whole can of worms. But if you want more on why most companies are able to beat expectations, read: 'Better-than-expected' has lost its meaning 🤷🏻♂️, Warren Buffett blasts ‘one of the shames of capitalism’ 🤬, and Jamie Dimon says the quiet part out loud about quarterly earnings 👀
Zooming out 🔭
Whether or not a company beats or misses earnings estimates may contribute to short-term volatility.
Also, none of this is to suggest that “better-than-expected” earnings won’t prevent stocks from pulling back in the near term. Price movements can be hard to predict over short periods of time.
But from a long-term, high-level perspective, I don’t think earnings season will be unusually notable unless the developments force analysts to make major adjustments to their outlook for earnings, which continues to look up.
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Related from TKer:
How to become one of Wall Street’s most accurate analysts in one step 🧮
12 charts to consider with the stock market near record highs 📈
RBC, Oppenheimer, and Yardeni raise their targets for the S&P 500 📈
On July 2, RBC’s Lori Calvasina raised her year-end target for the S&P 500 to 5,700 from 5,300. This was her third revision from her initial target.
“The story we see in our data for 2024 is that the stock market has gotten a bit ahead of itself from a valuation perspective, as well as on some of our sentiment work, but that some of our tools (including one of our sentiment models) do still point to the potential for the S&P 500 to move a little bit higher between now and year-end,” she wrote. “We think risks of a near-term pullback are growing, but for now think one would be temporary and limited to the 5-10% range. This is similar to the call we made at the end of March. We’ve described ourselves as a ‘tired bull’ and ‘neutral’ recently. Today, we would alter that slightly and characterize ourselves as a “nervous and jumpy bull.”
On Monday, Oppenheimer’s John Stoltzfus raised his target to 5,900 from 5,500. This is his second revision.
“S&P 500 earnings results over the most recent three quarterly reporting seasons (Q3 ‘23, Q4 ‘23, and Q1 ‘24) and economic data that has provided evidence of resilience underpinned by the Fed’s mandate-sensitive monetary policy remains at the core of our bullish outlook for stocks,“ he wrote.
On Wednesday, Yardeni Research’s Ed Yardeni raised his target for the first time to 5,800 from 5,400.
“The stock market seems to be discounting our Roaring 2020s scenario faster than we expected,” Yardeni wrote. “The bull market might continue to achieve our targets ahead of schedule.”
Calvasina, Stoltzfus, and Yardeni are not alone in tweaking their forecasts. Their peers at Citi, Capital Economics, Goldman Sachs, UBS, Morgan Stanley, Deutsche Bank, BMO, CFRA, Societe Generale, BofA, and Barclays are among those who’ve also raised their targets.
Don’t be surprised to see more of these revisions as the S&P 500’s performance, so far this year, has exceeded many strategists’ expectations.
Reviewing the macro crosscurrents 🔀
There were a few notable data points and macroeconomic developments from last week to consider:
🏛️ Powell sees rising risks of a cooling economy. In his testimony to Congress last week, Federal Reserve Chair Jerome Powell acknowledged the slowing activity reflected in the recent labor market data and the risks that come with the timing of monetary policy adjustments.
“[I]n light of the progress made both in lowering inflation and in cooling the labor market over the past two years, elevated inflation is not the only risk we face,” he said. “Reducing policy restraint too late or too little could unduly weaken economic activity and employment.“
“You see a labor market that is now pretty much in balance, pretty much where it was in 2019,” he said. “It's not a source of broad inflationary pressures for the economy now.”
For more on the Fed and the economy, read: Revisiting the key chart to watch amid the Fed's war on inflation 📈 and The labor market is cooling 💼
👍 Inflation cools. The Consumer Price Index (CPI) in June was up 3.0% from a year ago, down from the 3.3% rate in May. Adjusted for food and energy prices, core CPI was up 3.3%, down from the 3.4% rate in the prior month. This was the lowest increase in core CPI since April 2021.
On a month-over-month basis, CPI declined 0.1% as energy prices fell 2%. Core CPI increased by 0.1%.
If you annualize the three-month trend in the monthly figures — a reflection of the short-term trend in prices — CPI rose 1.1% and core CPI climbed 2.1%.
Broad measures of inflation are way down from peak levels in the summer of 2022 and now near the Fed’s target rate of 2%.
For more, read: Inflation: Is the worst behind us? 🎈
👍 Inflation expectations remain cool. From the New York Fed’s June Survey of Consumer Expectations: “Median one- and five-year-ahead inflation expectations both declined by 0.2 percentage point in June to 3.0% and 2.8%, respectively. In contrast, the median three-year ahead inflation expectations increased 0.1 percentage point to 2.9%.”
For more, read: The end of the inflation crisis 🎈
⛽️ Gas prices tick up. From AAA: “The national average for a gallon of gas rose three cents to $3.54 from last week. The slight nudge higher came despite Hurricane Beryl smacking into the coast of Texas, a record number of July 4th car travelers, and oil costs hovering above $80 per barrel.”
For more on energy prices, read: Higher oil prices meant something different in the past 🛢️
🛢️U.S. oil boom: From Apollo Global’s Torsten Slok: “For the first time in more than 60 years, US energy production is now higher than US energy consumption.“
For more on energy prices, read: Higher oil prices meant something different in the past 🛢️
💨 Wind is on the rise. From Sherwood News: “In April, wind power generated more electricity than coal for the second month in a row, according to the latest available data from the Energy Information Administration. Wind briefly surpassed coal once before in April last year, but this time it’s by a much larger margin and for two consecutive months.“
💳 Consumers took on more debt. According to Federal Reserve data, total revolving consumer credit outstanding increased modestly to $1.35 trillion in May. Revolving credit consists mostly of credit card loans. Nonrevolving credit, which includes auto loans and student loans, increased to $3.72 trillion.
Of course, consumer debt should always be normalized against some form of assets or income. As you can see below, household debt service payments as percent of disposable income, while up from pandemic lows, remain near historic lows.
For more on household finances, read: Stay mindful of the economic warning signs ⚠️ and There's more to the story than 'excess savings are gone' 🤔
💳 Card spending data is mixed. From JPMorgan: “As of 03 Jul 2024, our Chase Consumer Card spending data (unadjusted) was 3.9% above the same day last year. Based on the Chase Consumer Card data through 03 Jul 2024, our estimate of the U.S. Census June control measure of retail sales m/m is 0.34%.“
From Bank of America: “In June, total card spending per household was down 0.5% year-over-year, according to Bank of America internal data. Seasonally-adjusted total card spending dropped 0.1% month-over-month (MoM), but over the second quarter as a whole, total card spending rose 0.3%, suggesting that while softening, there is still some momentum behind consumer spending.”
For more on consumer finances, read: Unsettling stats about consumer health are missing the bigger picture 💵
💼 Unemployment claims fall. Initial claims for unemployment benefits declined to 222,000 during the week ending July 6, down from 239,000 the week prior. And while this is above the September 2022 low of 187,000, it continues to trend at levels historically associated with economic growth.
For more, read: Labor market: How cool will it get? 🥶
🏠 Mortgage rates tick lower. According to Freddie Mac, the average 30-year fixed-rate mortgage declined to 6.89% from 6.95% the week prior. From Freddie Mac: “Following June’s jobs report, which showed a cooling labor market, the 10-year Treasury yield decreased this week and mortgage rates followed suit. There is also more inventory on the market, including a fair number of listings with price cuts, which is an encouraging sign for prospective buyers.”
There are 146 million housing units in the U.S., of which 86 million are owner-occupied and 39% of which are mortgage-free. Of those carrying mortgage debt, almost all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged from 2021 lows. All of this is to say: Most homeowners are not particularly sensitive to movements in home prices or mortgage rates.
For more on mortgages and home prices, read: Why home prices and rents are creating all sorts of confusion about inflation 😖
👎 Consumer sentiment worsens. From the University of Michigan’s July Surveys of Consumers: “Although sentiment is more than 30% above the trough from June 2022, it remains stubbornly subdued. Nearly half of consumers still object to the impact of high prices, even as they expect inflation to continue moderating in the years ahead.“
Weak consumer sentiment readings appear to contradict resilient consumer spending data. For more on this contradiction, read: What consumers do > what consumers say 🙊 and We're taking that vacation whether we like it or not 🛫
👍 Small business optimism improves. The NFIB’s Small Business Optimism Index in June rose to the highest level of the year.
Importantly, the more tangible “hard” components of the index continue to hold up much better than the more sentiment-oriented “soft” components.
Keep in mind that during times of perceived stress, soft data tends to be more exaggerated than actual hard data.
For more on this, read: What businesses do > what businesses say 🙊 and Sentiment: Finally a vibe-spansion? 🙃
📈 Near-term GDP growth estimates remain positive. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 2.0% rate in Q2.
For more on economic growth, read: Economic growth: Slowdown, recession, or something else? 🇺🇸
Putting it all together 🤔
We continue to get evidence that we are experiencing a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
This comes as the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to get inflation under control. While it’s true that the Fed has taken a less hawkish tone in 2023 and 2024 than in 2022, and that most economists agree that the final interest rate hike of the cycle has either already happened, inflation still has to stay cool for a little while before the central bank is comfortable with price stability.
So we should expect the central bank to keep monetary policy tight, which means we should be prepared for relatively tight financial conditions (e.g., higher interest rates, tighter lending standards, and lower stock valuations) to linger. All this means monetary policy will be unfriendly to markets for the time being, and the risk the economy slips into a recession will be relatively elevated.
At the same time, we also know that stocks are discounting mechanisms — meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.
Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs, and those with jobs are getting raises.
Similarly, business finances are healthy as many corporations locked in low interest rates on their debt in recent years. Even as the threat of higher debt servicing costs looms, elevated profit margins give corporations room to absorb higher costs.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have recently had some bumpy years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
10 truths about the stock market 📈
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
The makeup of the S&P 500 is constantly changing 🔀
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks.
The key driver of stock prices: Earnings💰
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
Stomach-churning stock market sell-offs are normal🎢
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
High and rising interest rates don't spell doom for stocks👍
Generally speaking, rising interest rates are not welcome news for the economy and the stock market. They represent higher financing costs for businesses and consumers. All other things being equal, rising rates represent a hindrance to growth. However, the world is complicated, and this narrative comes with a lot of nuance. One big counterintuitive piece to this narrative is that historically, stocks have actually performed well during periods of rising interest rates.
How stocks performed when the yield curve inverted ⚠️
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
How the stock market performed around recessions 📉📈
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
In the stock market, time pays ⏳
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
What a strong dollar means for stocks 👑
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
Economy ≠ Stock Market 🤷♂️
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
Stanley Druckenmiller's No. 1 piece of advice for novice investors 🧐
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Warren Buffett's 'fourth law of motion' 📉
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
Most pros can’t beat the market 🥊
According to S&P Dow Jones Indices (SPDJI), 59.7% of U.S. large-cap equity fund managers underperformed the S&P 500 in 2023. As you stretch the time horizon, the numbers get even more dismal. Over a three-year period, 79.8% underperformed. Over a 10-year period, 87.4% underperformed. And over a 20-year period, 93% underperformed. This 2023 performance follows 13 consecutive years in which the majority of fund managers in this category have lagged the index.
Proof that 'past performance is no guarantee of future results' 📊
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. For example, 334 large-cap equity funds were in the top half of performance in 2021. Of those funds, 58.7% came in the top half again in 2022. But just 6.9% were able to extend that streak through 2023. If you set the bar even higher and consider those in the top quartile of performance, just 20.1% of 164 large-cap funds remained in the top quartile in 2022. No large-cap funds were able to stay in the top quartile for the three consecutive years ending in 2023.
The odds are stacked against stock pickers 🎲
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 24% of the stocks in the S&P 500 outperformed the average stock’s return from 2000 to 2022. Over this period, the average return on an S&P 500 stock was 390%, while the median stock rose by just 93%.
