These past five weeks have been characterized as a normal period of consolidation following a strong reversal of the narrative during the last week of August. The softer economic data fueling the bullish pivot has essentially taken the chance of a Fed interest rate hike at the September Federal Open Market Committee (FOMC) meeting off the table. And from my perspective, there is a growing likelihood that it is done raising interest rates altogether, assuming this week’s inflation data confirms this assumption.
The tech sector was rattled by news of the Chinese government restricting the sale of Apple iPhones to government workers. This impacted Apple’s shares, shedding some $200 billion from the stock’s market cap. Some see this as a furthering of the tech war between the United States and China, but what it does do is advance technology at an even faster pace in the race for global leadership.
According to FactSet, for Q2 2023 (with over 99% of S&P 500 companies having already reported actual results), 79% of S&P 500 companies have reported a positive earnings per share (EPS) surprise, and 64% of S&P 500 companies have reported a positive revenue surprise. This is a pretty good report card for the S&P 500.
From the most recent economic data, it appears as if the economy is indeed slowing, but not so much as to risk a recession. The market has bought into this narrative. I believe this week will see the market look to extend the rally into the second half of the month. This will take us to the end of the third quarter, when fund managers window-dress their portfolios to reflect market conditions.
Looking ahead to the market catalysts, August Consumer Price Index (CPI) data will be released this Wednesday, with the consensus forecasting a 0.6% gain for the month, with Core CPI (ex-food and energy) slated to come in at 0.3% The higher headline read would reflect a rebound in gasoline, diesel and jet fuel prices, as well as some food items. The key components to consider will be shelter and professional services, both of which have shown some signs of softness recently.
One thing that is glaringly obvious in the current market price action is how the bond market has its fingers on the scales of the short-term direction for the equity markets. Most investors will agree that over time, stock indexes trend higher 80% of the time. It’s the 20% of the time that can prove to be gut-wrenching and able to shake investors out. Those periods tend to be defined by sharp and nasty pullbacks that reduce months-long gains over a matter of days.
Given the pullback in most of the “Magnificent Seven” stocks that rule the index weightings, the S&P 500 has resolved to find support in the energy sector, and not so surprisingly, the utility sector has been crushed from the sequential interest rate hikes. If fund managers are starting to accumulate utility stocks at depressed levels, they are anticipating locking in the highest dividend yields offered by the sector in nearly three years with the idea that bond yields have peaked. A canary in the coal mine? Maybe.
The biggest reason energy stocks move higher is because of the base case that the global economy won’t falter. Instead, it will exhibit resilience, along with bullish production cuts by OPEC+ and a newly-anticipated stimulus by the Chinese government. There has been widespread breakout price action by the exploration and production, integrated, oil service and refining stocks of late. Barring a negative geopolitical catalyst, energy rallying is a leading indicator for the rest of the market. So, for all intents and purposes, we’ll take it!
I think the set-up for a strong finish to September, which ushers in the third quarter earnings season, is well-founded. It is based on friendly economic data, a bullish change in macroeconomic sentiment and the quintessential mix of a Fed pause and fourth-quarter seasonality. And if there is a reacceleration of information technology (IT) spending, it will fuel the FAANG (Meta, Apple, Amazon, Netflix and Alphabet), Magnificent Seven and other big tech stocks that dominate the S&P 500 to new all-time highs.
The moment that big money senses that the 5%+ short-term interest rates will begin to trend lower, there should be a tsunami of cash pouring back into big-cap dividend stocks that tend to outperform in such an early stage of interest rate easing. For income investors, it will be a golden point in time to shift away from short-term instruments and consider the blue-chip dividend stocks that have the potential to produce double-digit-percentage returns.
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