How was your Fourth?

The S&P 500 rose to yet another new all-time high this week, cheering Jerome Powell’s words that disinflation looks to be back on track. Over the last 20 years, July has been the strongest month for both the Nasdaq (up 3.5%) and the S&P 500 (up 2.3%), with the first half of the month being particularly strong. With the relative strength indicator suggesting overbought levels, we could be facing a consolidation before too long, as seasonality does tend to weaken in August and September. Breadth remains quite weak, with just 24% of S&P 500 stocks outperforming the index in the first half of this year. And it’s curious to see a cyclical sector like Materials underperform even as the broader market posts new highs. Still, nearly 80% of stocks are within 20% of their 52-week highs, so it’s not just Technology that’s faring well. And price is not the only form of return to equity ownership; dividends have been rising nicely, with S&P 500 average dividends up 6.5% in Q2 y/y. Flows have been strong, with equity ETFs seeing $265 billion of inflows in the first half of the year, second only to 2021’s $356 billion. As for global markets, they have participated in equity gains as well, with the MSCI ACWI hitting a new all-time high in June. 

The hurdle facing investors gets underway well before the Paris Olympics: it’s the 8-9% y/y earnings growth that consensus expects in Q2. If revisions and surprises are typical, that may wind up more like 11%. On an equal-weighted basis, EPS is currently seen rising a mere 4.9%. Deutsche sees mid-cap growth and Tech still leading the earnings race but at a slower pace, while cyclicals and defensives stay the course and Energy and Materials increase sharply. Historically, Q2 estimates fall 3% or so from the beginning of the quarter. Even after a strong Q1, we haven’t seen that happen this time, which looks like a bullish sign. Must AI continue to carry the ball? Strategas thinks the chief risk earnings face is a move from “AI Euphoria” to “AI Disappointment.” It would be great if managements will provide more color in their upcoming earnings calls on how they are using AI to improve earnings and productivity. Profit margins will be key to preserving jobs as the economy slows. Indeed, the Atlanta Fed’s GDPNow tracking model’s estimate of real GDP growth in Q2 dropped from a robust 3% on June 26 to half as much today. But for now, earnings estimates for 2025 continue to move higher.   

Actually, all of the 11 S&P 500 sectors are forecast to see earnings growth next year. So far, 2024’s AI theme has delivered an historically narrow market. We’ve seen just nine years since the 1950s where a mere five stocks provided 40% or more of the market’s return. Looking ahead? In general, those years have been followed by trend-like returns, with low P/E stocks leading and high revenue growth stocks trailing. The long-awaited broadening. But for now, the industry forecast to enjoy the fastest earnings growth in the entire S&P 500 is video games! The Gen Zs at our friend’s annual July 4th bash (he outdid himself this year with a spectacular fireworks display befitting a small municipality) will be thrilled when College Football 25 is out later this month and Grand Theft Auto VI is released next year! As for the rest of us, there were no fireworks on the ground. We kept our political filters in check, respecting the mixed opinions of the group, even the Mister (he contained himself until the whole ride home). Except for our host, whose traditional filet mignon entrée was nixed this year as he reported that prices have doubled since 2023. I think I know who he’s voting for …

Positives

• Goldilocks job report? The economy added 206K jobs in June, while unemployment ticked higher to 4.1%, numbers that keep a soft landing in scope. Of concern, this is the third month in a row that the unemployment rate has risen – something last seen in 2016 when the Fed reversed course. Also, the last two months’ payroll gains were revised significantly downwards. Earlier in the week, the JOLTS report showed total job openings rose to 8.14 million in May, further still below below peak readings of 12 million in early 2022.
• No cuts just yet Fed Chair Powell said that recent inflation reports “suggest we are getting back on a disinflationary path.” The FOMC’s June minutes noted three times that further favorable data will be needed before a cut will be in order. The Fed said that AI-driven productivity gains may be helping to push inflation lower and wondered whether the neutral rate of interest might be higher than previously believed, suggesting that current Fed policy may be less restrictive than thought.
• Green shoots of global expansion Global manufacturing PMIs rose in June, with EM Asia leading the way. Taiwan, Vietnam, Thailand and South Korea all saw improving, expansionary PMIs. Importantly, some of these countries are near the beginning of the manufacturing supply chain, so this may be a sign of spreading expansion. For now, Europe has not yet joined in, and Germany remains stuck in contraction.  

Negatives

• Long and variable lags In the U.S., the ISM services PMI fell to a disappointing 48.8, versus expectations of 52.5. (Curiously, S&P Global’s services PMI came in at 55.3, the highest reading in more than two years.) The manufacturing PMI was slightly weaker than forecast, 48.5 versus 49.1 expected. One bright spot: the prices paid index dropped 4.9 points, to 52.1 after a similar drop in May.
• The economy slows Factory orders dropped by 0.5% in May, versus an expected gain of 0.3%, and April’s figure was revised lower by 0.3%. Core capital goods orders rose 0.6% but shipments of them were revised down to -0.6%. Durable goods orders rose 0.1% but on an ex-transportation basis durable goods orders fell 0.1%.
• Building slows Construction spending fell at an annual rate of 0.1% m/m in May, versus expectations of an increase of 0.2%. May’s data shows weakness in residential spending, which fell by 0.2%. Single-family spending fell for the second straight month, though private residential improvement spending remains above pre-Covid levels. Nonresidential construction also fell 0.1% m/m.

What Else

Demographic shifts In Germany, deaths have outpaced births every year since 1972, but, due to immigration, the population has grown over this period. The U.S. has several hundred thousand more births than deaths annually, but that figure was 1.5 million little more than a decade ago. We may see an increasing reliance on immigration globally – even as the subject has become a political football.

Goodnight, air pillow Amazon says it has eliminated 95% of plastic air pillows from its packaging materials and will likely have phased out air pillows altogether by the end of the year. In their place: recycled paper. The company’s U.S. shipments are thought to have produced 208 million pounds of plastic waste in 2022.

When in the course of human events The U.S. population has gone up by a factor of roughly 100 since the first Independence Day in 1776. Collectively, we consumed about 150 million hot dogs at July 4th cookouts. As for all the flags and fireworks seen on the Fourth? More than 90% of that comes from China.