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Major stock averages rally on better than expected earnings

The upward move at the beginning of a bull market is almost always huge compared with the vacillations late in the bear market. If you try to pick a bottom, you will miss a good part of the action. – Kenneth Fisher 

Mostly better than expected second quarter corporate earnings lifted the major stock averages to healthy gains last week even though economic data pointed to a rapidly slowing economy. The technology-heavy Nasdaq Composite Index led the way with a gain of over 3% while the S&P 500 Index finished the week with a gain of 2.6%. After sliding 24% from its record high back in January to its low on June 24th, the S&P 500 Index has rallied 8%, raising the possibility that a bottom may have been put in for the stock market. The week began on a sour note as technology bellwether Apple announced plans to slow hiring and spending on growth next year to cope with a potential economic downturn. Despite beating analyst estimates on both the top and bottom lines, IBM followed that news on Monday by lowering its cash flow forecast in 2022, blaming the strong dollar and the suspension of its business in Russia. After rallying at least 1% in the morning, the major stock averages gave back all the gains and then some, closing lower on the day. But it was the earnings report from Netflix on Tuesday that seemed to turn the tide. The company beat earnings estimates and said that it ‘only’ lost 970,000 subscribers in the second quarter, far less than the 2 million it had previously projected.  A rising tide lifts all boats and not only did the stock of Netflix soar, but the Nasdaq Composite Index jumped over 3%. In fact, NYSE stocks experienced a “90% up day” with more than 90% of stocks listed on the exchange advancing and accounting for more than 90% of the volume. Such a strong move higher could be a sign that the stock market has bottomed. The positive sentiment was short-lived, though, as social media company Snap badly missed revenue and earnings estimates on Friday, sending other social media and technology stocks lower in sympathy. Although the stock market ended the week with a loss, the second quarter earnings season so far has been better than feared. With about one fifth of  S&P 500 companies having reported their earnings, slightly over 75% of them have topped expectations with most companies maintaining their forward guidance for the year.

Last Week

The data last week was gloomy on the housing front. June housing starts fell to the lowest level since September 2021 and were below forecasts as higher mortgage rates reduced affordability. June existing home sales also fell for the 5th consecutive month and hit their lowest level in two years. To add insult to injury, the National Association of Home Builders/Wells Fargo Housing Market Index measure of builder sentiment plunged to its lowest level since the start of the pandemic. Leading economic indicators in June recorded their fourth straight monthly decline and weekly jobless claims rose to 251,000 from 244,000 in the prior week.

The European Central Bank (ECB) raised its benchmark interest rate by a half of one percent, the first time the central bank has raised rates in 11 years as inflation has soared. The Bank of Japan (BOJ), on the other hand, left its benchmark rate unchanged despite high inflation.

For the week, the Dow Jones Industrial Average rose 2.0% to close at 31,899 while the S&P 500 Index climbed 2.6% to close at 3,961. The Nasdaq Composite Index surged 3.3% to close at 11,834.

This Week

The first estimate of second quarter gross domestic product (GDP) is expected to be 1.6%, compared to a decline of 1.6% in the first quarter. June durable goods orders are forecast to increase modestly and June new home sales are expected to be less than in May. The core personal consumption expenditures (PCE) index for June is expected to increase to 4.8% year over year, slightly higher than in May. Both the July consumer confidence index and the University of Michigan consumer sentiment index are forecast to approximate the low levels reported in June.

The Federal Open Market Committee (FOMC) meets to review its monetary policy and is widely expected to raise the federal funds rate by 75 basis points.

The most prominent companies scheduled to report second quarter earnings this week are Whirlpool, 3M, Raytheon Technologies, General Dynamics, Honeywell, General Motors, Ford Motor, Boeing, Visa, Mastercard, Microsoft, Alphabet (Google), Meta Platforms (Facebook), Qualcomm, Apple, Intel, Amazon, Kimberly Clark, McDonald’s, Coca Cola, Kraft Heinz, Altria Group, Procter & Gamble, Bristol Myers Squibb, Pfizer, Merck, Abbvie, Exxon Mobil and Chevron.

Portfolio Strategy

This could be a pivotal week for the stock market with earnings reports from a slew of high-profile technology companies, a Federal Reserve decision on interest rates and important data on the state of the economy. This week is the busiest one for second quarter earnings announcements as about 175 S&P 500 companies are on the agenda. The two largest companies, Microsoft and Apple, are on tap as well as other technology heavyweights such as Alphabet (Google), Amazon and Meta Platforms (Facebook). For the most part, earnings results so far have been positive, but it will also be important what the companies say about their outlook for the rest of the year and beyond. In addition, the Federal Open Market Committee (FOMC) meets this week to review its monetary policy and is widely expected to raise the federal funds rate by 75 basis points. (A basis point is one hundredth of one percent). After the release of the June consumer price index (CPI), which surged to 9.1% year over year, traders predicted that the Fed would raise interest rates by a full percentage point at the meeting. Since that time, however, economic data has softened and most economists now forecast a second three-quarter point rate hike to follow the one made last month. With no Fed meeting in August, the question then turns to September and how much it will raise the federal funds rate then. If the Federal Reserve tightens too much and too long, it loses the ability to achieve a soft landing and the probability of a recession increases. Finally, second quarter GDP will be released and although the consensus estimate is positive, the Atlanta Federal Reserve is forecasting a decline of 1.6%, which would match the drop in the first quarter. Some view two consecutive negative quarters in GDP as a recession, but others need to see unemployment rise substantially before calling it a recession. The market may now be more concerned with a rapidly slowing economy than with persistently high inflation with a policy error by the Fed becoming a bigger risk.

I will be out of the office on vacation for two weeks beginning August 1st. The next weekly newsletter will be sent on Monday August 15th.