July Update: A positive July ends on a sour note.

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  • S&P 500 hit more record highs in July.

  • Second quarter GDP growth beat estimates thanks to a strong consumer.

  • Q2 earnings season is better than forecast.  Trade and dollar strength are headwinds.

  • Via Nova’s view on the July FOMC rate cut and future moves.

  • Our outlook remains positive, but market jitters could keep stock prices volatile.

S&P 500 hit more record highs in July.

The S&P 500 rose to more record highs in July on the back of a healthy consumer, more accommodative Fed policy and better than forecast second quarter earnings.  However, scaled back U.S./China trade negotiations and concerns over whether the Federal Open Market Committee (FOMC) will lower short term interest rates more than once raised fresh concerns and prompted selling toward the end of the month.  Via Nova believes stock prices can continue trending higher over the remainder of the year, but the path could be volatile following the sharp 20% rally in the S&P 500 through the first seven months of 2019.

The S&P 500 finished 1½% higher in July led by gains in technology, communication services and financial stocks.  Gains in these sectors tend to reflect economic strength.  However, the energy and healthcare sectors declined and continued to lag the overall market so far in 2019.  Energy stocks have been under pressure from slowing demand within a weaker global economy combined with excess oil supply, particularly from the U.S.  Healthcare stocks are fighting political headwinds related to healthcare reform which could threaten current profitability.  As has been the case in recent months, the large cap S&P 500 led other areas of the market in July, besting a smaller rise in small cap stocks and declines in international and emerging market equities which remain pressured by slowing global economic growth.  The lack of broad strength across multiple market caps and geographies is an ongoing concern for us.  Ideally, we want to see all boats rising with the tide, but that is not happening.

Bond yields held relatively steady over the month and the Merrill Lynch Broad Bond Market Index rose a modest ¼%.  U.S. Treasuries were the weakest sector, while investment grade and high yield corporate bonds continued to outperform reflecting the ongoing strength of the economy and the ability of companies to service debt obligations.  In other markets, gold prices benefited from increased uncertainty, and Real Estate Investment Trusts (REITS) rose on continued stable interest rates.  The value of the dollar increased in reaction to heightened tensions, particularly in the Middle East.  The dollar remains a haven for investors in times of global uncertainty and was up 4% from a year ago.  A strong dollar makes imports cheaper for consumers but makes U.S. exports less competitive.

Second quarter GDP growth beat estimates thanks to a strong consumer.

Consumer strength was the dominant factor in the second quarter economy and was largely responsible for the somewhat better than expected increase in Gross Domestic Product (GDP).  The current expansion is now the longest in the post-World War II era.  A healthy consumer is vital to the strength and longevity of the cycle as it represents 70% of total activity.  One worrisome spot in the GDP data was relative softness in business investment spending.  We believe the uncertainty created by trade tensions and slower profits growth has been a major factor delaying much needed investment spending.  As the trade war with China continues into its second year, many companies have begun shifting their supply chains away from China to avoid expensive tariffs.  This process takes time and often requires building infrastructure in other countries.  We do not believe the current trade tensions will end the current expansion, but they could hamper the pace of growth in the coming quarters.

Q2 earnings season is better than forecast.  Trade and dollar strength are headwinds.

Companies in the S&P 500 are stepping over a low bar of earnings expectations in the second quarter, which provided support for the monthly market gain.  Three-quarters of companies have reported earnings through the end of July and three-quarters of those companies beat profit forecasts.  Still, overall earnings growth will likely increase just 1-2%, well below the 20% increase in 2018 and below the 7% long-term average.  We have already mentioned the drag from the trade war with China but slowing global growth and a strong dollar have also been factors weighing on earnings.  Slower growth hurts sales volumes, and a strong dollar lowers the value of sales earnings.  Available data show that S&P 500 companies with more than 50% of their revenues from overseas are experiencing a decline of over 13% in second quarter profits, while companies with over half of their revenues from the U.S. are seeing earnings gains above 3%.  The industrial, technology, energy and materials sectors have been most affected.

Via Nova’s view on the July FOMC rate cut and future moves.

Via Nova is pleased that the Federal Open Market Committee (FOMC) decided to cut short term rates by a quarter percent at its latest meeting that ended July 31st.  We believe the rate reduction not only lowers borrowing costs for businesses and consumers, but it helps correct some of the distortions in the credit markets created by the excessive rate increases in 2018 that lifted short term rates above long term rates.  Lower interest rates are broadly positive for the stock market.

In cutting rates, Chairman Powell acknowledged the healthy consumer and the low odds of recession, but cited growing risks related to weaker global growth and protracted trade tensions at a time when inflation remained below the Fed’s long-term target.  The Federal Reserve has a dual policy mandate to “foster maximum employment and price stability,” so continued low inflation is viewed as a problem even though the unemployment rate is near a 50-year low.  A certain amount of inflation is needed to lubricate and facilitate economic adjustments.  Persistent low inflation threatens a negative shift in expectations which can be bad for future spending and investment.  The Federal Reserve and most central banks agree that 2% is a desirable inflation target. 

The market consensus expected and got the quarter point cut it wanted, but investors were hoping Powell would promise more rate cuts this year.  Instead, the Chairman said the FOMC would continue to evaluate the incoming information and make any further rate adjustments as needed.  The failure to guarantee more rate reductions worried investors and precipitated a market decline on the last day of the month.

Via Nova believes Chairman Powell acted responsibly in not promising future rate cuts in his official statement, but we do believe the Fed should and will lower short term rates at least once more in 2019 and preferably twice more.  We do not believe the economy is at risk of an imminent recession that requires proactive rate cuts from the FOMC.  Instead, the rate cuts should help restore some normalcy to the structure of the credit markets as well as lower borrowing costs in an environment of below target inflation-both of which are positives for the stock market.

Our outlook remains positive, but market jitters could keep stock prices volatile.

Via Nova believes the economy and the markets will benefit from a healthy consumer and lower interest rates in the months ahead, but we do not expect smooth sailing in the stock market over the near term.Following the Fed’s lack of formal commitment to cut rates at future meetings, President Trump, frustrated with the lack of progress in trade talks with China, threatened a 10% tariff on the $300 billion in Chinese imports not already affected by existing charges. Interest rates and trade policy have been at the top of our Via Nova Worry Checklist for 2019 and checking off the risks from what we see as self-inflicted wounds has not gone smoothly. With the S&P 500 already up an impressive 20% so far this year, market volatility could increase over the remainder of the summer despite positive fundamentals.We see any potential market weakness as an investing opportunity.