VIA NOVA UPDATE: Stocks climbing the wall of worry

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  • The S&P 500 rises to the highest level since February.
  • Small businesses feel good, but inflation is moving higher.
  • Kavanaugh nominated to SCOTUS, President creates a stir at NATO Summit & UK.
  • Trade tensions, the Fed and the markets.
  • Big banks kick off the second quarter earnings season.
  • Week ahead: Earnings, Powell testimony, trade, retail sales, Philly Fed survey, housing starts and leading indicators.

The S&P 500 rises to the highest level since February.

The S&P 500 added 1.55% on top of the previous week’s gain to lift the index to its highest level since February.  However, it is still roughly 2.5% below the January high of 2873.  Technology, industrials and consumer discretionary stocks led the advance, while the more defensive utilities and telecom stocks fell.  Small cap stocks edged lower following the surge in recent weeks, but international and emerging market stocks rose, though they remain in negative territory year to date.

Bond yields rose slightly for the week but remain historically low.  Narrowing credit spreads helped the broad Bloomberg Barclays Aggregate Bond Index add 0.19%.  However, we believe bond yields will trend higher over the coming quarters, as the Federal Reserve continues raising interest rates and foreign central banks discontinue their protracted accommodative policies.  In this environment, stocks are likely to outperform bonds.  Inflation hedges, REITs, gold, TIPS and oil, all fell.  The value of the dollar rose.

Small businesses feel good, but inflation is moving higher.

The latest bits of economic data continue to suggest the labor market is tight and business confidence is high, both of which are positive for confidence, income, spending and investment.

The Small Business Optimism Index conducted by the National Federation of Independent Businesses (NFIB) hovered near a cycle high in June.  The report also showed businesses are having trouble finding qualified workers.  The share of U.S. firms with open positions matched the highest level since 1973.  Twenty-one percent of small-business owners said finding qualified workers was their biggest problem, superseding government regulations. 

A separate report, the Job Openings and Labor Turnover Survey (JOLTS) confirmed Americans’ confidence in employment prospects is soaring as the labor market tightens.  The May report showed a record number are voluntarily quitting to seek better jobs.  Consumer confidence is near record highs, and it was partially reflected in the May surge in consumer credit.  High confidence and borrowing tend to translate to stronger growth and higher sales for companies.

Inflation was the economic data focus for the week, and the latest metrics continued to move above the Federal Reserve’s 2% longer-term target.  The Producer Price Index (PPI) rose more than expected and was up 3.4% from a year ago.  The Consumer Price Index (CPI) increase was smaller than expected but was up 2.9% year-on-year.  The Fed’s preferred inflation gauge, the Personal Consumption Expenditures Deflation (PCE) was up 2.3% in May.  The Fed’s current position is that 2% inflation is not a ceiling, and that they would be willing to tolerate it for a time without automatically raising rates.

There are two key takeaways on the inflation data for investors.  The first is that speculation could intensify about Fed policy and whether they will feel a need to raise interest two more times this year.  The fear of a more aggressive Fed in turn could be a negative for bond returns.  The second is that producers are facing increased cost pressures throughout all stages of production, fueling concerns about profit margin pressures if businesses don't pass those costs onto customers and concerns about consumer inflation pressures if they do.

Kavanaugh nominated to SCOTUS, President creates a stir at NATO Summit & UK.

The nomination of Brett Kavanaugh to replace Justice Kennedy on the Supreme Court is considered by many to be pro-business and good for the markets.  Kavanaugh tends to take a skeptical view of the “administrative state” and has handed down decisions rolling back regulations that he believes Congress never expressly authorized.

The NATO Summit in Brussels was not the photo-op lovefest that has characterized many past meetings.  President Trump, as expected, railed against the failure of many members of the group to reach their promised 2% of GDP defense spending target.  NATO estimates of the shortfall exceeds $100 billion in the top ten nations outside of the U.S. and Britain (which spend 3.1% and 2.1%, respectively), according to data published by the Wall Street Journal.   Mr. Trump called for defense spending to ramp up to 4% of GDP, though that is unlikely.  At the end of Summit, however, the leaders, including the President, issued a joint declaration agreeing to setting the 2% target for military spending by 2024.

The President then went to the UK to visit with PM May and to have tea with Qeen Elizabeth II.  Mr. Trump was not overly happy with May’s current recommendation regarding Brexit and said as much.  He prefers a clean break by the UK from the EU, so he can negotiate a separate free trade deal with the UK.  Tony Abbott, former Prime Minister of Australia, in a WSJ OpEd accurately described Mr. Trump as a “transactional president.”  It may be worth a read.

Trade tensions, the Fed and the markets: our view.

The Trump administration announced plans to clamp 10% tariffs on a further $200 billion in Chinese goods in the next month or so.  The tariffs are much more broadly based, from tech gear like routers to furniture and handbags, so consumer prices are likely to move higher into the fall.  This move followed the imposition of 25% tariffs on $34 billion of Chinese goods.  A Chinese countermove is expected.  The talk and threats early in the year have turned into actions, though the scale remains relatively small compared to the economy and the tax cuts and stimulus package.

Fed Chairman Jerome Powell, at a meeting of the European Central Bank (ECB) Forum, addressed some of the uncertainty surrounding the impact of escalating trade tensions: “The (Trump) administration says that what it's trying to achieve is lower tariffs.  So, if it works out that way, then that'll be a good thing for our economy.  If it works out other ways, so that we wind up having high tariffs on a lot of products, goods and services... and that they become sustained for a long period of time, then yes, that could be a negative for our economy.”  Powell confirmed there is a broad consensus at the Fed to continue raising rates gradually which remains a headwind for bond returns.

From a stock market perspective, however, Via Nova believes rising interest rates are not currently a threat to the bull market.  Historically, in periods when the 10-year yield is below 5% but rising (as it is now), the S&P 500 is higher one year later 89% of the time with a median return of 10.67%, according to research from Chaikin Analytics.  The conclusion is that interest rising rates, on their own, are not a cause for concern for the equity market.  We continue to favor stocks over bonds.

Big banks kick off the second quarter earnings season.

The second quarter earnings season kicked into gear on Friday with big banks.  Most, not all, banks beat estimates.  Overall earnings are expected to increase 20.9% over the previous year, led by huge percentage gains in energy and materials.  Technology and financials are the two other sectors projected to have above average earnings growth.  Revenues are estimated to increase 8.1%.  Tax cuts are providing a big boost to earnings, while the stronger economy and rising confidence are helping sales growth.  During the week of July 16, sixty S&P 500 companies are expected to report quarterly earnings.

Week ahead: Earnings, Powell testimony, trade, retail sales, Philly Fed survey, housing starts and leading indicators.

There will be no shortage of factors that could influence the markets in the coming week.  Sixty S&P 500 are scheduled to release earnings for starters.  We could see a trade response from China.  Fed Chairman Jerome Powell testifies before Congress, and we also have a broad array of economic reports due.

President Trump visits with Russia’s Vladimir Putin.  We suspect the list of items the two leaders will discuss will be lengthy and will probably include Friday’s indictment of twelve Russian intelligence officers by special counsel Robert Mueller on charges of hacking the computers of Democratic organizations and for trying to influence the 2016 election.  We suspect the meeting will garner considerable media attention, and rightly so, but it is unlikely to have a meaningful impact on the financial markets.