Markets kicked off the new month by taking in a large number of Q2 earnings reports and a healthy calendar of economic reports in a challenging week for risk assets. The S&P 500 broke a three-week win streak by posting its worst week since the March banking sector turmoil, falling 2.27% while most other major indices joined the S&P in the red including the Nasdaq (-2.85%), Russell 2000 (-1.22%), international developed (- 3.06%), and emerging (-3.3%) markets. Bond yields declined through 5yr maturities but increased beyond that adding to a string of volatile weeks in the bond markets. WTI oil increased 2.7% but most other commodities declined on the week while the USD enjoyed a risk off bid, increasing 0.39% on the week.

• Equity markets have experienced some consolidation to begin August on the back of two strong months due to a combination of rising yields, policy uncertainty, and an overbought/overvalued market conditions reminding us the S&P 500’s reliance on mega caps cannot extend indefinitely.

• Bond yields fell on shorter maturities and rose across longer maturities, ending with yields of over 4% across the entire yield curve. Large Q3 Treasury issuance, labor market dynamics, and perhaps a marginal nod to the Fitch downgrade contributed to these moves.

• Whether or not we’re out of the woods of inflation could be a significant determinant for financial markets over the next 12-24 months with unexpectedly renewed inflation pressures a primary risk to risk asset returns.

• The bullish narrative of peak Fed funds rate/soft landing from here stands opposed to the bearish narrative of higher for longer and lagged effects of the very aggressive tightening cycle yet to work its way fully into the economy.

• BCA Research notes while valuations have little predictive value over the short term, they are a significant determinant to longer term (strategic) investing outcomes as evidenced by a simple regression on P/E multiples and subsequent returns on the S&P 500.

• Bianco Research noted the SLOOS cyclical and balance sheet pressure on small and mid-sized banks is translating as expected to tightening lending standards, posing a headwind to economic growth looking forward.

• Fitch Ratings’ downgrade of U.S. debt from AAA to AA+ grabbed headlines (and podiums) but did not translate to any meaningful market impact. Analysis by JPM and the ratings agencies suggests a one notch downgrade by all three agencies narrows yields by approximately 8bps.

• Chile became the first major emerging market central bank to cut rates (-100bps) and signaled more rate cuts are likely to follow.

• July payrolls increased by a less than expected 187,000 (200,000 expected) and the unemployment rate fell from 3.6% to 3.5%. Average Hourly Earnings growth remained at 4.4% (0.4% MoM), against consensus calling for a decline.

• June’s JOLT Survey revealed 9.582M job openings, slightly under consensus forecast of 9.650M but within the forecast range.

• July’s ISM Manufacturing Index registered 46.4, in line with the spot consensus forecast of 46.5.

• Eurozone 2Q GDP registered 0.3% q/q, returning to positive growth following a 0% Q1 and -0.1% Q2. Headline inflation eased from 5.5% to 5.3%.

• Stretched valuations, overbought technicals, decent earnings, resilient growth, strong labor markets, and a resulting mixed outlook for inflation/monetary policy suggests a differing short-term versus cyclical outlook for risk assets.

• The FOMC meeting delivered the expected 25bps hike to Fed Funds, increasing it to 5.25%. They stopped short of overtly signaling a pause, opting for a ‘meeting by meeting’ approach. Nothing changed in the post- meeting statement while Powell’s post-meeting presser acknowledged favorable inflation trends and resilient (too?) labor markets.

• The ECB meeting last week delivered the expected 25bps hike taking the deposit rate to 3.75%, equivalent to the October 2000 record high, the refi rate to 4.25%, and marginal lending facility rate to 4.5%. The BOJ kept rates unchanged but surprised markets by changing its YCC program.

• Refinitiv IBES data at the midway point of Q2 earnings season has earnings declining 6.4% alongside upside earnings surprises at 78.7% and revenue surprises at 64%.

• Public equity valuations aren’t alone in the lofty zone. Private equity (buyout) valuations look very stretched relative to historical ranges with year-end 2022 sporting purchase price multiples of 13x and debt multiples over 7x.

• China’s Politburo signaled only targeted stimulus measures as opposed to broad based fiscal or monetary loosening. The Hang Seng fell 2% on the announcement.

• Russia’s refusal to renew the Black Sea Grain Initiative after expiration on July 17th raises supply side risks in ag markets. Wheat and corn prices have surged by 16% and 11%, respectively since Russia’s action.

• Second quarter U.S. GDP came in well above the spot consensus forecast (2.4% vs 1.5%) and more in line with the Atlanta Fed GDPNow modeled forecast. Personal Consumption Expenditures of 1.6% came in slightly ahead of consensus but within the 1.1%-4.1% range.

• June PCE inflation data showed continued deceleration with headline readings of 3.0% YOY / 0.2% MoM alongside core readings of 4.1% YOY / 0.2% MoM.

• Second quarter Employment Cost Index grew 1% versus spot consensus of 1.1% and a forecast range of 1.0%-1.3%, a reduction from Q1 reading of 1.2%.

• Personal Consumption Expenditures of 0.5% ticked higher and slightly exceeded estimates while Personal Income of 0.3% fell slightly under the spot forecast.

• July U.S. flash PMI (C,M,S) registered 52.0, 49.0, 52.4 with manufacturing exceeding the forecast of 46.0 and services falling short of consensus forecast of 54.0.

• July’s flash non-U.S. PMIs (C,M,S) for the Eurozone (48.9,42.7,51.1) and UK (50.7,45.0,51.5) revealed some downside surprises.

• Consumer Confidence reading for July registered 117.0, well above consensus estimate of 111.8 and the forecast range of 108.0-116.0. July’s final revision to UofM Consumer Sentiment took it down from 72.6 to 71.6.

• The June Durable Goods Orders reports on New Orders (4.7% vs 0.5%), Ex-Transportation (0.6% vs -0.1%), and Core Capital Goods (0.2% vs -0.1%) beat consensus forecasts across the board.

• Case-Shiller Home Price Index for May posted a gain MoM of 1% versus consensus estimate of 0.8% and a YOY decline of 1.7% versus a consensus call for a 2.5% decline.

• New (697k) and Pending (0.3%) Home Sales were both within their respective forecast ranges.

Market drivers last week included second quarter earnings reports and a continuation of U.S. disinflation and economic soft landing themes. The S&P 500 and NASDAQ both marked 15-month highs, closing up marginally for the week. Bonds traded down slightly with interest rates rising in the belly of the curve (2y, 3y, 5y) while the 10yr yield remained largely unchanged at 3.84%. The USD (+1.16%) and commodities (+2.17%) both edged higher on the week with the energy complex leading the way.

• A look at equity market technicals shows we may be somewhat extended (overbought) in the short term, the longer-term trend remains constructive.

• Liz Ann Sonders posted a useful illustration highlighting the notable improvement in breadth (participation/leadership) we’ve seen since early June and Bianco Research followed that note with a similar observation through a market cap lens.

• Q2 earnings season, with 18% reporting, has a blended earnings decline of 9.0% and revenue of -0.3%. The street is still projecting recovering earnings growth in the second half with 3Q estimates of +0.1% and 4Q of +7.5%.

• We’ve seen some material USD weakness following the U.S. CPI report triggering debate as to what exactly this weakening USD may be signaling.

• Expectations of a U.S. recession have receded slightly with the soft core CPI report feeding a soft landing narrative backed by sustained consumption, a resilient labor market, and robust service sector activity. The counter argument, however, is supported by recessionary manufacturing conditions, restrictive monetary policy, weak LEIs, and a deeply inverted yield curve.

• An FT article highlighted positive trends in private debt with demand supported by the high costs of public issuance, fewer reporting obligations, loss of business/operational control, and less rigor surrounding related party transactions.

• Bloomberg noted home equity dry powder has increased 56% over the past three years; Black Knight estimates the magnitude at $28.7t ($9.3t accessible at 20%).

• A lackluster reopening trend and weak GDP report has China signaling potential stimulative measures including a currency peg adjustment, relaxed mortgage requirements, and potential rate cuts.

• A Bloomberg article last week highlighted a significant increase in bankruptcies reaching the highest levels since 2010 but the article sparked some intense debate on the BCA Research weekly research call.

• June headline Retail Sales came in below expectations (0.2% vs 0.5%) but ex-vehicles (0.2% vs 0.3%) and ex- vehicles & gas (0.3% vs 0.3%) readings were both more in line with consensus.

• The four week moving average of Initial Jobless Claims fell from a near-term high on June 24th of 256,750 to last week’s level of 237,500.
• Industrial Production in June was soft, well under forecasts (-0.5% vs 0.0%) as were the Manufacturing Output (-0.3% vs 0.0%) and Capacity Utilization (78.9% vs 79.5%) readings.
• July’s Housing Market Index came in right at the consensus forecast of 56 after rising 5 points to 55 in June.
• June Housing Starts (1.434M vs 1.48M) and Permits (1.440M vs 1.483M) both came in below forecasted
• levels but within the larger consensus range.
• June Existing Home Sales cooled slightly from May’s reading to 4.16M.

Markets followed up a holiday shortened week with a healthy rally across risk assets on the back of an abbreviated but favorable economic calendar and a ‘relative’ good start to second quarter earnings season. U.S. equity markets posted a nice rally, up 2.5%-3.5% across the cap spectrum while developed (+4.2%) and emerging (+4.1%) international rallied even more so, benefiting from a notably weakening USD (- 2.3%). Interest rates 2yrs and beyond pulled back a fair amount leaving the 10yr UST (-0.23%) back to 3.83% while commodity markets posted a relatively broad-based rally across energy, grains, and industrial metals.

• With a relatively narrow market driving the S&P 500 up 17% year to date and 23% off the October 2022 low, concerns are bubbling again regarding short term overbought conditions. However, we are seeing improving breadth and participation over the past few weeks.

• The 2Q earnings season began last week by weaving a silver lining on a red earnings number (blended – 7.1%) with strong beat rates (80%) and beat magnitudes (8.8%). Revenue is coming in at -0.4% with historically average beat rates (63%) and beat magnitudes (1.6%).

• MRB highlighted the ‘Implausible Trinity’ of central banks’ mission of providing liquidity enough to maintain relatively constructive sentiment, support risk asset prices, tighten monetary policy sufficient to achieve a 2% core inflation rate, and sustain global economic growth.

• Inflation dynamics, labor market, and ensuing Fed policy are key market variables at this time and an item of note was last week’s low CPI print not influencing July fed funds futures at all and in fact, the probability of a 25bps rate hike increased to 96%.

• Bianco Research is making a strong point that the CPI base effect from 2022 inflation readings suggests the July – December window will be much more challenging to maintain the same deflationary trends that what we’ve seen in the first half.

• While the inverted yield curve is suggestive of recession historically, the long end today is clearly influenced by the Fed’s 2.5% long-term equilibrium rate as well as QE.

• BCA Political Research estimate on government spending impact on 2024 GDP from the 2023 FRA and SCOTUS decision on student debt forgiveness to modify the fiscal drag from -0.12% to 0.49% in 2024.

• A healthy consumer thanks to a robust job market and well capitalized balance sheets (excess savings) have a significantly larger influence on U.S. GDP than government spending.

• A Stanford research paper on work from home trends estimated average commuter time savings of 72 minutes per day (2 weeks/yr) and a value to workers of approximately 8% of their salaries – suggesting employees would take a pay cut to maintain work from home privileges.

• Markets received more indications of China’s weak post-reopening recovery in the form of deflationary readings for CPI (0%) and PPI (-5.4%).

• June CPI declined further than expected on both headline (YOY 3%a vs 3.1%e) (MoM 0.2%a vs 0.3%e) and core (YOY 4.8%a vs 5%e) (MoM 0.2%a vs 0.3%e) readings.
• Consumer Sentiment improved by a larger than expected margin, registering 72.6 versus consensus estimate of 65.5.
• The June NFIB Small Business Optimism Index improved to 91 from an 89.4 reading in May, above consensus forecast of 89.8 and the forecast range of 89.0-90.3.