- Equity benchmarks surged in July led by large caps and growth stocks.
- The NDX is outperforming the Dow by 32 percentage points YTD, its largest margin since 2009 (35%).
- Growth is outperforming Value by 31 percentage points YTD, its largest on record since late 1970’s.
- 11 of twelve GICS sectors finished July in the green; Energy (-5.1%) was the lone sector in the red.
- 2YR and 10-YR UST’s closed at all-time lows in the final session of July.
- The U.S. Dollar Index (DXY) had its largest monthly decline in 10 years.
- Gold (+10.9%) had its best monthly performance since 2012, while silver (+34%) had its best month in over 40 years.
- 84% of S&P 500 companies are beating earnings estimates, largest percentage on record.
U.S. equity gauges sailed higher in July amidst a mixed backdrop of fundamental, geopolitical, economic, and market crosswinds. S&P 500 companies are reporting Q2 earnings and revenues well above reduced expectations, as well as their 1-YR and 5-YR averages, yet the blended earnings decline (-35.7%) is the worst since Q4 2008 (-69.1%). Valuations are rich compared to historical standards with the forward 12-month P/E ratio for the S&P 500 at 22x, well above the 5-year (17x) and 10YR (15x) averages.
Congress is working on a second fiscal stimulus package. The two parties remain far apart on the overall size ($1T vs. $3T) and certain components such as unemployment assistance ($200 vs. $600/week) and state/local government aid. COVID-19 cases and deaths have been on the rise since late June, and fortunately the latter death metric is rising at a far slower pace. The White House is set to take additional measures against Chinese software companies aimed at reducing national security risks.
Economic data has been mixed. Housing has rebounded sharply off the Spring lows aided in part by fiscal and monetary stimulus, as well as the increased migration out of big cities into the suburbs. However, consumer sentiment is beginning to soften, and weekly unemployment claims have ceased to decline over the prior two weeks. Q2 GDP (lagging indicator) declined at an annualized rate of 32.9% versus expectations of -35%, measuring the worst quarter on record.
Safe-haven treasuries remained firmly bid despite the risk-on price action in equities. The 10YR UST Yield finished July at its lowest closing price (0.53%) on record. Gold “broke-out” to a new all-time high, previously made in 2011, while coming within 1% of the psychologically important $2,000 level. Spot silver had its best month (+34%) in over 40 years. The Federal Reserve left rates unchanged and reiterated it will do whatever it takes to lend support to the economy. The Fed expects unemployment levels to remain elevated for a long time and noted the pace of recovery has recently slowed. Weekend reports speculate the Fed will change its inflation target from 2%, to an average of 2%, thus allowing inflation to trend above 2% for periods of time.
The major averages extended their streak to four consecutive monthly gains with an impressive July performance. The Nasdaq 100 (+7.7%) continued to outperform its large cap brethren in the S&P 500 (5.6%) and Dow Jones Industrial Average (+2.5%). For the NDX and SPX, it was their best July performance since 2009 and 2010. The flagship Dow was the only one of the three large cap benchmarks unable to make a higher high (MoM) in July, and it closed the month underperforming the NDX by 32 percentage points YTD. The last time the Dow underperformed the NDX to this degree was 2009 (35%), a similar era when equity markets crashed into a March low before rebounding sharply with massive monetary and fiscal stimulus. The Fed responded to the 2008 crisis by slashing overnight rates to zero and buying $3 trillion in assets over the ensuing five years. In 2020, the Fed again cut rates to the zero bound, however it purchased $3 trillion in assets over just three months’ time, part of which was directly into the private sector via corporate bond purchases. This time around the speed and scale of the intervention was more appropriate to the crisis.
Smaller caps underperformed and while their absolute performance was respectable – S&P Midcap 400 (+4.6%), Russell 2000 (+2.8%), and Russell Microcap (+1.1%) – they remain down double digits YTD. Once again Growth (+7.7%) trounced Value (+4%). On a YTD basis Growth is outperforming Value by 31 percentage points. This is its largest outperformance on record going back to the late 1970’s, and handily eclipses the prior two records of 24% and 27% from 1998 and 1999.
Mid-month, after Moderna Inc. reported COVID vaccine progress and Goldman Sachs outperformed earnings estimates, there was a temporary rotation into “old economy” stocks which rallied at the expense of “work from home” leaders on hopes of a faster economic reopening. Yet by the end of the month, tech stocks reasserted their dominance of the broad indexes after significant earnings beats.
Ten of the 11 GICS sectors finished higher led by Consumer Discretionary (+9%), Utilities (+7.8%), Materials (+7.1%), and Staples (7%). Energy (-5.1%) was the lone sector in the red as those companies are reporting record earnings and revenue declines so far in Q2. The rebound in Utilities is noteworthy given it remains more than 14% below its 52-week highs.
Q2 earnings season has been relatively positive so far based on 63% of the companies in the S&P 500 that have reported. Within this group, 84% of the companies reported EPS above estimates. This is the highest percentage on record going back to 2008 when FactSet first began tracking this data, and above the 1-YR (71%) and 5-YR (72%) averages. Better than expected fundamentals played a part, as did the low bar set by analysts.
Blended earnings growth declined 35.7%, on pace for the largest YoY decline since Q4 2008 (-69.1%). Q3 earnings guidance was limited with seven companies issuing negative guidance and 25 issuing positive guidance. Companies are beating on the top line as well with 69% of companies reporting sales above estimates, versus the 1-YR (59%) and 5-YR (60%) averages. The Utilities sector reported the largest (YoY) earnings growth (+4.9%), while the Energy sector reported the largest (YoY) decline (-165.5%). The Technology sector reported the largest (YoY) revenue growth (+3.7%), while Energy reported the largest (YoY) revenue decline (-50%). Energy’s earnings and revenue metrics are each on pace for the biggest declines on record.
Even as some analysts have raised estimates for Q3, the current FactSet projection is for earnings to decline 22.9% and revenues to fall 4.5%. Q4’s earnings are projected to decline 12.1% with revenue growth dropping 1.3%. Q1 of 2021 sees the first projected earnings and revenue growth, 13.4% and 3.2% respectively.
Rates, Commodities, and the Dollar:
Rates moved lower across the curve with both the 2YR UST Yield (0.11%) and 10YR UST Yield (0.53%) closing at all-time lows in the final session of July. At the July FOMC, Chairman Powell stated the committee is not even thinking about raising rates. As previously noted, there is growing expectation the Fed will change its inflation objective from a 2% target, to an average of 2%.
Spot gold gained 10.9% for its best monthly performance since January 2012. Gold is benefitting from low nominal and real rates, as well as a softening dollar (DXY) which itself just registered its largest monthly decline (-4.2%) in 10 years. In the last week of July, gold “broke out” above its prior all-time high from 2011. Spot silver gained 34% for its best monthly performance in over 40 years, yet it remains more than 104% below its 2011 highs.
WTI crude gained a relatively modest 2.6%. Copper finished in the green for the fourth consecutive month with a gain of 5.7%. The DXY broke below a nine-year rising trendline which may suggest the weakness in July could be the start of a longer lasting trend.
After the benchmarks registered their largest decline from all-time highs, followed by the biggest rebound from crash lows, there is a growing debate surrounding the health of the market’s recovery and its sustainability. Simply put, is the stock market in the early stages of a new cyclical bull, or is the current rebound a bear market rally before the market resumes to the downside? The Nasdaq 100 and Nasdaq Composite are already back to new highs which for some is confirmation a fresh bull market is at hand and the other indices will eventually follow. However, recent history suggests this is not enough evidence. The NDX declined more than 19% in the summer of 2015 before rebounding 25% to record highs by Q4. The other majors came close but never reached new highs, like the present. Selling then resumed into Q1’16 and the Dow, SPX, and Russell 2000 all made lower lows.
Breadth continues to improve for the NDX. New all-time highs in price was confirmed by new highs in the advance-decline line (ADL) in July. However, while the percentage of members making 24- and 52-week highs expanded over the four consecutive months following the March lows, they remain below the highs registered in Q1.
A broader breadth measure looks at the ratio of the “Equal Weight” S&P 1,500 Index over the S&P 1,500. This ratio made an 11-year low in March before rebounding to a high in the first week of June. It has since been in decline.
The copper/gold ratio made multi-decade lows in April, which then was accompanied by a bullish divergence whereby its weekly RSI made a higher low – a potential bottoming signal. However, the ensuing rebound stalled right at its 40-week sma (synonymous with the 200-day sma) in early July, and the ratio has since been in decline. A move back above both the July high and 40-week sma would be a bullish signal the economy is on the mend.
At the end of the day price is king and while the Nasdaq 100 and Nasdaq Composite are in record high territory with gains of 26% and 21% YTD, six of 11 GICS sectors are in the red YTD, the Russell 1000 Value Index is down 13% YTD, the small cap Russell 2000 is down 11% YTD, and the large cap Dow Industrials is down 6% YTD. History has shown the diverging performance between the NDX and the Dow can go on for far longer. For i.e. in 1998 and 1999 the NDX outperformed the Dow by 69 and 77 percentage points. But while the NDX and SPX made new MoM highs in July, the Dow peaked back on June 8 and has since been consolidating. (Coincidentally this is when the Fed’s balance sheet peaked.) The Dow has spent much of the last two months oscillating around its 200-day moving average (blue line), and below a cluster of technical resistance at the ~27,000 level. The resistance represents the declining trendline connecting the February and June highs, as well as a price gap made in June. If the Dow fails to resume the trend of new highs (MoM) in August, it could be another concerning signal to go along with weakening breadth, strength in safe havens, slowing economic data, and political uncertainty, which combined may suggest the market is at risk of a more significant pullback. Conversely if the Dow can join the party and make a bullish breakout above its June highs, it likely would reflect broader participation, particularly by Value oriented sectors such as financials, which also would bode very well for the Russell 2000. August could be a key month and it is worth noting that August and September are traditionally the weakest performing months on the calendar.
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