Stocks moved sideways in a listless session to start the month of August. Bond yields edged higher. The Dow was lifted by a strong earnings report from Caterpillar. Overnight, Fitch, the smallest of the three major rating services, downgraded U.S. credit to AA+ from AAA, citing the cliff hanger debate over the debt ceiling and the sharp rise in Federal debt, both in absolute terms and as a percentage of GDP. While equity futures fell modestly, bonds were pretty much unchanged. More charges against Donald Trump had no market impact. Both the new indictments and the Fitch announcement told investors nothing they didn’t already know.
This is another big week for earnings, the last big one of this earnings season. The highlight to watch is tomorrow after the market closes when both Apple# and Amazon# are due to report. This is also a big week for economic data highlighted by Friday’s employment report. The ADP forecast will come out this morning before the market opens. It hasn’t been a very active predictor lately. While there is always a focus on the number of jobs created and the employment rate, given the battle against inflation, all eyes will also be interested in the change in wages and the size, in hours, of the employment week. Investors will want to see both of those numbers moderate. The next big economic number will come next week when the July CPI report is issued. June was a pleasant surprise. Hopefully, the July data reinforces the expectation that inflation is coming down.
Markets have been celebrating that the battle against inflation is all but over. For the most part, prices have been moderating. Part, of course, relates to the downward economic pressure stemming from higher interest rates. But a large factor has been the healing of fractured supply chains. Shortage of supply without an attendant slump in demand forces prices up. Conversely, when supply levels are restored, prices fall back to a more normal level. Nowhere has that been more evident than in the used car market.
But is the battle over? Energy prices have started to rise again over the past six weeks. Russian oil isn’t getting to the market that easily. U.S. sales out of the Strategic Petroleum Reserve are set to end. Economic growth in much of the world has been a bit stronger than expected. And, of course, record heat has increased demand for electricity to run air conditioners. It is unusual for oil prices to rise through the summer. Should a soft landing occur rather than a recession, can prices flatten out again or resume their downtrend? That’s a rhetorical question that I can’t answer.
Look at housing. Obviously, higher mortgage rates shrunk demand. But not so obvious has been the impact on supply. Potential sellers are not eager to trade in a 3% mortgage for a 7% mortgage. Thus, while higher rates did crimp demand as planned, they also crimped supply. The net has been that prices have remained elevated while transaction counts fell sharply. Meanwhile, a housing shortage remains. Perversely in a slower market, homebuilders are doing just fine filling the gap of quality homes left empty by an inadequate number of desirable existing homes listed for sale.
For sure, there is good news on the inflation front. Wage demands recede coincident with a drop in inflation. Workers want to stay even or ahead of inflation. They have that ability in a world with unemployment hovering near 3.5%. They can ask for a lot more, but that might be a stretch. UPS workers got a big upfront first year increase in a contract recently negotiated but not yet ratified. But beyond Year 1, the increases will be closer to 4% which should give them small real wage increases. That’s an improvement over recent years. The UPS contract will be the largest private sector services union contract this year and will likely be a bellwether for future negotiations. The other big strike news, the ongoing battle between Hollywood and the actors and screenwriters is likely to be an extended battle. Given the lack of profits in the streaming industry, this is a battle where all sides are seeking bigger slices of a shrinking pie. There won’t be any winners. When all sides realize this, compromise will be possible but the cold reality is going to be hard to accept.
Back to the markets, I have little to add to the steady mantra I have been espousing recently. The economy is doing OK, long-term interest rates are about where they should be, and company managements are finding ways to pivot and benefit. All this is reflected in higher equity prices and fewer apparent bargains. While we all know about the tech leadership in this market, there have been other very strong sectors as well. These include travel companies, homebuilders, and industrial companies set to reap the benefit coming from the massive infrastructure package now getting through the permitting stages. But there are also laggards including regional banks, utilities, consumer staples, and companies that experienced Covid-19 spikes whose benefits in 2021 and 2022 now make for very tough comparisons.
It would be great to extrapolate June and July gains to record highs. Some have done so. But the normal path is two steps forward, one step back. Some pause should be coming soon. It doesn’t have to be a significant correction, just enough to allow some bargains to reappear.
Today Mary-Louise Parker is 59.
James M. Meyer, CFA 610-260-2220