Stocks crept higher Monday in very light trading. Today’s volume may also be light as traders slowly return to a focus on the market. Very little news will shed minimal light on future directions. Factory orders, notes from the Philly Fed, and a speech from one Fed official are about all the pending news on the calendar. Bond markets are quiet this morning. Yields are approaching levels last seen in March. The yield curve remains significantly inverted.
As for the stock market itself, valuations remain elevated. Given the strength in June, few bargains remain. The S&P 500 rose 6.5% in June, its best monthly performance since last October when it moved sharply off a bear market low. There is absolutely no economic news to support a repeat performance in July. Right now, Fed Funds Futures indicate that markets are pricing in an 86% chance of another 25-basis point rate increase at the next FOMC meeting July 26. Beyond that, the future course of rates will be dependent on inflation and economic data to be released between now and the ensuing FOMC meeting in mid-September.
In the interim we will digest second quarter earnings to start later next week. We will also get a slew of economic data including Friday’s employment report for June, and a CPI number next week. Predicting monthly net job changes is a fool’s game, but the 3-month average has been trending lower. Newer jobs in recent months have tended to be in relatively low paying industries like hospitality and restaurants. The skew leads to an indication that the pace of wage growth is slowing. That is probably true but not quite as promising as the headline numbers indicate. Also note that the employment report focuses on net job changes. It is the outcome of jobs added less jobs lost. Retirees universally are paid more than those entering the work force, a constant depressant on the pace of reported wage increases.
The historic reality is that wage demands mirror the pace of inflation. Since the start of the Biden administration, inflation has eaten away the purchasing power of higher wages. In fact, for the average American, the purchasing power since January 2021 is down over 3%. The average worker wants to catch up. The biggest private union employer, UPS# is in active negotiations right now with the Teamsters. A strike authorization has already been approved for the end of July. Both sides are making progress on a multitude of issues. UPS management expects a deal to be reached but Teamster officials are rattling sabers. For them, this is a signature negotiation, one that will set the table for future efforts to achieve better terms, and perhaps, gain leverage in attempts to organize non-union companies like Amazon#.
Normally, one company’s labor negotiations aren’t important to the overall economy. But UPS is one of those exceptions. UPS delivers well over 20 million packages a day, roughly a quarter of all US parcel shipments. It has more delivery vans than Amazon. While a short strike (less than a week) could be tolerated, a longer strike would lead to empty shelves and long delivery delays. At the present time, odds of a strike are subjective. The Teamsters are talking tough, but a strike isn’t a plus for anyone. It’s a situation that bears watching.
As for earnings season, it is likely to be a mixed bag mirroring the overall economy. The first key area to watch is regional bank earnings that will start coming out the week after next. What one should be looking for are signs of stress. Did the bank failures this past spring change behavior? Are credit matrices holding up? Money flow is essential to economic growth. There has been a lot of focus on commercial real estate loans, but they are only a fraction of the overall lending market. We all see stresses there, but if they can be isolated, problems may not be as bad as feared.
Beyond regional bank earnings, the focus will be on the large tech companies. Stocks of names from Apple# to Meta Platforms# will react meaningfully to reported results. All these stocks are up 30% or more so far in 2023. All have higher P/E ratios than they did at the start of the year or even the start of the second quarter. That suggests rising expectations. In 2022 and 2023, the focus was on the implications of decelerating growth, the impact of the law of large numbers. But the surge in interest related to the emergence of generative artificial intelligence changes outlooks, offering the promise of growth acceleration. It is too early to see meaningful impact from AI except for a few exceptions like Nvidia#. Investors will be looking for more.
One way to increase demand is to cut prices. Tesla proved that with its report of second quarter vehicle sales on Monday. We now know the price cuts drove higher volume. What we don’t know is whether they also drove higher profits. When Tesla had the EV market to itself, it was able to achieve huge gross margins once it achieved scale. But now it faces more competition, particularly in China. Bulls still expect margins to stay far above those of the average car manufacturer. Bears say once everyone is making EVs at scale, margins will moderate toward industry averages. We will see the outcome once Tesla reports earnings mid-month. Price cutting doesn’t happen when one is gaining market share. Tesla fans also see opportunities in battery sales, charging stations, etc. But history also shows that large successful companies have a hard time replicating success from one market to another. Tesla’s stock has more than doubled from its lows last year but is still less than half its all-time peak. What happens from here will be a barometer for the net change in speculative fever in the market.
So far this year, it has been in an accelerating trend. For markets to continue moving higher, particularly in a world of higher interest rates and flat-to-down earnings, speculative fever must flourish. The reaction to earnings reported by Tesla, and the big tech names will be a strong signal as to what equity investors should expect over the next several months.
Today, soccer star Megan Rapinoe is 38. Edie Falco turns 60. Huey Lewis is 73.
James M. Meyer, CFA