Stocks gave ground Friday amid profit taking. A few earnings reports from key retailers unnerved markets. Bond yields stayed within a tight range.
Lululemon and Nike both disappointed. It isn’t that either isn’t growing; it’s that both are growing more slowly than investors had hoped for. Success invites competition. Some of the competitors have become rather successful. In the case of Lululemon, it’s names like Vuori. In the case of Nike, it’s Hoka in sneakers and a whole host of names within the athletic apparel arena. Both are reacting, freshening their merchandise and revamping marketing approaches. Whether that reignites investor enthusiasm or not will only be known over time.
This week promises to be a quiet one from an economic standpoint. We will get a PCE report on inflation but investors already have a decent idea where that is going. Last week, the Fed said that even as inflation is hanging tough, particularly in the services sectors, three rate cuts are likely this year. That doesn’t mean that will happen. Reality and Fed forecasts rarely match. But for now, markets are hopeful and that optimism was expressed in rising equity prices last week. The PCE report is unlikely to change that dynamic.
Perhaps the most important event this week will happen at the Supreme Court. Tomorrow Justices are going to hear arguments related to the availability of mifepristone, the key abortion pill. This case will offer them wide latitude to do anything from nothing, to ruling that the FDA acted wrongly decades ago when it approved the pill. More specifically, debate is likely to focus on rule changes made during the pandemic that made the pill easier to get, allowing access by mail without an in-person visit with a physician. A lower court sharply restricted access but the Supreme Court ruled last April to suspend that ruling until the full court could hear the case.
Far from me to opine on the merits of the case specifically. But the reason I bring it up at all within an investment letter is to note that abortion remains a hot political issue, one that by itself motivates many to vote. The outcome of this case, likely to be released at the end of the Court’s current term in late June, could very well have material implications for the elections this fall. That’s why I point out the importance of tomorrow’s session.
So far, markets have ignored the election. The general consensus today is that odds favor Republicans winning the Senate. All Republican seats up for reelection seem safe while several Democratic seats may flip. The races most at risk for Democrats are in West Virginia, Arizona, Montana, Ohio and Nevada. Not all will need to flip for the Republicans to regain control. As for the House, several dozen seats are competitive. The abortion issue will be key. So will inflation and the economy. Also thrown into the mix this time is the ineffectiveness of the Republican majority that took over House leadership in 2022. Unfortunately, many of the most extreme on both sides of the aisle occupy safe seats. They won’t go away. But there are many incumbents from both parties who will need to defend a two-year record of very little accomplishment. The House is still a toss up but Democrats, knowing they have a tough fight keeping the Senate, will spend heavily to try and regain control of the House.
Investors would like a split Congress. The reason markets haven’t reacted so far is that there are no clear trends to react to. It is also useful to go back to the 2016 election. Prior to Election Day, markets were concerned about a Trump victory but polls showed Hillary Clinton likely to win. Then, in the evening when Trump emerged as the likely winner, futures fell sharply. But that all changed the next day as markets realized that a pro-business, low regulation and low tax advocate had been elected. The point I am making is that markets don’t digest politics very well, and as a result, largely ignore elections only to react after the fact. As for Biden versus Trump, I will only note that markets did well after each was elected, testimony that who’s President matters a lot less than what central banks decide to do.
Back to markets, a key beyond this week will be first quarter earnings. Since it appears the economy was solid in the first quarter, no one should expect a bad earnings season. But as we learned last week after hearing from Lululemon and Nike, it’s all about matching earnings to expectations. While our economy continues to grow, there are stress points. Debt default rates are rising. So is the unemployment rate. Fed Chair Jerome Powell has made it a point to note that he sees those stress points, and recognizes that keeping rates too high too long increases economic risks. Thus, the key to first quarter earnings reports are statements by corporate managements regarding the outlook for the balance of the year. Obviously, that will be most important to companies operating in economic segments most sensitive to economic change.
Companies collectively will beat forecasts for first quarter earnings. They always do as managements massage analysts to keep estimates within achievable ranges. But while they will earn more than expected in the first quarter, within a slowing economy it is also likely that future expectations may have to be modified to a lower range. The yin and yang of better than expected earnings and lowered expectations will play out differently company-to-company. Fedex’s stock price rose last week even as it reduced its outlook while Lululemon shares sank when forecasts showed less future growth than expected. Stay tuned.
Today, Sarah Jessica Parker is 59. Elton John turns 77. Gloria Steinem will celebrate her 90th birthday.
James M. Meyer, CFA 610-260-2220