While the previous week provided good news on the inflation front, this past week’s data brought further indications that the U.S. economy is slowing but still growing. Along those lines, and with Federal Reserve (Fed) rate cuts expected to begin in September, equity performance continued to broaden in the large and small- and mid-cap (SMID) asset classes.

Wide-Ranging Economic Data Beats Expectations

Retail sales were expected to be down -0.2% in the month of June but instead came in flat. When accounting for falling goods prices in the June Consumer Price Index (CPI) report, inflation-adjusted retail sales were up 0.3% in the month. Idiosyncratic issues also impacted the inflation print, particularly in auto sales, where a cyberattack temporarily took dealerships offline and contributed to a 2% monthly fall. Even still, the ex-autos figure of +0.4% also beat expectations of +0.1%. The control group (which excludes more volatile components like auto sales, gas, and building materials, and which feeds into the Personal Consumption Expenditures component of gross domestic product (GDP)) was up an impressive +0.9% for the month, notably above both the +0.2% estimate and the +0.4% registered in May.

The encouraging news carried over to business spending with industrial production up 0.6% during the month, beating estimates of 0.3%. Capacity utilization also ticked up from 78.3% to 78.8%, beating estimates of 78.5%. As mentioned in last week’s client call, the industrial sector is still being supported by strong spending in high-tech industries like communications equipment and semiconductors, both of which are up double digits year over year.

Both regional Fed surveys for the week also beat expectations. The New York Fed’s Empire State Manufacturing Index came in at -6.6, better than the expected -8.0 but still a step down from -6.0 last month. The index continues to attempt to climb from its worrisome low of -44.0 in January. The Philadelphia Fed’s Manufacturing Business Outlook Survey, usually a better indicator of the national mood of purchasing and supply managers, recorded a big beat at 13.9 versus consensus at 2.9 and well ahead of the 1.3 recorded last month. Of note were the sharp increases in new orders and employment, while the prices paid component declined a further three points as firms generally expect wage increases to hold steady over the coming months.

Housing markets continue to take one step forward and one step back. The NAHB/Wells Fargo Housing Market Index fell to 42 from 43 last month, a slight miss of the 43 estimate. Since 2022, the index has struggled to stay over 50 (the typical demarcation line for optimism in the diffusion index). On the other hand, housing starts of an annualized 1.353 million beat expectations of 1.314 million. It was a 3.0% increase from 1.3 million last month. As the 30-year mortgage rate settles back below 7%, economic growth remains solid, and a rate cutting cycle looms. We’ll be looking for signs of a more sustainable recovery in the sector. A promising early indication was the 3.3% increase in building permits, which handily beat economists’ expectations.

A week of solid economic reports combined to send the Atlanta Fed’s GDPNow estimate for the second quarter up from 2.0% to 2.7%. We get our first official estimate for the second quarter this Thursday.

In another sign that labor markets continue to normalize, initial jobless claims ticked up again to 243,000, above the estimate of 230,000 and last week’s 223,000. This week’s figure matches the year’s high in the first week of June, but it appears to have been skewed by the impact of Hurricane Beryl, which caused a spike in claims in Texas. Continuing claims also rose again to 1.867 million, the highest since 2021 but still nowhere near an alarming level. For context, after the global financial crisis of 2007–2009, it took until 2017 for continuing claims to fall back below 2 million.

The ECB Isn’t Committed to an Easing Path

Overseas, after easing rates 25 basis points at its previous meeting, the European Central Bank (ECB) left its key rate unchanged at 4.25% and said it will continue to be data-dependent and not precommitted to a particular path. ECB Chair Christine Lagarde admitted that the European economy is slowing and risks to growth are on the downside, but she also expressed some concern that wages and unit labor costs remain elevated. These moves can provide some insight into the Fed’s potential dilemma of easing monetary policy into an economy that is still growing.

Equity Markets Continue to Broaden

With a little more detail on the broadening of the rally that began at the start of July, the outperformance of the market-cap-weighted S&P 500 Index to the equal-weighted S&P 500 has narrowed from 10.2 percentage points to 8.7 percentage points. The gap between the market-cap S&P 500 and the Russell 2000 small cap index has narrowed by an even greater margin, from 13.6 percentage points to 7.4 points. Explanations for the narrowing include the increase in former president Donald Trump’s polling numbers, short covering, and wider earnings dispersion as the Fed cuts rates. The next few weeks will be important in determining whether the recent broadening trend is durable or not. We continue to hold tactical overweight positions to the equal-weighted S&P 500 ETF (RSP) and SMID equity class in anticipation of the Fed successfully bringing inflation back to its 2% target without causing a recession, which, in turn, supports the equity rally broadening.

Most Companies Are Exceeding Earnings Estimates So Far

Earnings reports for the second quarter now kick into high gear, with one-quarter of S&P 500 companies reporting this week. Included this week are reports from a range of different industries, including two members of the Magnificent 7—Tesla and Alphabet. The earnings season is off to a good start with 86% of companies exceeding estimates and analysts revising up expectations for the full quarter’s results. However, it must be noted that we are still very early in the season, with only 14% of companies having reported thus far.

Markets Uncertain as Presidential Race Enters Uncharted Waters

On Sunday afternoon, after much speculation and anticipation, President Joe Biden announced that he is ending his reelection campaign and endorsing Vice President Kamala Harris to become the Democratic nominee. This type of move is obviously unprecedented, and the road to a formal nomination at the Democratic National Convention on August 19 remains unclear. While former President Trump is still the front runner in the race, the timing of the announcement may have taken some of the wind out of the sails after the momentum gained over the past month and after the Republican convention. This opens the door to uncertainty for markets that had been moving toward an early consensus around a Republican sweep, but now must try to adjust in real-time to a fast-changing situation with no clear historical analog. Vice President Harris is a heavy favorite to win the Democratic nomination and although the policy platform will be similar to Biden’s, she should be a much more formidable opponent of former President Trump. Just as before, we will continue to monitor developments in the presidential race, with a particular focus on its impact on financial markets.

Source: FactSet

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