We don't typically use this column to provide weekly summaries, yet we're making an exception this time around because the past week was some week. In a certain respect, it had it all -- important earnings news, key economic data, an FOMC policy decision, record-setting moves by the major indices, and political drama.
After a week like the one that just transpired, it's worthwhile to carry out a debriefing and that's what we intend to do.
Questions and Answers
Q: How did the earnings reports go?
A: The earnings reports went very well. According to FactSet, the blended earnings growth rate (combines actual results with estimates for companies that have yet to report) stood at 7.2% entering the week. Exiting the week, the blended earnings growth rate stood at 9.1%.
The key takeaways from the reports were as follows:
- The earnings strength isn't limited to the technology sector. Blue-chip companies, namely Caterpillar (CAT), McDonald's (MCD), and Boeing (BA), provided some of the most impressive reports and/or guidance.
- Every sector, with the exception of the consumer discretionary sector, has a blended growth rate higher than the year-ago period.
- The quality of the earnings growth is good, too. It isn't being engineered simply through cost cuts, lower tax rates, and share buybacks. Rather, it is being fueled by solid revenue growth.
- The blended revenue growth rate for the second quarter increased to 5.2% versus 5.0% when the week began. In the second quarter a year ago, revenue growth was just 0.2%.
- Notwithstanding the strong earnings results, there has been a tendency to sell the news, as many stocks were bid higher in advance of their actual reports
- As of this writing, the S&P 500 is unchanged for the week
Q: What did the FOMC decide and how did the market react?
A: In a unanimous decision, the Committee decided to leave the target range for the fed funds rate unchanged at 1.00% to 1.25%. The directive also stated that the Committee expects to begin implementing its balance sheet normalization program "relatively soon," provided the economy evolves broadly as anticipated.
The initial response to the decision was mixed.
- The stock market did little because (1) the decision and the guidance weren't a real surprise and (2) the directive reinforced the belief following Fed Chair Yellen's semiannual monetary policy report that there isn't going to be another quick hike in the policy rate as it seems unlikely at this juncture that the Fed would raise the target range for the fed funds rate in September and start the process of normalizing its balance sheet.
- The dollar got hit hard immediately following the decision as traders jumped on the notion that there isn't going to be an imminent rate hike and carried on with the downside momentum trade that had already been weighing heavily on the greenback
- Bonds rallied with longer-dated securities leading the move, helped in part by short-covering on a seemingly counterintuitive response and the thinking that rising market rates resulting from a scaling back of the Fed's reinvestment activities could temper growth prospects and inflation pressures
Q: Was Q2 GDP growth better than Q1 GDP growth?
A: Yes. Real GDP increased at a seasonally adjusted annual rate of 2.6%, helped by a pickup in consumer spending, nonresidential fixed investment, exports, and government spending.
The second quarter marked the second-highest rate of growth over the last eight quarters, yet that didn't excite the masses necessarily considering the first quarter growth rate was revised down to 1.2% with the annual benchmark revisions.
The average growth rate for the first half of the year, then, was a subpar 1.9%. That should keep the Fed in a watchful mode and perhaps fuel a sense of urgency in Congress to get some type of tax deal done before the end of the year.
Q: What happened with the health care reform effort in the Senate?
A: In a mostly party-line vote that ultimately required a tiebreaking vote to be cast by the vice president, the Senate voted 51-50 to proceed to open debate on the health care reform bill passed by the House GOP.
The bill calling for the repeal and replacement of the Affordable Care Act was subsequently voted down. Similarly, a bill calling only for a straight repeal of the ACA, without a replacement plan, was voted down, as was a so-called "skinny repeal," which among other things would have gotten rid of the individual mandate to have health insurance, the mandate for employers with 50 or more employees to provide affordable health insurance, and the medical device tax for three years.
In short, then, nothing really happened in the Senate in terms of the effort to institute a new health care plan. Still, though, there was a lot of drama on the road to getting nothing done.
The effort will continue, and, undoubtedly, so will the drama.
Q: The Dow Jones Transportation Average had a terrible week. What was that all about?
A: That is the question. The DJTA declined 2.6% this week while the Dow Jones Industrial Average increased 1.1%, setting new record highs in the process. It always raises some eyebrows when those two averages diverge in such a distinct manner since the DJTA has leading economic indicator status.
There was an effort late in the week to pin the weakness on the airline stocks and specifically to concerns about rising labor costs for the industry that were triggered by Spirit Airlines' (SAVE) disappointing earnings report. Some disappointing third quarter unit revenue guidance from United Continental (UAL), Southwest Airlines (LUV), and American Airlines (AAL) contributed to the difficulties for the airline stocks over the past week or so.
It would be remiss not to add, however, that the DJTA started behaving poorly after the earnings report from CSX Corp. (CSX) before the open on July 18 and that the railroad stocks have also been quite weak during the sell-off, hit by pricing worries surrounding CSX and Union Pacific's (UNP) guidance for flat volume growth in the third quarter.
Trucking stocks got pulled into the jetwash following C.H. Robinson's (CHRW) weaker than expected second quarter results and guidance from Landstar Systems (LSTR) that the number of loads it hauls via truck in the third quarter is likely to be in-line with the seasonal norm of being down slightly from the second quarter.
For good measure, UPS (UPS) topped second quarter earnings estimates by a considerable margin, yet it only reaffirmed its full-year earnings outlook.
With the DJTA hitting a new record high of its own mid-month, there is a basis to think investors were expecting more upbeat guidance out of the transports than what they heard. When that didn't happen, some pent-up selling interest was unleashed.
The question on everyone's mind is whether this notable weakness of late is a correction of a short-term overbought situation (DJTA rallied 10% from its intraday low on May 18 to its intraday high on July 14) or a harbinger of disappointing economic activity ahead.
Q: Why are oil prices rallying so much?
A: Crude futures jumped 8.3% this week to $49.58 per barrel and are now up 17% from June 21. Several factors have combined to drive the reversal of price fortune:
- The weakness in the dollar, which is supportive for dollar-denominated commodities like oil
- Indications that oil drillers are cutting their capital expenditure budgets, which will presumably curtail new supply
- Renewed enthusiasm that OPEC members, and namely Saudi Arabia, will adhere more closely to production cuts
- A weekly inventory report from the Department of Energy (and the American Petroleum Institute) showing a large drawdown in crude stockpiles
- Short-covering activity; and
- Momentum-based buying interest
The move in oil prices provided some nice support for the S&P 500 energy sector, which gained 1.8% for the week as of this writing despite ExxonMobil (XOM) declining 1.1% for the week. Shares of XOM dropped 1.9% on Friday after the oil giant came up short of second quarter earnings estimates.
What It All Means
It is difficult to extrapolate what everything that happened in the past week means for the market. Some of it was good, some of it was okay, and some of it was bad.
The best thing this week was the overall earnings news. It provided some important support and was a welcome distraction from the political drama.
Our suspicion is that the stock market would not be acting as well as it has been this year if the earnings story wasn't as good as it has been since the drama in Washington has called into question the ability to get tax reform done. To be sure, the enthusiasm surrounding possible tax reform was the basis for the post-election rally. That enthusiasm has faded, but remarkably, the stock market's enthusiasm hasn't to this point.
Valuation concerns bubbled up some this week, though, as several respected market pundits expressed their worries about low volatility readings and high P/E multiples.
The fact that the S&P 500 was basically unchanged for the week in the wake of good earnings results spoke to those concerns as it suggested the good news had been priced in already.
What comes next is the question, but don't be surprised if the stock market moves into a consolidation phase as it awaits some important answers pertaining to fiscal, monetary, and economic matters in the waning weeks of summer.