Train Kept a Rollin’
The song “Train Kept A-Rollin,” which was first performed by jazz and blues artist Tiny Bradshaw in 1951 and further popularized by the rock group Aerosmith during the 1970s, is about a guy who is stunned by an attractive woman on a train but must act cool to not scare her away. The stock market continues to keep rolling higher but can the participants remain cool, or will something happen to scare it?
Last week the S&P 500 posted its fourth weekly gain in the past five and the Dow Jones Industrial Average capped off its 10th straight daily gain on Friday; its longest winning streak since August of 2017. The small cap Russell 2000 outperformed the S&P 500 for the second straight week but the Nasdaq, whose improbable run may be cooling, was slightly lower as the shift from mega-cap tech stocks that began about a month ago continues with other sectors now showing strength. Second quarter earnings kicked into full gear with strong results from the banking and financial sector. Disappointing reports from Tesla and Netflix weighed on the sentiment of big tech, adding to scrutiny around valuations and higher expectations following outsized year-to-date gains.
Optimism remains in the market around the broadening of the rally and increased hopes of a soft landing. Overall earnings reports have been generally positive and exceeded previously lowered expectations. Signs of resilience in consumer spending and lower inflation have helped provide optimism to investors. The headline CPI and PPI inflation reports from June showed inflation at the lowest levels in over two years, however it should be cautioned this was compared to June of a year ago when inflation reached its peak when CPI was over 9% on an annual basis. With inflation moderating in the ensuing months of 2022, future inflation reports could become interesting since they will be compared to a year prior. Core inflation, which does not include food and energy, remains elevated, hovering near 5% compare to a year ago. Energy prices have been moving steadily higher this month and therefore are likely to put upward pressure on non-core, or “headline,” inflation readings over the next few months.
What could derail the recent market rally or cause it to slow? Likely culprits include higher interest rates and disappointing earnings. Most market analysts and economists are predicting we are near the top of the current interest rate cycle. If that is the case, then this might be an opportune time to lock in the highest interest rates we have seen since before the Great Financial Crisis over 15 years ago. There is also a chance interest rates continue to move higher. We would suggest looking beyond some of the traditional fixed income strategies for ways to earn higher amounts of interest and protect against loss in stocks and bonds. Despite inflation falling, it remains elevated and continues to eat away at purchasing power, especially over longer time periods, making it especially important to ensure your savings are able to keep up. This could prove more challenging in coming years as prospects of lower interest rates and more subdued stock market returns are seemingly rising.
With earnings season fully underway, the S&P 500 is reporting an earnings decline of 9% for the quarter compared to a year ago; the largest drop since the second quarter of 2020, in the midst of the COVID pandemic. So far this has not been enough to throw the market rally off course since expectations going into earnings season were already lowered. However, this remains an important lesson in the markets – performance is based upon expectations with future events often “baked in” to current prices. Major price movement, either negative or positive, tends to primarily be caused by surprises.
The Fed is widely expected to raise interest rates by a quarter point at the conclusion of their meeting on Wednesday. Looking back, the trajectory of interest rates from Fed action this year has surprised to the upside but it has not been enough to thwart the stock market rally as investors have mostly shrugged it off and instead focused on the likelihood that the end of the rate hike cycle may be near. Future Fed action will be become very dependent upon inflation data in following months so it is too early to make predictions, but current odds are the Fed will pause at the next meeting in September with about a 50/50 chance of another quarter point hike in early November.
Earnings season continues in earnest with tech heavyweights Microsoft, Alphabet (Google) and Meta (Facebook) set to report. Preliminary GDP from the second quarter will be reported on Thursday and is expected to show positive growth of around 2%, indicating a recession has thus far been averted but does not mean we are completely out of the woods.
It has been hard to ignore the strong performance of the mega-cap tech stocks this year but with the broadening rally better opportunities may lie in other market segments such as small and mid-cap stocks, as well as other sectors which previously have lagged. Given the surprising bull run, this would be a good time to review your investment strategy and rebalance your portfolio appropriately. When markets rally, many investors tend to get greedy and take on excess risk; the opposite of what should be done. Be sure to protect yourself in the event of a market downturn, but not so much that you miss out on future opportunities. We remain cautious in the short term but bullish in the long term. You should remain focused on the long term and what can lead to your secure retirement and do not let it get derailed by short-term events.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
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