Investors have breathed a sigh of relief up to this point in July as worst-case scenarios for the economy have failed to materialize.
The Nasdaq Composite and S&P 500 are up an impressive 7.5% and 4.8%, respectively, so far this month. Shares of meme stock darlings GameStop and AMC have jumped 17% and 14.5%, respectively, as traders embrace the risk-on backdrop. Even 2022 laggard Netflix has seen its stock rise 25% month to date, even after another lackluster earnings report on July 19.
Pros point to several reasons for the summer rally.
“Odds of a deep recession eased last week as weak PMI data reinforced that 1) growth is slowing, 2) pricing pressures are coming down,” explained 22V Research founder Dennis Debusschere in a client note. “While prices are easing, the Fed can afford to be patient with data. That does NOT mean a policy pivot is coming this week, but it does mean there is little need for the FOMC to adjust their policy path higher either. Growth will continue to slow and the recession risks remain elevated, as evidenced by the further collapse in the 10yr-3 month curve over the past week. But, a deep recession should not be a base case yet, and the case for a slowdown/mild recession has improved.”
Debusschere added that “the worst fears about second quarter earnings have not been realized” as another positive catalyst the markets have jumped on.
“We’re acquiring spending and we see future travel bookings [strong] so I don’t see it [a recession] in my numbers at all,” American Express CEO Stephen Squeri told Yahoo Finance.
Despite the feel good vibes in markets thus far in July, storm clouds are a brewing.
For starters, the Federal Reserve is likely to hike interest rates by an aggressive 75 basis points later this week. Hawkish comments by Fed chief Jerome Powell may ensue amid still surging inflation, much to the surprise of a market in rally mode pros say.
“We expect something of a disconnect between the abruptly more optimistic tone in markets on the inflation outlook and the posture the Fed will take at the meeting,” Evercore ISI strategist Krisna Guhu warned in a note to clients. “We think Powell will strike a stern tone on recent price developments and – while acknowledging some more positive forward-looking developments – will pour cold water on the notion that we are anywhere close to accumulating clear and convincing evidence that inflation is moderating.”
Furthermore, this week’s second quarter GDP print may show growth contracted once again to follow a 1.6% first quarter GDP drop. Two quarters of negative growth are generally indicative of a recession, and that would run counter to the upbeat tone currently playing out in markets.
“I’d say all businesses, large and small, are being more cautious right now,” Goldman Sachs chairman and CEO David Solomon told Yahoo Finance Live. “There’s more uncertainty around the economic trajectory of the country. Inflation is a big, big headwind.”
And while corporate earnings haven’t been recession-like, they have hardly been strong enough to encourage a more sustained move higher in stocks. It’s pretty clear that companies are having difficulty passing along high levels of inflation and are turning to hiring slowdowns and layoffs to protect profits.
FactSet estimates that 68% of S&P 500 companies have reported a positive earnings surprise for the second quarter, below the five-year average of 77%. S&P 500 companies are beating estimates by a paltry 3.6%, also shy of the five-year average of 8.8%.