The S&P 500, the Nasdaq Composite index, and the Wilshire 5000 index all scored record highs this week, purportedly stirred by comments from Fed Chair Jerome Powell during his semi-annual testimony to Congress. This was despite the fact that Powell was clear during his testimony that he was not sending signals about any rate cut and that more good data was needed prior to any rate cut. Still, CME’s FedWatch continued to price in 50 basis points of easing this year and a 72% chance for a 25-basis-point cut at the September meeting.

In January, the consensus was expecting eight Fed rate cuts, and this dropped to two. In short, rate cut expectations have fallen well short of earlier forecasts, and in our view, it is evident that Fed rate cuts are not a driving force of the 2024 stock market. Earnings expectations linked to AI growth have been the catalyst for a number of technology stocks, and this has kept the popular averages moving higher.

Liquidity

The second quarter earnings season begins this week, and good earnings results may be a necessary factor for further gains. Shares of The Goldman Sachs Group, Inc. (GS – $472.83), JPMorgan Chase & Co. (JPM – $207.63), Citigroup Inc. (C – $66.55), and Wells Fargo & Company (WFC – $59.88) rallied ahead of earnings releases expected from the latter three later this week. Bank stocks may have been boosted by Powell’s comments to Congress indicating that regulators should seek additional feedback on the contentious “Basel III Endgame” proposal which would change risk guidelines and hike bank capital requirements. He added that a re-proposal was essential given the significant changes that would be imposed and that this would take time. Since Powell’s comments were in line with what the major banks had been asking for, this may have sparked the rally. Nonetheless, gains in banking stocks are always a welcomed factor since it is a favorable sign for the economy and the stock market. But if these gains are to be sustained, earnings results need to be in line with, or better than, expectations.

We noticed that liquidity in the banking sector is at record highs, which is a bit surprising since the Fed has been shrinking its balance sheet. After the mini bank crisis in March 2023, the Federal Reserve returned to its policy of quantitative tightening and since the April 2022 peak of $9.01 trillion, the Fed’s balance sheet is down $1.7 trillion to $7.27 trillion. This decline includes a $1.22 trillion decrease in US Treasury securities, a $404 billion drop in mortgage-backed securities, and a $115.5 billion reduction in loans. See page 3.

But despite this shrinkage in the Fed’s balance sheet, liquidity in the banking sector remains healthy. Near the end of June, demand deposits, retail money market funds, and small-time deposits were at, or near, record highs. “Other liquid deposits” appear to be most sensitive to the Fed’s balance sheet and have declined $3.5 trillion since their April 2022 peak. However, total assets at all commercial banks were $25.51 trillion at the end of June, an all-time high. See page 4. Liquidity is a necessary ingredient for any bull market, and it appears that liquidity remains robust despite the Fed’s tightening policies.

The Economy

June’s employment report was reassuring for investors since it was in line with the consensus. The establishment survey reported 206,000 new jobs and the household survey showed a small 0.1 increase in the unemployment rate to 4.1%. June’s total employment of 158.6 million jobs was a new record. The year-over-year growth rate eased to 1.67%, just under the long-term growth rate of 1.7%, but still healthy. Meanwhile, the household survey continues to be weaker than the establishment survey. Total employment of 161.2 million was below the record 161.9 million set in November 2023 and the year-over-year growth rate was 0.12% YOY, fractionally below May’s 0.23% YOY pace. Over the last six months, the growth rate in the household survey has been trending toward zero which could be significant and a negative sign for the overall economy. Year-over-year declines in total jobs have been one of the best predictors of an economic recession, as seen in the chart on page 5. Neither survey is there yet, but upcoming job releases will be important.

The good news in June’s jobs report was the steady 4% YOY increase in average hourly earnings. This means real hourly earnings grew slightly more than inflation, which is currently at 3.3%. The same was true of weekly earnings, which rose 3.7% YOY to $1012.69. See page 6.

Last week’s ISM manufacturing indices showed broad-based weakness. The ISM service indices, released Wednesday, were surprisingly soft with seven of ten indices coming in below the breakeven 50 level, and nine of ten indices declining for the month. Only the imports index rose from 42.8 to 44.0, but this was still below the 50 neutral level. Business activity was one of the weakest segments of the service industry survey, falling from 61.2 to 49.6. A key takeaway from the ISM surveys was that both employment indices were below 50 in June. Another sign of possible job weakness. See page 7.

Technicals

The Nasdaq Composite index and the S&P 500 recorded all-time highs again this week led by big-cap technology stocks. However, the Dow Jones Industrial Average is 1.8% below its record high on May 17, 2024 and the Russell 2000 index remains 16.9% below its high of 2442.74 made on November 8, 2021. The Russell is still trading below its 50-day and 100-day moving averages this week and the DJIA is trading slightly above its two moving averages. This is not a broad-based advance. See page 10.

The 25-day up/down volume oscillator is minus 0.82, still in neutral territory, but retreating toward the uptrend in place in this oscillator since the October 2022 low. What this minus 0.82 reading means is that while the S&P 500 and the Nasdaq Composite index continued to score a series of all-time highs, over the last 25 trading sessions there has been slightly more volume in declining stocks than in advancing stocks. This is a bad omen for the market. Bull markets tend to stay overbought for long periods of time in this indicator – a sign of sustained buying pressure. The oscillator was last in overbought territory for four consecutive trading days between May 17 and May 22. Since a minimum of five consecutive trading days in overbought is required to confirm a new high, this indicator has not yet confirmed any of the new highs made in the S&P 500 index and Dow Jones Industrial Average since January. See page 11. Conversely, the NYSE cumulative advance/decline line did make a new high on July 8, 2024. But while advancing stocks may define the trend of the market, advancing volume defines the strength of the trend. In short, the current rally is falling short of being confirmed. This is worth noting since at current prices the S&P 500 is trading at 25.1 times trailing and 21.3 times forward earnings. Both are extremely rich. See page 8.

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Global Elections

One in three Democrats think US President Joe Biden should end his reelection bid after last week’s cringe-making debate against Republican Donald Trump. However, Biden disagrees, and maybe he is right, because according to a Reuters/Ipsos poll disclosed this week, no prominent elected Democrat does better than Biden in a hypothetical matchup against Trump. Still, last week’s presidential debate may have been a turning point in the 2024 election. Not surprisingly, markets are looking at what a change in the Oval Office could mean for companies, stocks, inflation, and interest rates.

Most prognosticators are pointing to higher inflation as a result of a Trump victory. So, we checked. This view ignores the fact that during Trump’s presidency monthly CPI data averaged 1.9% from the end of 2016 to the end of 2020. More surprisingly, GDP growth averaged 2.44% in the same period despite, and including, the Covid-inflicted recession in early 2020. This growth rate was actually higher than 2.0% average quarterly GDP growth rate seen during the 8-year Obama administration. Surprised?

The reason many economists are worried about inflation is that Trump imposed significant tariffs on China during his presidency and “tariffs are inflationary.” Moreover, the Tax Foundation issued a report on June 26, 2024 on the impact of the Trump-Biden tariffs. They coined it the “Trump-Biden Tariffs” because Biden kept most of Trump’s tariffs in place during his term and announced $18 billion more tariffs on Chinese goods in May 2024. According to the Tax Foundation, “the Trump administration imposed nearly $80 billion worth of new taxes on Americans by levying tariffs on thousands of products valued at approximately $380 billion in 2018 and 2019, amounting to one of the largest tax increases in decades.”

These are imputed tax increases estimated by the Tax Foundation that assume Chinese tariffs would be passed on as price increases to US consumers. But actual history shows that in many cases, they were not, and the Chinese government subsidized their exporters. The Foundation also estimates there would be a loss of consumer choices, a loss of jobs, and a loss of trade as a result of tariffs. But we disagree. What did happen is that other Asian countries such as Viet Nam, Thailand, and Cambodia, became new sources of goods for US consumers and this buoyed these Asian economies. They also underestimated the fact that small US businesses picked up the slack when Chinese imports became more expensive for US consumers. What is also being ignored is that the revenue from these Chinese tariffs go straight to the US Treasury which helps to balance the budget and could therefore lower the need for revenue (i.e., new taxes). And to the extent that tariffs reduce Chinese imports (which is a negative to GDP), it would thereby increase GDP. In our view, the Tax Foundation is only looking at one side of the coin, ignoring that we live in a dynamic global economy, and is making assumptions that simply did not occur. And finally, most tax-payers would agree that taxes were lower under the Trump administration. In short, we suggest you do not believe everything you read, even from the “experts.”

In Europe, Marine Le Pen’s National Rally (RN) far-right anti-immigrant Euroskeptic party scored historic gains to win the first round of France’s parliamentary election this the weekend. This means that President Emmanuel Macron’s gamble on calling for a snap election backfired since his centrist camp came in at a lowly third place behind the RN and a hastily formed left-wing alliance. Pollsters calculated after the first round of voting that the RN is on track for anything between 250-300 seats in a race in which 289 seats are needed for a majority. However, that was before the tactical withdrawals and cross-party calls for voters to back any candidate that is best placed to defeat the local RN rival. In short, politics is chaotic in France. Moreover, the RN party has very different opinions on European politics, and this could put the Eurozone, and the European economies, in turmoil.

The UK also has a parliamentary vote later this week, and if polls are correct, the ruling Conservative party will be replaced by the centrist Labour Party, currently led by Keir Starmer. Starmer is running on a platform of economic stability, which is an attractive concept to British voters after Conservatives ran through five prime ministers in eight years. The disastrous six-week premiership of Liz Truss demolished what was left of the Conservative party’s claims to competent economic management. More importantly, Britain’s economy continues to struggle in the aftermath of Brexit and Covid. But financiers in the City of London are said to be privately optimistic about a change of administration since a large majority will allow Starmer to make necessary long-term decisions and resist pressure from his party to boost government spending. It is worth noting that the issues driving elections in Europe are immigration, the economy, and soaring federal debt, just like at home.

The US Economy

We review recent releases on housing, personal income, wages, personal expenditures, the PCE deflator, and the ISM indices this week. The standout data for us in housing was the pending home sales index, which fell 1.5 points to 70.8, in May, the lowest level since the index began in 2018. This is not good news for the future of residential construction which fell 19.3% YOY in May, to 1.277 units. Single-family housing starts were marginally better, falling only 1.7% YOY. New permits for housing also fell 9.5% YOY, but single-family housing permits rose 3.4% YOY. Overall, these are signs that the housing sector is slowing. See page 3.

Despite the fact that new home sales were down 16.5% YOY in May and total existing home sales also fell 2.8% YOY, home prices were strong. The average price of a newly constructed home was $520,000 in May, up 2.2% YOY and the median price was $417,400, off slightly by 0.9% YOY. The median price of an existing single-family home hit a record $424,500 in May, up 5.7% YOY, or 6.8 times disposable income per capita. The record for home prices to DPI per capita was 7.55 times set in June 2022. See page 5.  

Personal income increased 4.6% YOY in May. Disposable income increased 3.7% YOY and personal consumption expenditures increased 5.1% YOY, or slightly above the long-term average of 5.0%. The recent strength in consumption appears unsustainable over the longer term. See page 6.

We noticed an interesting trend in consumption and inflation. Healthcare represented less than 5% of PCE in 1960 but has grown to be the second largest expenditure after housing (17.8%) and now is 16.6% of PCE. In 2023, healthcare pricing was negative or benign. But in May, healthcare, which represents nearly 8% of the CPI, saw prices rise 3.1% YOY. More importantly, healthcare prices tend to rise in the fourth quarter of the year when healthcare insurers set pricing for the upcoming calendar year. This could be a handicap for the CPI and consumers in the second half of 2024. See page 8. The ISM manufacturing index for June fell from 48.7 to 48.5; however, all but one category of the index was above 50 (prices paid 52.1) and all but one category of the index declined in June. New orders rose from 45.4 to 49.3 in the month. Employment fell from 51.1 to 49.3. See page 9. The ISM service sector survey will be reported later this week[AC1]  and it will be important since services represent 70% of consumption, and housing and manufacturing appear to be slowing.

 [AC1]Add comma after “week”