Earnings season kicked into full gear last week as several bellwether companies reported mixed results, adding to the precarious position of US financial markets. With data suggesting a softening economy, focus turned to this week’s Federal Reserve meeting. The last big data point before the meeting—the Fed’s preferred inflation measure, US monthly core Personal Consumption Expenditure (PCE)—posted a slight increase but well within consensus expectations. The inflation report was cheered by investors, who are now pricing in the first rate cut at the September Fed meeting and up to three rate cuts by year-end. Equity markets (as measured by the S&P 500 Index) closed the week lower by 0.8% with a strong Friday rally helping offset losses earlier in the week, while the US Aggregate Bond Index rose 0.3% following a drop in short-term rates. Of note, US small caps continued their recent outperformance as rate cut expectations rise—the Russell 2000 Index surged 3.5% for the week and is up 10.4% for July, handily outperforming large cap peers.
Small Caps Set for Best Outperformance Against S&P 500 Since 2000
Monthly % Change: Russell 2000 Index Minus S&P 500 Index
Source: Bloomberg, S&P, Russell.
Source: Bloomberg MLIV Pulse Surveys
A steep selloff in high-flying technology and artificial intelligence names sent investors reeling last week, with some wondering if this is the start of a broader summer correction. The S&P 500 Index snapped the 356-day streak without a 2% decline on Wednesday, falling 2.3%, pulled lower by weaker-than-expected earnings and softer sentiment around the AI trade.
Entering earnings season, many investors thought the corporate sector would carry market momentum into Q3; however, the earnings thrust has so far yet to materialize. Following mediocre reports from the mega US banks the week prior, technology behemoths disappointed on earnings and forward guidance. Tesla shares plunged following an uninspiring earnings report, Google parent Alphabet fell on weaker-than-expected advertising revenues, and Visa shares cratered following weak revenue growth. Adding to the unease, several European multi-national companies also reported weaker-than-expected revenues and earnings last week.
Despite the broader softness, there were still several bright spots, notably in smaller, value-oriented, and defensive industries, with executives pointing to resilience in margins and underlying demand. This week, investors will get another look with nearly 40% of S&P 500 constituents (measured by market cap) reporting earnings including mega cap names such as Apple, Microsoft, Amazon, and Meta (fka Facebook).
2Q GDP Rises 2.8%, Fueled by Robust Consumer and Business Spending
US GDP vs US Final Sales (QoQ%)
Source: Bloomberg, Bureau of Economic Analysis.
On Thursday, the Bureau of Economic Analysis (BEA) reported a robust 2.8% annualized rate for Q2 US GDP, surpassing consensus expectations for 2.0%. While the headline figure suggests robust economic growth, there was some underlying weakness noted in personal consumption and building inventories. Stripping out inventories, government spending and trade, inflation-adjusted final sales to domestic purchasers—a key gauge of underlying demand—rose 2.6% for a second straight quarter. This report is likely to be well-received by the Federal Reserve, reinforcing the case for a soft landing.
Consumer Spending Growth Cooled in June After Strong Advance the Month Prior
PCE ex food, energy vs Inflation-Adjusted PCE (MoM%)
Source: Bloomberg. Bureau of Economic Analysis.
Finally, on Friday, the BEA reported that US inflation as measured by the PCE rose at a tame 0.2% in June and up 2.6% from one year ago. On a three-month annualized basis, core inflation cooled to 2.3%, the least since December. In the same release, inflation-adjusted consumer spending rose 0.2%, while May’s increase was revised higher. The report also noted personal income growth came in at 0.2%, slower than the 0.4% expected, while the May figure was revised lower. With personal savings rates back close to pre-pandemic levels, increased future consumption growth will be challenging without corresponding increases in income.
– Written by Eric Schmitz, CFA