The stock market will be focusing on Q223 corporate earnings and the message coming out of the July 25-26 FOMC Meeting over the next few weeks. Both will not likely derail the rally. Earnings may not pose a problem, as the macroeconomic data don't fully support the weak consensus expectations. The FOMC Meeting, to be sure, should not be market friendly. A 25 BP rate hike seems to be in the cards. And, the Fed will probably leave open the door for at least another rate hike ahead. However, both are widely expected. And, further tightening is far enough away that it could be put on the back burner.
Consensus estimates a large 7% or more y/y drop in Q223 S&P 500 corporate earnings. The macroeconomic evidence is not altogether weak, however, suggesting consensus may be too downbeat (see table below). Negatives among the evidence include a drop in oil prices (reflecting a spike in Q222) and softer economic growth outside of the US. But, the dollar is not as strong on a y/y basis as it has been, so it is less of drag on earnings from abroad. Another negative appears to be a decline in profit margins, as the CPI slowed by more than Average Hourly Earnings. In contrast, a speedup in Real GDP Growth could save the day for corporate earnings.
The Fed can point to the latest CPI report to justify its recent downshift in tightening. Although it will likely emphasize that one report does not make a trend, and therefore leaves open the door for further tightening ahead, the inflation trend does appear to be down. Excluding Used Car Prices and Shelter, the Core CPI was flat in June and registered its fifth month of deceleration. Moreover, Used Car Prices should fall over the next few months and Owners' Equivalent Rent (the largest component of Shelter) may be in the process of slowing, as it did in June. Nevertheless, the Fed cannot take its foot off the brake while the Unemployment Rate is so low. A speedup in economic growth, as well as in commodity prices, could reignite inflation. Ironically, the Fed may have to overshoot in its tightening to create enough slack in the economy to allow for faster, non-inflationary growth.
The next round of key US economic data may illustrate the problem. Early evidence points to a speedup in July Payrolls (particularly adding back strikers). And, the recent upturn in oil prices could feed through to core prices.
This week's US economic data are expected to be mixed, but consensus risks being too low for some. Consensus looks for a speedup in June Retail Sales, which seems reasonable. But, its estimate of flat Manufacturing Output in the June Industrial Production Report risks being low. While consensus expects a drop in June Housing Starts, this could be due to volatility or the weather. Permits are expected to rise. Consensus sees some improvement in the July Phil Fed Mfg and Empire State Mfg Indexes.
Macroeconomic Evidence Regarding Corporate Earnings
Markit
Eurozone Real GDP Oil Prices Trade-Weighted
Dollar AHE Core CPI PMI
[ y/y percent
change ] (level)
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