Higher Stock Market Into July?

The stock market will likely stay on an upward trajectory into July, as expectations of a strong Q217 earnings season are partly offset by evidence of a modest slowdown in economic growth.   The evidence still suggests softer June Mfg ISM and Payrolls, due in two weeks.  Potentially major events for the stock market are more likely later this summer.  They include decisions by the Fed, BoE and ECB whether to hike rates or not and potential progress on corporate tax reform.  How these events play out are far from certain, and could be either positive or negative for stocks depending on their resolution.   As a result, stocks are likely to trade more cautiously once the boost from Q217 profits ends in mid summer.  

The consensus estimate for Q217 Corporate Profits is about 11% y/y.  This is a bit softer than the near +15% in Q117, but still strong.  The double-digit gain in part reflects favorable base effects -- GDP data show that Corporate Profits fell q/q in Q216.  The decline in profits then makes a y/y comparison easier now.   But, base effects turn unfavorable for y/y comparisons in H217, as profits rose q/q over H216.  Combined with slower economic growth, the positive influence of profits on the stock market may reverse after the upcoming earnings season.

Macro evidence is not as supportive for Q2 Corporate Profits as it was for Q1 Profits.  Although Real GDP at this point is expected to accelerate on a y/y basis, other factors have softened (see table below).  Oil prices slowed their y/y gain, impacting that sector's profits (but helping others, like airlines).  The trade-weighted dollar sped up relative to last year, which should hurt the translation of earnings abroad.   And, profit margins appear to have shrunk, as prices slowed by more than wages.  In contrast, non-US economic growth sped up in Q217, which should have helped profits earned abroad.  (The speedup is apparent in the Markit Eurozone Composite PMI, which rose q/q in Q217.  But, this Index fell in June to 55.7, joining US evidence pointing to slower growth into Q317.)   The overall softer macro background already may be built into the market consensus. 

Meanwhile, forecasts of Real GDP Growth are coming down.  The Atlanta Fed model now projects 2.9% (was 3.2%) for Q217 Real GDP Growth, while the NY Fed model projects 1.9% (was 2.2%).  The NY Fed model lowered its Q317 Real GDP forecast to 1.5% from 1.8%, as well. There is still a lot more data to see before a final estimate of Q217 Real GDP, so these forecasts can change.  At the moment, both model forecasts for Q217 are above the long-term trend of about 1.5% and thus still portray relatively strong growth.  The first release of Q217 Real GDP is due July 28.
                                                                    
                                                                                                                                          Markit
                                                                                                                                          Eurozone              Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level)
Q316            1.7                 -3.4                    2.2                              2.6          2.2
Q416            1.9               +16.4                   3.9                              2.7          2.2
Q117            2.0                +65.3                  2.3                              2.7          2.2                55.6
Q217            2.2-2.4          +13.1                  3.1                             2.5          1.8                56.8