CWS Market Review – July 30, 2024

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Q2 Earnings Are Still Looking Good

We’re getting to the heart of Q2 earnings season and so far, the results are pretty good. I would have expected to see more damage from elevated interest rates, but Corporate America seems to have weathered the threat fairly well.

According to numbers from FactSet, 41% of companies in the S&P 500 have reported so far. Of those, 78% have beaten their earnings estimates – that’s very high – and 60% have topped their revenue estimates.

FactSet said we’re currently tracking earnings growth for Q2 at 9.8%. If that’s right, it will be the best quarter for earnings growth since Q4 2021. That’s a lot better than was expected. On June 30, Wall Street had been expecting earnings growth of 8.9%.

Here’s a look at the S&P 500 (black line, left scale) along with it earnings (blue line, right scale). The two lines are a scale ratio of 18 to 1 so whenever the lines cross, The P/E ratio is exactly 18.

The net profit margin for companies is 12.1% which is high by historic standards. Interestingly, Wall Street expects margins to go even higher. Analysts see margins of 12.4% for Q3 and Q4.

I’ve also looked to see if there’s any trend in guidance. As of now, guidance is perfectly even. For Q3, 16 companies have issued positive EPS guidance, and 16 have issued negative guidance. Overall, stronger earnings can support higher share prices. Also, lower interest rates can give a boost to valuations. This is the one-two punch that the market needs.

The stock market had a brief misstep recently when it fell six times in seven trading sessions. The S&P 500 even dropped below its 50-day moving average, which is often an omen of bearish sentiment.

Are we out of the woods? I’m afraid it’s too early to say. The S&P 500 was up very modestly on Friday and Monday, and it was down again today. The big story on Wall Street is the summer rotation, and it’s still unfolding. The plot is easy. Investors are fleeing large-cap tech stocks and seeking safety in smaller value stocks. Microsoft will report earnings after today’s close while Amazon, Facebook and Apple are due to report later this week.

Today’s trading was another example of the rotation. The Nasdaq was down over 1% today while the Russell 2000 Small-Cap Index was up.

It’s hard to convey how dramatic this turn has been. All those big-name tech stocks have gotten battered. Nvidia is now 26% below its 52-week high. That’s a loss of $900 billion in a little over one month. Meanwhile, those overlooked small names are doing quite well. This has been an especially good time for our Buy List, and CWS.

There are several ways to show the rotation on a chart. They all basically illuminate the same phenomenon.

In this chart, I have the S&P 500 Growth ETF divided by the S&P 500 Value ETF (black). The other line is the Nasdaq Composite divided by the Russell 2000 (blue). Notice how the two lines went from a low correlation to a very high one.

Don’t Expect Any Changes Tomorrow from the Fed

Last Thursday, the government released its first estimate for Q2 GDP growth. I have to confess that my expectations were way off. I thought the U.S. economy had grown in real annualized terms of about 1%, maybe a little higher. Instead, the economy grew by 2.8% for Q2.

To be fair, I wasn’t alone. The consensus on Wall Street had been for growth of 2.1%. The economy did a lot better than it did during Q1 when it grew by 1.4%.

Digging into the details, this was a solid report.

Personal consumption expenditures, the main proxy in the Bureau of Economic Analysis report for consumer activity, increased 2.3% for the quarter, up from the 1.5% acceleration in Q1. Both services and goods spending saw solid increases for the quarter.

Inventories also were a significant contributor, adding 0.82 percentage point to the total gain. Government spending added a tailwind as well, rising 3.9% at the federal level, including a 5.2% surge in defense outlays.

On the downside, imports, which subtract from GDP, jumped 6.9%, the biggest quarterly rise since Q1 of 2022. Exports were up just 2%.

On Friday, the government released the PCE price data for June. This data is important to keep an eye on because it’s the Fed’s preferred measure of inflation.

For June, the headline price index rose by 0.1% which matched expectations. Over the last year, headline PCE is up by 2.5%. That’s still above the Fed’s target of 2%, but it’s getting close.

We also want to look at the core PCE which excludes volatile food and energy prices. For June, the core PCE was up by 0.2% which also matched expectations. Over the last year, core PCE is up by 2.6. Again, it’s above the Fed’s preference but it’s a lot better than where it was two years ago.

The Federal Reserve started its two-day meeting today. The central bank’s policy statement will be released tomorrow afternoon at 2 p.m. ET. I’ll break the suspense: the Fed won’t make any changes to interest rates at this meeting, but this will be the last time. We can almost certainly expect the Fed to cut rates at its September meeting.

Wall Street currently thinks there’s a 4% chance of a rate cut tomorrow, but there’s an 85% chance of a 0.25% rate cut in September, and a 13% chance of a 0.50% cut. I doubt the Fed will give us a 0.50% cut, but it’s not unthinkable. Traders currently expect two more rate cuts before the end of the year.

I’m skeptical of looking at data that goes too far out, but futures traders expect the Fed to cut three more times in the first half of 2025. They may or may not be right, but it’s the change in interest rate expectations that’s driving the big rotation.

The labor market is mostly healthy for now, but I’m not sure how long that can last. As the New York Times noted, “Job openings have come down sharply, part-time employment is up, fewer companies are turning to temporary help to fill gaps and fewer workers are job hopping.”

I’ll also point out that historically, this has been a good time to be in the market. From July 28 of an election year until the end of the year, the Dow has gained an average of 10.07%. Citigroup said that stocks and bonds have generally done well around Fed meetings.

Stock Focus: Flowers Foods (FLO)

Many of the stocks I tell you about aren’t widely followed on Wall Street. This week, we’ll look at Flowers Foods (FLO) which does have some coverage. I see that eight Wall Street analysts follow the stock.

Flowers makes a wide range of packaged bakery products including “fresh breads, buns, rolls, snack items, bagels, English muffins, and tortillas, as well as frozen breads and rolls under the Nature’s Own, Dave’s Killer Bread, Wonder, Canyon Bakehouse, Mrs. Freshley’s, and Tastykake brand names.”

Flowers is a good example of a defensive stock. It’s been a wonderful stock for decades. Since October 1990, the stock is up 12,000%. Would you have guessed that Flowers Food outperformed Intel over that time? I wouldn’t have.

Flowers’s next earnings report will probably be in about three weeks. I’d stay away from the stock right now, but if there are signs that the business is improving, then Flowers could be a very good buy.

There could be an opportunity for shareholders. Flowers hasn’t done well lately, and it missed its last two earnings reports. The company announced plans to shut down a bun-making plant. Last month, the board increased the quarterly dividend by one penny to 24 cents per share. The shares currently yield a little over 4%.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

Posted by on July 30th, 2024 at 9:31 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.