Markets retreated on the week against the backdrop of inflation fears after the S&P and Nasdaq mid-week reached new intraday highs. The expectation of Q2 strong corporate earnings reports was not enough to hold the gains of mid-week. The Russell 2000 Small cap index lost ground for the third consecutive week to the large-cap S&P 500 and fell behind the S&P 500 year to date. For the week, the TSX decreased 1.35%, the S&P 500 lost 0.97%, the Nasdaq gave back 1.87%, the S&P 400 Midcap dropped 3.54%, and the Russell 2000 fell 5.71%. European equities also fell in the week on concerns over an increase in Covid cases and worries monetary authorities might tighten earlier than anticipated to quash inflation. Announcements of a two-tier system based on vaccination status resulted in civil unrest in several cities and might stall the re-opening.
This past week was the start of Q2 earnings reports and, as expected, of the 41 companies in the S&P 500 that have reported earnings, 90.2% have reported earnings above analyst expectations, according to Refinitiv.1 Industrials and consumer discretionary sectors reported the highest earnings growth for the quarter. Industrials in aggregate reported a 587.4% increase, with all sub-sectors anticipating substantial earnings improvement over last year’s Q2. Earnings exploded from $3.9B in Q2 2020 to $27.1B for Q2 in 2021. Consumer discretionary reported a 280.6% jump in earnings, with leisure products up 2255.7% and restaurants up 1970.9% over Q2 of last year at the depths of the lockdown. Earnings leaped from $7.5B in Q2 2020 to $28.4B in Q2 2021.2
As the market anxiously waited for the inflation data for June, the increase was almost double the .5% expected by economists, climbing .9%, the most significant jump since 2008. One-third of the increase is attributed to used cars, but the cost of food and energy, impacting the poorest of society, also continues to climb at an alarming 12-month 4.5% rate from 3.8%.3 On Wednesday, the Producer Price Index released a final demand increase of 1% for June following an 0.8% increase in May and 0.6% in April. A statement from the U.S. Bureau of Labor Statistics read, “On an adjusted basis, the final demand index moved up 7.3% for the 12 months ended in June, the largest advance since 12-month data were first calculated in November 2010.”4 On Thursday, Treasury Secretary Janet Yellen parroted previous statements from Fed Chairman Powell saying she expected “several more months of high inflation readings, but it remained transitory.”5 However, she voiced concerns over the high cost of housing and affordability for first-time homebuyers.
On Thursday, the Department of Labor reported initial claims of 360,000 for the week ending July 10 compared to last week’s adjusted level revised higher to 386,000. Continuing claims dropped below 14 million, falling to 13,836,598.6 On Thursday, the New York Fed’s Empire State business conditions jumped to a reading of 43. Economists expected a reading of 17.3, according to the Wall Street Journal. Encouragingly the subcomponents of the survey were strong, with the new orders index up 16.9 points to 33.2 in July and shipments up 29.6 points to 43.8. The recovery in manufacturing, while strong, is still struggling with a shortage of workers and supply constraints. The auto sector is an example as chip shortage is hampering production.7
Market sentiment staggers from one data point and central bank comment to another. Uncertainty over inflation, interest rates, monetary and fiscal policy will plague equities for the remainder of the year and into next year. Investors are hardly interested in bonds with real interest rates negative (coupon rate minus inflation) and when higher yields can be found in equities. While the ride may be bumpy, equities seem to be the only game in town if earnings remain supportive.
Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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