Trepidation seems to be growing as investors prepare for two days of Fed Chair Jerome Powell’s “Humphrey Hawkins” testimony to Congress starting tomorrow. U.S. stocks could follow European markets’ overnight lead downward to start Tuesday as weakness grows ahead of Powell’s remarks.
Hopes for a series of rate cuts fell after last week’s jobs report, and there’s concern Powell could sound less dovish than he did a few weeks ago when the Fed met. As Powell speaks, we’ll see if we get any insight into longer-term Fed thoughts as well as a July rate cut confirmation. The futures market still puts 100% odds on a rate cut of at least 25 basis points at the next meeting later this month.
Keep on Snacking
At the same time, earnings season approaches with many analysts expecting year-over-year declines. The news was good on Tuesday thanks partly to peoples’ appetites for crunchy, salty snacks. PepsiCo Inc. (NASDAQ: PEP) reported earnings and revenue that beat third-party consensus views. The Frito-Lay division—part of PEP’s snack business—looked very strong.
Americans love their snacks, and they also love their pets. Several major investment banks started coverage of Chewy Inc (NYSE: CHWY), the online pet food retailer, with positive ratings early this week. Some cited a strong market for the company’s business, though others pointed out there could be competitive pressures.
Meanwhile, top U.S. and China trade negotiators are set to speak by phone this week as they lay the groundwork for the next round of negotiations, The Wall Street Journal reported. If things go well on the phone, a face-to-face meeting could be next. The negotiators haven’t had formal talks in about two months, and the same issues around intellectual property and tariffs could continue to bog things down, the paper noted.
Fed Still Front and Center
U.S. indices stumbled to start the week, and headlines blamed the Fed. Well, not exactly the Fed itself, but ideas that the Fed might not be as dovish as some investors had hoped. This stems in part from last Friday’s solid jobs report, which might have reinforced some of the Fed hawks’ impressions that things are going well in the economy.
Odds of a Fed rate cut at this month’s meeting still rest at 100%, where they’ve been for weeks, according to futures prices. The situation gets a little harder to tell with the September meeting, however. Chances of another cut then outweigh chances of the Fed standing pat, but not by a huge margin. As of late Monday, futures projections were 62% for a quarter-point of additional Fed easing in September, but around 38% that the Fed would let that occasion come and go without moving the levers.
Basically, If the Fed doesn’t take action at the July meeting, it’s likely going to be mightily disappointing for the market. Looking ahead to its September meeting, the probabilities are still relatively high for another cut, but there may be a little bit of waiting to see what the data says going into September.
The Fed’s most recent “dot plot,” or forward projection by various Fed officials, actually showed officials still at odds about whether to cut rates this year. Officials were almost evenly divided between making no cuts and making one or more cuts before 2020. The jury is still out, apparently, with nine Federal Open Market Committee (FOMC) members predicting no rate cuts this year and eight predicting one or two.
Trepidation Ahead of Earnings
The rally since early June has rate cuts as its foundation, but when you think about it, that’s not necessarily the best building block for a big upside move. The Fed tends to cut rates when the economy is slowing, and a slowing economy doesn’t always bode well for fundamentals behind the stock market. In one possible sign that all isn’t well, many analysts project earnings to fall in Q2. According to some projections, a drop in Q2 would be the second quarter in a row of negative earnings growth, something that hasn’t happened in three years (see more below).
Earnings drive the market long-term, and might give everyone a better chance of figuring out where things stand. The big banks kick off earnings season in less than a week, and analysts expect at least a few of the major firms to post better results than a year ago. This could reflect several things, including the high-flying stock market, decent volatility that led to some additional trading volume in Q2, and strong consumer sentiment that might have helped banks grow their loan businesses. Falling mortgage rates could also play a role, though generally the lower interest rates seen since the start of the year tend to hurt bank profit margins.
Before the banks approach the starting gate, the Fed gets another chance to have its say when Fed Chair Jerome Powell takes the short trip to Capitol Hill on Wednesday and again Thursday to deliver his mid-year testimony to Congress. He’s likely to be asked to expand on his recent remarks about the U.S. and global economy, and to give a better sense of where he sees the rate situation going. Markets might be a little subdued today ahead of the Powell testimony until people get a better sense of his views.
Will Powell Expand on Post-FOMC Comments?
You never want to get too predictive, but the odds of Powell departing substantially from what he said just a couple weeks ago at the last Fed meeting don’t seem all that likely, at least based on past Fed testimony to Congress. After the June meeting, he pointed out that economic “uncertainties” are growing and discussed how inflation isn’t keeping up with the Fed’s 2% goal. The inflation part of that has been an ongoing theme for years. We might hear more about this Wednesday and Thursday, and consumer and producer prices for June both come out later this week.
Also, the Fed last month removed the word “patient” from its post-meeting statement, signaling to many investors that perhaps the central bank isn’t going to just keep watching data come in, but might take quicker action to keep the economic tailwinds blowing.
Powell’s testimony is accompanied Wednesday by release of last month’s Fed minutes, which might provide additional insight into the conversation at that meeting. European Central Bank (ECB) minutes are due Thursday.
Figure 1: CAN’T KEEP UP: After a strong start out of the gate this year, stocks in the Russell 2000 Index of small-cap stocks(candlestick) have started to lose ground vs. the S&P 500 Index (purple line). Small-caps, like transports, are sometimes seen as a leading indicator. Data Source: FTSE Russell, S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
Monday Wrap: Selling was pretty widespread on Monday but not out of hand, with the markets finishing mostly off their lows. Technology is taking it on the chin, hurt in part by an analyst lowering his rating on Apple Inc. (NASDAQ: AAPL). Shares of the company fell 2% as the report talked about falling iPhone demand.
The other FAANGs didn’t do much better, though Amazon.com, Inc. (NASDAQ: AMZN) managed a slight gain. Weakness in the FAANGs, however, doesn’t necessarily mean the same thing now as it did a year ago when those stocks led the parade higher. The rally since early June has been pretty broad-based, if you judge it by how many stocks have made new record highs. Various sectors have led at times, including both defensive and cyclical ones. On Monday, the defense appeared to be on the field, led by Utilities and Real Estate.
Some of the closely watched commodities started the new week without much spark. Neither gold nor crude oil changed much in value Monday, which could reflect some investors waiting for word from Powell before deciding on market direction. Bond yields also stayed pretty quiet Monday.
Millennial Notebook: Some stock market experts over the years have told people not to buy stocks if they don’t use or know about a given company’s products. Millennial investors appear to be taking that to heart, recently snapping up shares of companies whose products tend to be associated with youthful demand. Some of the stocks Millennials bought in June included Tesla Inc (NASDAQ: TSLA), Canopy Growth Inc (NYSE: CGC), Beyond Meat Inc (NASDAQ: BYND), Uber Technologies Inc (NYSE: UBER) and Nvidia Corporation (NASDAQ: NVDA), according to the latest Investor Movement Index (IMX)—TD Ameritrade’s proprietary, behavior-based index that measures what investors actually were doing and how they were positioned in the markets.
It might be worth pointing out, however, that all of the companies mentioned above (except for NVDA), haven’t yet shown signs of profitability. So young people are apparently buying what they know — but they should research these companies. On the other hand, millennials were net sellers of higher than average risk names such as Apple, Netflix, Inc. (NASDAQ: NFLX), Snap Inc. (NYSE: SNAP) and Sirius XM (NASDAQ: SIRI) last month, according to IMX data. The overall IMX fell 6% in June versus May as it looks like investor cautiousness continued, even as markets rallied in June, reaching all-time highs by mid-month. This could reflect in part how one of the primary factors behind the rally – anticipation of Fed rate cuts – is arguably motivated by deeper insecurities about the economy.
Working the Railroads: As we mentioned last week, the transport sector hasn’t been keeping up with the broader S&P 500 Index (SPX). Sometimes that’s seen as a negative signal for the market as a whole, because transports—along with small-caps—are often a leading indicator. However, it would be a mistake to look at the dragging transports as one single entity. There’s actually been a lot of strength in some of the railroad stocks lately, including Union Pacific Corporation (NYSE: UNP) and CSX Corporation (NASDAQ: CSX). Both of these are up sharply year-to-date, though they rolled back downhill a bit Monday. Strength in the railroad sector can sometimes hint at strong consumer and business demand, and in this case might also reflect ideas among some investors that the railroads might have a bit more protection than some industries from trade skirmishes with China and Europe.
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