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Weekly Update 7/22/2022: Earnings Season Kicks Off

  • Boeing announces a firm order for 100 of its 737 Max 10 jetliners from Delta Air Lines
  • CACI International wins $80 million task order with the U.S. Army’s Intelligence and Security Command; company is also names as one of the top places to work in the DC area
  • IBM, Johnson & Johnson, Omnicom, Elevance Health, Dow, AT&T and Travelers all release earnings beating profit and revenue expectations
  • Kinder Morgan releases earnings matching profit expectations but blowing past analysts’ forecasts for revenues while raising fiscal year guidance
  • ABB reports a great quarter on strong order growth and raises guidance

Domestic Economic News

We had a relatively light week for data on the U.S. economy and for the most part it had a negative tone. New US home construction fell in June to the lowest since September after plunging the prior month as inflation and high borrowing costs continue to throttle demand and the overall housing market. Residential starts declined 2% last month to a 1.56 million annualized rate, after an upwardly revised 1.59 million pace in May, according to government data released Tuesday. The median forecast called for a 1.58 million pace. Applications to build, a proxy for future construction, eased to an annualized 1.69 million units. The housing market has been coming under pressure due to higher interest rates. A cooling of the housing sector is not necessarily a negative at the moment as that will help ease inflationary pressures in the economy at some point.

Sales of previously owned US homes fell in June to a two-year low as a surge in borrowing costs continues to erode affordability. Contract closings fell 5.4% from May to an annualized 5.12 million, figures from the National Association of Realtors showed Wednesday. The median estimate called for 5.35 million in a Bloomberg survey of economists. The latest decline in sales marks the fifth straight – the worst streak since 2013 -- and it’s likely to deepen further. The Federal Reserve is aggressively increasing interest rates to combat inflation, a pivot that’s chilled the broader housing market. Mortgage rates near the highest since 2008 have curbed buyer demand and pushed some buyers to back out of deals. And as inventory starts to grow, some sellers are now cutting prices. Homebuilder sentiment has also tumbled, and both groundbreakings and building permits for single-family homes dropped in June to two-year lows. Meantime, mortgage applications are at the lowest since early 2000, according to separate data released Wednesday. “Falling housing affordability continues to take a toll on potential home buyers,” Lawrence Yun, NAR’s chief economist, said in a statement. “Both mortgage rates and home prices have risen too sharply in a short span of time.”

Applications for US state unemployment insurance rose for a third week to the highest since November as more companies announce job cuts, suggesting some softening in the labor market. Initial unemployment claims increased by 7,000 to 251,000 in the week ended July 16, Labor Department data showed Thursday. The figures coincide with the reference period for the July jobs report that’s due early next month. The median estimate called for 240,000 applications in a Bloomberg survey of economists. Continuing claims for state benefits rose 51,000 to 1.38 million in the week ended July 9, the biggest weekly increase since November. Unemployment claims are rising as more companies announce job cuts amid increasing fears of a recession. The trend may continue as the Federal Reserve ratchets up its fight against rampant inflation with some of the largest interest-rate hikes in decades, which could ultimately curb demand for workers. The jobless claims four-week moving average, a measure which smooths out some of the volatility in the series, ticked up to 240,500, the highest since early December.

US business activity contracted in July for the first time in more than two years as manufacturers and service providers signaled sluggish demand that only adds to heightened recession anxieties. The S&P Global flash composite purchasing managers output index slid 4.8 points to 47.5, the weakest reading since May 2020, the group reported Friday. Outside of the early months of the pandemic, the July figure is the weakest in data back to 2009. Readings below 50 indicate contraction. The new orders gauge expanded modestly after contracting the previous month. “The preliminary PMI data for July point to a worrying deterioration in the economy,” Chris Williamson, chief business economist at S&P Global Market Intelligence, said in a statement. “Manufacturing has stalled and the service sector’s rebound from the pandemic has gone into reverse, as the tailwind of pent-up demand has been overcome by the rising cost of living, higher interest rates and growing gloom about the economic outlook,” Williamson said. Similar results were seen in Europe. The group’s index of activity in the euro area unexpectedly shrank for the first time since early 2021. Output worsened among manufacturers, while growth in the service sector came close to stalling.

The US contraction was led by a steep decline in service-sector activity. The group’s services gauge slid to 47, the lowest print since May 2020. Excluding the pandemic, the July figure was the weakest in records back to 2009. Even so, firms continued to add jobs at a solid pace. Meantime, the group’s manufacturing index eased to a two-year low of 52.3 in July. New orders shrank for a second month and employment growth slowed. Export orders also contracted as a stronger dollar and grimmer global picture weighed on foreign demand. Inflation metrics softened somewhat in the month, though remained extremely elevated. The group’s composite gauge of input prices eased to a six-month low and the output prices measure dropped to the lowest since March 2021. Firms’ expectations for the future also deteriorated, falling to the lowest since 2020, as weaker demand and inflation weighed on sentiment. While the employment gauges signaled continued growth in July, the report said more firms mentioned plans to cut costs and reduce staffing numbers.

Interest Rate Insight and the Fed

As noted above, the U.S. economic releases this week had a relatively negative tone, especially on the housing front. That actually provided support for the equity market as interest rates declined on the news. Traders are very focused on the Fed’s path of interest rate hikes so weak data is interpreted as a signal to the Fed that they do not need to be as aggressive in raising rates. The Fed’s intent has been to slow demand and the pace of hiring and it appears they are being successful in that endeavor. For example on Friday, Treasuries and high quality bonds rallied sharply after data showing a contraction in US business activity for the first time since 2020 heightened fears the economy will tilt towards recession. The slide in bond yields gathered pace on Friday, with the weak economic reading spurring bets the Federal Reserve will slow the pace of rate hikes to half a point in September after an all-but-certain 75-basis-point increase in July. Treasuries across the two- to five-year sector led gains, with yields at one point tumbling more than 17 basis points. The 10-year yield fell below 2.8%. The Fed is seeking to cool off demand in response to surging prices that have persisted longer than expected. If the Fed does deliver another 75 basis-point move next week, the combined increase of 150 basis points over June and July would represent the steepest rise in Fed rates since the early 1980s when Paul Volcker was chairman.

Impactful International News

The European Central Bank raised its key interest rate by 50 basis points, the first increase in 11 years and the biggest since 2000 as it confronts surging inflation even as recession risks mount. With Italy enduring a fresh bout of political turmoil, President Christine Lagarde and colleagues also unveiled a tool they hope will ensure markets don’t push up borrowing costs too aggressively in vulnerable economies, as happened in 2012 when the euro’s very existence was questioned. Thursday’s move aligns the ECB with a global push to tighten and ends an eight-year experiment with subzero borrowing costs. The ECB said in a statement that further normalization of interest rates will be appropriate at upcoming meetings. “The frontloading today of the exit from negative interest rates allows the Governing Council to make a transition to a meeting-by-meeting approach to interest rate decisions,” it said, refraining from guidance on the size of future hikes. As those steps are implemented, it said it will establish the Transmission Protection Instrument, which “can be activated to counter unwarranted, disorderly market dynamics.” Purchases aren’t restricted “ex ante.” The euro extended gains, rising 0.8% to $1.0256 immediately after the announcement. Traders raised wagers on the pace of tightening, pricing an additional 137 basis points of hikes by year-end compared with less than 120 basis points earlier. Thursday’s hike in the deposit rate to 0% was twice the amount telegraphed until just days ago and was predicted by only four of 53 economists surveyed by Bloomberg.

The ECB joins 80 international peers, including the US Federal Reserve, in lifting rates this year to fight red-hot inflation after months of predicting such pressures would fade. Consumer prices in the euro area are now rising by more than four times its 2% target. The central bank faces a tougher task than most. On top of setting monetary policy for 19 economies, the threat of a recession is greater as the war in neighboring Ukraine pushes up food and fuel costs, while a rising dollar leaves the euro flirting with parity. When it last raised rates, in 2008 and 2011, it soon turned back as growth slumped. Germany, Europe’s largest economy, is particularly at risk due to a greater reliance than most on natural gas from Russia, which has limited supplies in response to Western sanctions over its invasion. Flows through the Nord Stream pipeline resumed on Thursday after maintenance, bringing some relief to markets. But as that happened, euro-area political risks came to the fore with the resignation of Italian Prime Minister Mario Draghi, Lagarde’s predecessor. It is a tough situation all around in the European Union right now and we feel the ECB made the right decision by front-loading interest rate hikes to send a strong message to markets. The strengthening of the euro too helped our equity averages here in the U.S. as well because one of the headwinds we have been facing when listening to company earnings calls has been the strength of the U.S. dollar relative to other currencies. On the positive side, we receive our dividends and interest payments within our portfolios in U.S. dollars which go further today then they have in years when traveling overseas.

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