Quick Recap
- Markets had a strong week but gave up momentum going into last Friday after Snap’s earnings miss led to fears about other large-cap names that derive digital advertising revenue.
- Defensives showed strength with the S&P 500 closing at 3,961.63. The VIX fell to $23.03. Despite Friday, the VIX is again more subdued than it has been in recent weeks.
- On Friday, the S&P started with a modest gain of around 14 points and then faded into the day. Markets seemed spooked after Snap’s earnings miss and Nasdaq-led losses.
- Technology earnings will be a major catalyst or detractor this coming week. The sector has been experiencing recent relative strength.
Details
Markets had a relatively strong week, given what we have witnessed, but unfortunately with a sour ending. The broad market S&P 500 actually got above 4,000 on Friday, very briefly, but retreated into the close. Snap Inc. (ticker SNAP) reported earnings after the closing bell, Thursday, July 21, and based on its financial reporting update, experienced a significant deterioration in its results. Several analyst downgrades followed. The company stock price was punished by investors, finishing down nearly 40% into the close.
The action in Friday’s market suggested investors are worried Snap’s weaker results foretells weakness for other companies who pay the bills with digital advertising. Communications Services (Newday has been consistently under weight) was the biggest laggard, followed by Technology (Newday has reduced its overweight exposure). However, Defensives saw relative strength. The markets still managed to close the week in positive territory. While Friday’s drop was big, it was concentrated mostly in digital advertisers, a few of whom are huge parts of the index. Bank earnings showed a stronger US consumer than those with mounting growth fears likely would have predicted. At Bank of America, Brian Moynihan, CEO, in an interview I participated in, seemed quite positive around trends for repayment on credit cards, auto loans and home equity products actually increased year-over-year. Signs of credit distress were down across the board. Banks have had to increase reserves for loan losses, which can make earnings numbers a bit confusing. Nonetheless, underlying credit strength when looking at loan performance seems strong for the moment. Consumers are starting to use credit more frequently as their savings begin to run down, but that does not necessarily suggest imminent recession. American Express, for instance, showed a 31% increase in revenue.
On the strong side of the earnings season Netflix (not owned) delivered results that the Street viewed as being decidedly less bad than anticipated and this helped its shares rally. Tesla (owned) also had a great quarter compared to analysts expectations. Despite the companies that have beat consensus, earnings for the season are on track so far to have the lowest annual rate of growth since Q42020. This week will have crucial earnings reports of many large technology firms. These companies have been rallying lately and given their weight in the indexes, this will be a very important catalyst for how the markets perform this week and beyond. Some large technology firms have announced hiring freezes or job cuts following the ramp to meet COVID 19 work from home demands. This downsizing has prompted some investor concerns.
The events in Europe should continue to catch the attention of the world this week. The news of the collapse of the Italian government, led by former ECB Chairman Mario Draghi may have made investors apprehensive and maybe a little bit of the wrong kind of nostalgia. For what it is worth, I am a huge Mario Draghi fan. But this may be a “Bridge too Far” for him. The other issue in Europe has been whether or not the Russians would permit the renewed flow of natural gas through the economically crucial Nord Stream pipeline. The Euro currency has been retreating against the U.S. dollar but has hovered still just around parity. Fears of a renewed sovereign debt crisis in Europe are rising. In recent years, the German economy has become more and more dependent on cheap Russian energy, together with its manufacturing output and if a complete shutdown of the pipeline occurred the effects on German GDP could potentially be devastating. The German economy is the bulwark of the Eurozone. Weak German growth combined with rising rates and hawkish ECB could make the sovereign debts of the heavily indebted southern countries re-emerge in problematic ways. While Putin has let the partial flow of gas resume, keep an eye out for him to continue using this leverage to apply pressure to the West and shake European unity. The closer we get to winter, the more effective this leverage likely becomes. This issue could become larger as time goes on and Putin may want to reduce supply further.
One potential problem that could be exacerbated by issues with the Euro is persistent dollar strength. Morgan Stanley Analyst, Michelle Weaver has estimated that for every percentage point rise in the US dollar, S&P 500 earnings would get hit by 0.5%. So, by her math, since the dollar has risen 16%, this would equate to an 8% hit to U.S. earnings. Larger cap companies usually have a greater percentage of international sales. IBM was one company that saw dollar strength hit its earnings. Microsoft also guided a few weeks ago to this effect. Given that markets are having the weakest earnings season in a while, the downside action has not been as bad as some investors expected. Strength in economic data like labor markets and credit performance, as well as the recent rally in high-yield debt could be helping give investors suffering from dismal sentiment levels some positive news to focus on.
I believe this earnings season is very important for the direction of markets. As we receive more data it may become clear that fears of recession are overblow. If this insight converges with softening inflation, a strong rally in the second half is possible. This remains my base case.
Scotsman’s Outlook
Looking at what led the rally over the past week, we see fairly broad performance out of quite a few important sectors. The Technology, Materials, Industrials, Communication Services and Financials sectors were all higher by more than 6%.
Some have argued that the lowest quality names have made the largest moves (for example, Retailers, and Casinos) and this certainly has been true to some extent. However, I feel it is always important if groups like Technology are leading the way, given this group’s 28% weighting within the S&P 500. Meanwhile, Defensive groups like Utilities have lagged and underperformed throughout most of July.
Overall, this outperformance might show some mean reversion between now and mid-August, with bounces in the laggard groups and weakness in some of the leaders. Overall, I feel strongly that any near-term weakness in Technology particularly into early to mid-August should constitute a buying opportunity.
This commentary is provided for information purposes only and is not an offer or solicitation of an offer to buy or sell any product or service. Unless otherwise stated, all information and opinion contained in this publication were produced by Newday Funds, Inc. (“Newday Impact”) and other sources believed by Newday Impact to be accurate and reliable. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions about the financial markets, general investment strategy, or particular investments are not recommendations to clients and are subject to change without notice.
Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Past performance does not guarantee future performance.