Stocks Rise With Trouble Under The Surface

Earnings season entered its final weeks, with only 52 S&P 500 companies reporting. On a positive note, the earnings improved to all but guarantee year-over-year earnings growth for the quarter. Despite rising yields, the S&P 500 rose 1.3% for the week. While the preeminent stock index posted a positive week, things were less encouraging under the surface.

After some relief from worries about additional Federal Reserve rate hikes following the softer jobs report, the measure of expectations for short-term interest rates one year in the future shows that some of that optimism has been dampened. While markets are still not pricing in more rate increases, the odds rose last week, and the probability of a rate cut was pushed further into mid-2024. The 2-year U.S. Treasury yield rose from 4.84% to 5.06%, while the 10-year moved from 4.57% to 4.76%.

Stock performance was narrow last week, with the Magnificent 7 dragging the S&P 500 higher while the average stock sank. The Magnificent 7 consists of Microsoft
(MSFT), Meta Platforms
(META), (AMZN), Apple

(NVDA), Alphabet (GOOGL), and Tesla
(TSLA). These seven rose by 3.8% last week, taking them to a 95.6% total return year-to-date and handily outpacing the S&P 500 at 16.6%. Smaller companies did not participate in the rally, evidenced by the 0.6% decline in the equal-weight S&P 500. In addition, interest rate sensitive sectors like banks, utilities, and real estate suffered after a significant bounce the previous week.

After an absence of high-profile economic releases last week, the week features October consumer inflation (CPI) and retail sales. Continued progress in fighting high inflation readings will be critical to allowing the Federal Reserve to end its rate-hiking cycle. The supercore inflation reading, which removes housing inflation, will be crucial to watch. The government data for rents within the CPI lags the real world, so removing it helps cure the distortion. Retail sales results will provide a read on consumer spending, which is a primary driver of U.S. economic growth.

With the reporting season almost complete, blended earnings, which combine actual with estimates of companies yet to report, are above the forecasts at the end of the quarter. Earning season is winding down, with only 14 companies scheduled to report. This week’s earnings are focused on retailers like Target
(TGT) and Walmart

Nine of the eleven S&P 500 sectors have year-over-year earnings growth exceeding the expectations at the end of the quarter. The only two below expectations are healthcare and utilities.

Blended earnings performance exceeds expectations at the quarter’s end. Combining actual results with consensus estimates for companies yet to report, the blended earnings growth rate for the quarter is 4.1% year-over-year, ahead of the expectation of -0.1% at the end of the quarter. If the quarter ends with year-over-year earnings growth, it will finally snap a three quarter streak of earnings declines.

While there was good news from earnings and the S&P 500, trouble lurks below the surface. The broader lift to stocks outside the Magnificent 7 faded last week as yields increased. Stocks are not doomed to fall just because a small group has been leading the charge higher, but it is noteworthy that much of the market remains hostage to Federal Reserve and interest rate expectations. Notably, the inflation and consumer spending economic releases on Tuesday and Wednesday will likely be critical inputs into those market action drivers.

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