The stock market has experienced significant growth over the past nine months, driven by improving rates of change in various economic indicators. However, in order to sustain this upward momentum, corporate fundamentals need to validate the market’s advance. The upcoming second-quarter earnings season is expected to serve as a catalyst for pushing the market even higher.
According to reports, the earning season began on a strong note, with major banks reporting profits that surpassed expectations. JPMorgan CEO Jamie Dimon expressed optimism about the resilience of the US economy and the growth witnessed across various business sectors. This positive start to the earnings season bodes well for the upcoming reports and contributes to an overall optimistic outlook.
While the market has been reflecting the positive changes in inflation rates, this resiliency also raises concerns about the potential for a more restrictive monetary policy. Recent consumer confidence reports have shown a significant increase, indicating that consumers view the job market as strong and inflation as stabilizing. However, sentiment levels still have room for improvement and remain below pre-pandemic levels, with low-income households being the exception. Nevertheless, it is expected that sentiment will improve across all groups in the near future.
One of the factors supporting a bullish outlook for the market and the economy is the anticipated return to real wage growth as consumers gradually spend down their excess savings. Recent data from the Bureau of Labor Statistics reveals a convincing improvement in real average weekly earnings growth, taking into account changes in the workweek length. This positive rate of change in real earnings is expected to contribute to sustained growth in consumer spending.
On the inflation front, while there are concerns about the headline inflation rate upticking in July, the core rate, which is more significant to the Federal Reserve, is expected to continue declining. Lower used-vehicle prices and shelter costs are contributing to this trend. The Producer Price Index report indicates a deflationary trend, with just a slight increase over the past year. The data suggests that when the spread between the PPI and CPI is at a record high, as it is now, we typically observe a period of above-average stock returns.
An important factor influencing the market is the rate of change in corporate earnings expectations. Although only a small percentage of S&P 500 companies have reported their earnings so far, the results have exceeded estimates by 8.8%, surpassing the 5-year and 10-year averages. This marks a significant improvement from the previous quarter and the fourth quarter of 2022, which was the low point of the cycle. Rates of change hold more importance than absolute numbers in assessing the market’s performance.
Investor sentiment has also undergone a meaningful improvement recently. While low sentiment can present buying opportunities, a more positive sentiment is essential for attracting more investors to buy stocks and drive prices higher. However, this also reduces the number of new investment opportunities. Currently, there seems to be a speculative fervor among retail investors, as evidenced by their increasing participation in stock call options.
In a market where it is becoming increasingly challenging to find undervalued assets, looking outside the US for value may be a viable option. The decline in the US dollar, driven by favorable inflation news and declining bond yields, benefits emerging markets whose debt is predominantly priced in dollars. The Vanguard Emerging Markets ETF (VWO) offers an attractive investment option with a relatively stable return and a yield of around 3.3%, presenting an opportunity to gain exposure to stocks while potentially avoiding the valuation risks associated with the major US market averages.
