Stocks rose yesterday as investors attempted to look past this next big rate hike, hoping that the Fed will slow down in the future. Slower rate hikes may be favorable, but the reason for them is not so favorable – recession.
Give me shelter. Now firmly past the halfway mark of the year, the northern hemisphere is easing into a hot summer, and investors attempt to guess where the economy…and the markets might be by the end of the year. The dominant themes in the first half of the year were inflation and rising interest rates. Inflation could lead to a pullback in consumption, which ultimately leads to recession. Through the first half of the year, despite the rising inflation, consumption remained strong. The Fed embarked on its tightening maneuvers and inflation did not capitulate. This led to higher yields on longer maturity bonds. Those high yields were the leading cause for the decline in the stock market, specifically in growth shares. The poster children for growth stocks are, of course, technology, but tech stocks were not the only ones affected. Many consumer discretionary stocks and communications services stocks suffered as well. Those stocks, which are generally more volatile than most, are popular due to strong historical earnings growth which is expected to persist in the future. The emphasis here is on that future growth. Higher long-maturity bond yields make those fast-growing future earnings less valuable in today’s dollars, so, BY MATH ALONE (yield is in the denominator of the equation), current stock prices of growth stocks should be, theoretically lower. Math, or no math, traders didn’t take any chances and sold, especially considering that those stocks enjoyed a healthy run over the past several years leading to frothy valuations. Now, with all those higher yields, Fed hikes, and high inflation factored into the markets, a new theme has emerged…recession.
Remember, all those Fed rate hikes are designed to cause consumers and companies to spend less. That decreased spending, or reduced demand, will ultimately reduce inflation pressure. The problem is that if that spending is cut back too much, it can cause a recession. Though most prominent economists (Fed economists included) don’t expect a recession in the near term, more and more professional money managers believe that the probability of a recession is on the rise. Likely reasons for that rise are the early signs that can be found in waning consumer sentiment, lower long-maturity bond yields, and a now-inverted yield curve.
Let’s talk about the Fed rate hikes for a moment. Those hikes have an almost direct effect on consumer and institutional borrowing costs. For consumers, that means higher credit card rates, higher auto loan costs, and higher mortgage rates. If we focus on auto loans and mortgages, those cover two of the biggest culprits in rising prices over the past few years: automobiles and housing. Higher rates mean that those once-hot items will cost even more and will likely cause consumers to pull back. Vehicle sales are already down by some -30% from last year alone. Housing numbers are beginning to show some cracks as well. In these past few days alone, we learned that Housing Starts and Building Permits have declined for a third straight month. Yesterday, we learned that Existing Home Sales slipped by a greater than expected -5.4% …IT’S FIFTH MONTH OF DECLINES. What can be causing this pull back in demand? Yesterday, we also learned that mortgage applications declined for a second straight month to a multi-year low. This shows that demand for homes is waning. Fear of recession can be one factor, but the dominant factor is most likely rising mortgage rates which have sprung from just over 3% to just under 6% since the Fed began to tighten its key lending rate. Do all these signs portend a pullback in inflation? The answer is, yes, likely, but exactly when remains the unanswered question. Stock investors are hoping that these signs will cause the Fed to slow its hiking path. At this point, Fed Fund futures are still pointing to a Fed Funds rate of 3.5% at year-end.
WHAT’S SHAKIN’
Danaher Corp (DHR) shares are higher by +3.9% in the premarket after the company announced that it beat EPS and Revenue estimates by +17.65% and +5.94% respectively. The medical diagnostics company did warn of increased costs, but it reaffirmed its growth guidance for the year. Dividend yield: 0.39%. Potential average analyst target upside: +21.2%.
United Airlines Holdings Inc (UAL) shares are lower by -7.29% in the premarket. UAL announced that it was profitable for the first time since the pandemic, but it missed EPS targets by -24.10%. Analysts were disappointed in UAL expected capacity as well as its announcing that it would curtail its growth plan as it attempts to navigate the challenges it has been experiencing. Potential average analyst target upside: +31.9%.
Tesla Inc. (TSLA) is trading higher by +2.47% in the premarket after the EV maker announced that it had beat EPS and Revenue estimates by +22.37% and +0.41% respectively. The company reaffirmed its delivery growth rate but warned of “supply chain hell.” The company also announced that it liquidated roughly 75% of its Bitcoin holdings last month. The announcement caused Bitcoin to reverse early gains to a loss of -2.85 from yesterday’s close. Potential average analyst target upside: +17.3%.
ALSO, THIS MORNING: Dow Inc (DOW), AT&T (T), Philip Morris International (PM), Blackstone (BX), Huntington Bancshares (HBAN), and Union Pacific (UNP) all beat on EPS and Revenues. Domino’s Pizza (DPZ) and American Airlines (AAL) missed on Sales while DR Horton (DHI) and AutoNation (AN) fell short on sales.
YESTERDAY’S MARKETS
Stocks rallied yesterday as investors were hopeful the Fed would curb its future rate-hiking plans in response to waning consumer demand…and good earnings. The S&P500 rose by +0.59%, the Dow Jones Industrial Average gained +0.15%, the Nasdaq Composite Index jumped by +1.58%, and the Russell 2000 Index advanced by +1.59%. Bonds slipped and 10-year Treasury Note yields were unchanged at 3.02%. Cryptos lost -0.85% and Bitcoin slipped by -0.20%.
NXT UP