Wheels Down

Lower inflation and strong earnings from the financial sector drove markets higher last week. In the US, the Dow Jones gained 2.29%, the S&P 500 rose 2.44%, and the NASDAQ rallied 3.32%. Within the S&P 500, Communication Services (+3.36%), Consumer Discretionary (+3.31%), and Information Technology (+2.81%) sectors led. Energy (+0.62%), Consumer Staples (+1.21%), and Financials (+1.98%) were the worst performing sectors. European stocks rose 3.86%, with France gaining 3.69%, Germany rising 3.22%, and the UK gaining 2.52%. Asian markets were mixed, with Japan’s Nikkei rising 0.01% and China’s Hang Seng rising 5.72%.

Inflation Watch

In the US, the Consumer Price Index dropped from 4.0% to 3.0% year-over-year in June, 0.1% lower than expected. The decrease was mainly due to the exclusion of June 2022 figures from the rolling 12-month period. Core inflation, which excludes volatile food and energy prices, decreased from 5.3% to 4.8%, 0.2% lower than expected. Investors appear to have extended bond durations and favored riskier assets. The shorter end of the treasury curve also shifted higher.

The Federal Reserve maintains its projection of another 0.50% increase in the Federal Funds rate by the end of the year. Concerns over persistent inflation in the services sector and housing, which accounted for 70% of core inflation in June, bolster the Fed’s stance. However, it’s important to note that month-over-month housing inflation dropped to 0.4%, and the US Zillow Rent Index indicates a continued decrease in housing inflation. Unless there is a significant and unexpected weakening of the labor market and the US economy, the Fed is unlikely to change its position.

International inflation rates vary. China reports 0.00% year-over-year inflation due to a weak post-COVID domestic recovery and ongoing international pressures over Chinese trade/intellectual property rights practices. Japanese inflation stands at 3.2%, relatively high for a country that historically averaged a 0.3% year-over-year inflation rate since 2000. As of May, the Eurozone experienced 6.1% inflation due to the added inflationary pressures resulting from the ongoing war in Europe.

Earnings Season

Corporate earnings have started with positive signs of resilience in the financial sector. JP Morgan, a key player, exceeded revenue expectations by 7.79% and adjusted earnings by 24.05%. Net interest margins widened, indicating improved profitability in the near term. Citigroup and Wells Fargo also reported modest positive surprises.

The strength in corporate earnings suggests a “soft landing” for the economy, with a slowdown but no recession. Among the companies that have reported in the S&P 500 in the second quarter, there have been +2.28% revenue surprises and +10.42% earnings surprises on average. It’s still early, so these figures may change in the coming weeks.

Wrap Up

Strong corporate earnings, a resilient labor market, and easing inflation provide a positive outlook for US markets. However, it is important to exercise caution and avoid excessive optimism, as inflation still needs to reach the target of 2%, which may not happen until around October 2023 to March 2024. The Federal Reserve’s messaging aligns with this outlook. Overall, there is reduced near-term uncertainty in financial markets, supporting the upward momentum in risk markets.

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