When bad news is bad news

After a quiet European session, stocks sank during US hours on Tuesday. The S&P 500 closed down more than 2%, with the Nasdaq down some 3%, both indices closing near their daily lows. This suggests that there wasn’t much buying interest in the market and could point to more declines as we move into the middle of the week. Growth lagged value, with big tech some of the largest losers of the day. Amazon and Facebook were down more than 5%, although they are flat in early market trading on Wednesday. The decline was not broad based, with the energy sector enjoying a decent rally, and financials and utilities managing to avoid larger losses that befell the consumer discretionary, communications and IT sectors. While the market reverted to its recent performance, after a brief respite from the decline, the key driver was another batch of weak macro-economic data, that off saet some of the good news about China opening back up again after its long Covid lockdown.

Why fundamentals remain key in these choppy markets

The major indices are extremely sensitive to news and data as the market assesses just how durable the recent rally in stocks was likely to be. It appears that a trio of negative US economic data knocked market sentiment. Data from the Conference Board, which found that US consumers’ confidence in the US economy had fallen further in June, to its lowest level in a decade, sent shivers down the spines of those looking for the market rally to last. The reading for consumer confidence also fell and comes hot on the heels after last week’s University of Michigan consumer confidence report, which fell to its lowest ever level for this month. The Conference Board report is interesting, firstly the expectations index fell sharply for June to its lowest level since 2013, while the present situation index declined only marginally. From a market psychology standpoint, why would anyone buy stocks if they think the economy will deteriorate from here?

Recession signals spread

Since so much of the global economy is driven by the US consumer, we all need to stand up and take note of this sharp deterioration in future expectations, which fell below 80, which suggests weaker growth in the second half of this year and is a clear recession signal before year-end. It is also worth noting that US consumers have cooled towards spending on big ticket items such as cars, homes and electrical appliances. Vacation plans have also been scaled back as higher prices take their toll. Thus, looking ahead, consumer spending and economic growth are likely to continue to face enormous headwinds in the next 6 months.

Depressed US consumer sentiment continues to dominate

The Conference Board data also told us that consumers are more pessimistic about business conditions in the next 6 months, 29.5% are pessimistic, up from 26.4% last month. 22% of respondents expect fewer jobs to be available in the short term compared to 19.5% last month. This comes on top of the University of Michigan gauge of Inflation expectations, which remain at a 40-year high of 5.3%, although they were revised down a notch compared to an earlier reading this month. Thus, with US inflation expectations unanchored compared to the Fed’s 2% target rate, it makes it unlikely that the Fed will respond to the weakening economic conditions by shifting to a less aggressive rate hiking cycle. That was the hope last week, when weak economic news was considered good news if it made the Fed less hawkish. Economic data in the last few days suggests that the Fed will need to keep hiking rates even if the US is heading towards a recession. This is a toxic combo and could dent sentiment towards risky assets as we progress through to the middle of the week.

Why markets won’t recover any time soon

Other factors weighing on the market include month end and quarter end, which could be causing liquidity to dry up. However, there is a good argument to remain cautious if you are a fund manager. For there to be a prolonged rally in risky assets we think that two things need to happen: 1, peak inflation, 2, a pickup in the macro picture and in economic data. Neither of these has happened, which is why the market is in ‘sell the rallies’ mode.

Earnings season: analysts in contradictory mood

Elsewhere, fears about the Q2 earnings season, which will kick off in the next two weeks, are also keeping traders on the side-lines. Nike didn’t help the situation when it released fiscal Q4 results that were below expectations and had a weaker than expected outlook for fiscal year 2023. Interestingly, industry analysts have an unusually high number of buy ratings for the S&P 500. More than 57% of all ratings on stocks in the S&P 500 are buy ratings, which is more than the 5-year average of 53%, according to FactSet. Added to this conundrum, analysts bottom-up targets for the S&P 500 on June 23, dipped below 5,000 for the first time since August 2021. However, analysts still think that stocks will rise by 30% from the June 23 low, in the next 12 months. So, either the analysts are all wrong, or a weak earnings season is short lived.

Overall, the usual suspects were higher on Tuesday, with energy, oil and the dollar surging ahead. Treasury yields rose, and prices fell, as the fears of an aggressive Fed came back to haunt the markets.