CWS Market Review – July 18, 2023

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China’s Economy Misses Expectations

On Tuesday, the Dow Jones Industrial Average rose for its seventh day in a row. This is the index’s longest winning streak since 2021. Across those seven days, the index added more than 1,200 points. One of the old sayings on Wall Street is that good markets tend to build on themselves.

There’s some truth to this. Bespoke Investment Group said that this year was the 23rd year since 1945 that the S&P 500 rallied more than 10% during the first half of the year. Of those 22 previous times, 18 saw gains in the second half of the year. The median gain for the back half of the year was 10%.

Of the 55 years when the Dow lost ground or gained less than 10% in the first half of the year, the median second half performance was a gain of just 3.5%. Of course, we’re barely halfway through the year and a lot could happen between now and December 31.

Lately, the big concern hasn’t been about our economy. Instead, the worry is about China’s economy. Yesterday, the Chinese government said that its economy grew at a slower-than-expected rate for the second quarter. This was a bit of a shock. Analysts had been expecting an increase of 7.3%. Instead, it grew by 6.3%.

That number sounds healthier than it really is because it’s compared against a very weak number from a year ago when China was still locked down during Covid.

China’s sour news poses a novel issue for Americans. Many countries around the world have become used to having problems in their economies due to the U.S. economy having problems of its own. For Americans, however, this spillover effect is a new phenomenon. The idea that we can be doing everything right and yet some policy mistake in China redounds on us is rather new. We’re now just dealing with what everyone else has had to contend with.

The problems in China may get worse. The unemployment rate for people aged 16 to 23 is 21.3%. That’s a new record. The unemployment rate for people in cities was 5.2% in June. Earlier this year, China set a growth target for this year of 5%. That may have been overly optimistic.

A few months ago, China relaxed its Covid controls and that helped the economy get an initial boost, but that boost has clearly faded. In fact, the government recently said that China had 0% inflation for June. For the most part, the government has shied away from doing a large-scale stimulus program. It appears that shoppers in China are wary of buying more.

Many countries around the world depend heavily on growth in China to keep their own economies afloat. Plus, many jobs in developed nations have been outsourced to China.

The fear is that slower growth from China could help push the U.S. economy into recession, and this is happening at the same time the Federal Reserve is trying to kill off inflation. This could put the Fed in a tight spot with a need to cut rates at the same time it wants to fight inflation. Treasury Secretary Janet Yellen said that problems in China could impact the U.S. economy but not enough to push us into a recession. We’ll see.

A lot of observers are hoping for a soft landing in the U.S., but weaker growth from China could make that more difficult. It’s not a major problem yet for the U.S. but it could become one soon.

This is coming at the same time as earnings season starts. All in all, I think this will be a fairly mediocre earnings season for Wall Street. Some good and some bad, but it easily could have been a lot worse. For this earnings season, Wall Street expects a 9% drop in profits. If that’s right, then Q2 will be the worst quarter for GDP growth since Q2 2020.

We already have some early numbers. So far, 79.3% of reports have beaten their earnings estimates and 73.3% have beaten their revenues estimates. A total of 62.1% have beaten on both. That’s not bad, but it’s still early.

The major weak spot is Energy. That’s not a surprise. That sector is on pace to post an earnings drop of 48.59%. On the plus side, Consumer Discretionary looks to see earnings growth of 20%.

This earnings season is on track to be the third quarter in a row with an earnings decline. The silver lining is that Q2 will likely be the earnings trough.

Here are some key stats I got from John Butters at FactSet. Quarterly earnings growth for the S&P 500 has exceeded estimates 37 times in the last 40 quarters. Over the last ten years, the average earnings beat has been 6.4%. An average of 73% of companies have topped estimates. In other words, you’re expected to beat expectations. Over the past four quarters, earnings have beaten estimates by “only” 3.2%.

On Thursday, Abbott Laboratories (ABT) will be our first Buy List stock to report this earnings season. Three months ago, ABT topped earnings and the stock jumped 8% in one day. This time, Wall Street expects ABT to report earnings of $1.05 per share. My numbers say it will be closer to $1.10 per share. ABT is a very good company.

The U.S. Dollar Tumbles

One area of concern lately has been the slumping U.S. dollar. There’s been a lot of scaremongering about the “pending collapse” of the dollar for a long time. In fact, the dollar already gave us a bearish head fake a few months ago. I use these words cautiously, but this time may really be different.

With investors betting that the Fed’s rate hike cycle is coming to an end, and with possible rate cuts not too far off, this leaves the dollar in a tight spot. Bear in mind that rate cycles tend to last a few years rather than a few weeks. Traders see the Fed starting to cut rates in March of next year.

Currency traders aren’t wasting any time. The U.S. dollar is currently going through its worst drop since November and is now at its lowest level in more than a year. Not only is the dollar weak, but it may stay weak for some time. The recent drop has also helped spark gains in oil and gold.

The Fed meets again next week and will almost certainly raise interest rates by 0.25%, but what about after that? The outlook gets murkier, but the Fed may stay on the sidelines for several months.

The fear is that there could be a mismatch between Fed policy and the European Central Bank. For example, if the Fed calls off its inflation battle at the same time the ECB is hiking, that could lead to a dollar rout. I doubt it will happen, but it’s not an unreasonable fear.

Here’s a very ugly chart of the dollar versus the euro:

It’s hard to avoid the simple fact that the dollar is probably overvalued. Bloomberg notes that the real effective exchange rate for the Japanese yen is at its lowest point in decades.

We may be witnessing an unwinding of the “carry trade.” This refers to a strategy of borrowing in a low-yield currency like the yen and buying a higher-yielding one like the dollar. So far in 2023, this has been a no-brainer move but it may be coming to an end.

The yen-dollar is only one such pairing. Investors have also been playing the carry trade with emerging market currencies.

On Tuesday, we got the retail sales report for June. This is an important report because if shoppers are in a good mood, then the economy will likely do well. Unfortunately, shoppers were a little sluggish last month.

For June, retail sales rose by 0.2%. That’s not adjusted for inflation. Economists had been expecting an increase of 0.5%. The rate for May was revised to 0.5%. Consumer spending makes up roughly two-thirds of the economy.

Consumer spending tends to be tied to the strength of the labor market. The June payroll figure, while still positive, came in well below the figure for May. Gary Alexander reminds me that the Conference Board said earlier this year that a recession in the coming 12 months was 99% certain. The same group recently reported that their June Consumer Confidence survey turned positive for the first time since January of 2022.

Interestingly, Goldman Sachs just cut its odds of a recession happening over the next 12 months from 25% to 20%. I’m ready to christen 2023 “the year of the recession that never came.” We’ll know more on July 27 when the government releases its initial estimates for Q2 GDP growth.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

P.S. If you want more info on our ETF, you can check out the ETF’s website.

Posted by on July 18th, 2023 at 6:23 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.