Hope you are all doing well. The S&P 500 posted its third positive weekly result in a row, gaining around 1%, and the NASDAQ added about 2%. The Dow on Wednesday climbed for the 13th trading day in a row, marking that index’s longest positive streak since 1987. The streak ended on Thursday, and the Dow finished up nearly 1% for the week. The heat wave and record high temperatures has been dominating the news this week so I have broken down this week’s update using things you’re not supposed to do in extreme heat.
Don’t overexert yourself
The Fed is trying to bring down inflation without exerting too much pressure on the economy. As expected, the U.S. Federal Reserve returned to rate hiking mode after pausing in June, as it lifted its key benchmark rate by a quarter-percentage point to the highest level since 2001. The increase to a range between 5.25% and 5.50% was the 11th hike since March 2022, when spiking inflation led the Fed to lift rates from a near-zero level. The Fed and markets will digest two more readings of the Consumer Price Index (CPI) inflation and two monthly U.S. jobs reports between now and the next meeting in September. Fed Chair Powell continues to repeat the same message that the Fed must continue aggressively fighting inflation. The markets think this is the last rate hike. Inflation is now well off its peak which is what is fueling that optimism. Headline CPI inflation has come down from 9.1% in June 2022 to 3.0% in this past June. The Fed is focused on core inflation and that remains elevated. People are still spending particularly on services. The spending is being driven by wage growth which has not shown meaningful signs of slowing. I continue to believe the Fed is likely to make good on their rhetoric, and might do an additional rate hike at one of the next two meetings hoping that it further cools core inflation.
Don’t drink sugary beverages
The U.S. economy has been on a bit of a sugar rush picking up momentum in the second quarter, easing anxiety about the prospect of a recession in the wake of interest-rate increases. GDP expanded at an annual rate of 2.4%. That is well above the consensus forecast of economists and it’s up from a 2.0% rate in this year’s first quarter. A glass of Kool Aid or cold Coke makes you feel good but could end up dehydrating you faster. Similarly, the GDP data make the economy seem great and feel as if there is no imminent risk. However, as mentioned earlier the economy is being driven by spending on services which still is benefiting from pent up post Covid demand. If services spending slows the economy could rapidly dehydrate
Don’t go out during the hottest part of the day
The sun is hottest during a 3 hour window right the majority heat in the market is being provided by just seven stocks. We had a great week of earnings reports highlighted by significantly positive reports from Alphabet (Google) and Meta (Facebook). Earnings are the biggest driver of stock prices. We are at about the midpoint of earnings season, companies in the S&P 500 are on track to record an overall decline in their profit margins for the sixth quarter in a row.
The average net profit margin halfway through earnings season was 11.1%, versus 12.2% in the same quarter a year earlier. Margins peaked at 13.0% in the second quarter of 2021. The S&P 500 is up about 19.3% so far this year which exceeds the rate of earnings growth. Could a correction be coming? If it does, any pullback is an opportunity to buy. The reason I feel that is because the S&P is up largely because of 7 stocks, Apple, Microsoft, Tesla, Meta, Alphabet, Amazon and Nvidia. Through the first half of the year the other 493 stocks increased just 2%. The seven aforementioned stocks are trading at prices close to 29 times what they are earning and we may get a short-term dip if investors start taking some profits from those stocks. The other 493 stocks are not overvalued at all and are trading at about 16.6 times their earnings. I am not advocating selling those seven stocks if you own them and almost all of you do either directly or indirectly through an index fund. Those seven stocks comprise about 27.5% of the S&P 500 index fund. If you have new money going to investments then now is time to look to complement these growth stocks with small-cap stocks and international stocks. For example, if 100% of your contributions in your 401k have been going into large company stocks it might make sense to change it so that a percentage of those contributions go into the small cap index and the international index.
Don’t be caught unprepared
The market is hot and inflation is the broken air conditioner that the Fed needs to get fixed before they can stop with the rate hikes. Stocks rallied Friday after the U.S. Federal Reserve’s preferred gauge for tracking inflation showed that consumer prices increased in June at the slowest monthly pace in more than two years. The Personal Consumption Expenditures Price Index rose at a 3.0% annual rate, down from 3.8% in May. Excluding volatile food and energy prices, core inflation rose 4.1% in June versus 4.6% in May. This is the number to watch. The Fed has repeatedly said they want to get this number to 2 percent. At 4.1% inflation is getting closer to the target but still has more to drop
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