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Happy Sunday, friends! I hope you've all had a wonderful weekend. Next week promises to be quite busy, but before we dive into that, let's zoom out.
The Big Picture
Last week a lot of economic data came in. GDP was surprisingly strong in Q2 per this advanced reading, coming in at 2.4% vs expectations of 1.8%. Consumer spending and business spending were large contributors. Federal government spending dropped off from Q1 as we approach the fiscal impulse peak.
This economic recovery from the COVID crash has been the fastest since WW2 in nominal terms, with no small share of that driven by the roaring inflation we saw not too long ago.
Fortunately inflation has been slowing, particularly at the headline level. Though core remains sticky, above 4% year-over-year per PCE. Suggesting that the Fed still has more work to do. Which is exactly what Chair Powell reiterated last week, though it wasn't a particularly hawkish presser.
What's concerning is that disposable personal income is falling as outlays are rising. That suggests that we could see consumption trends flatten out or even fall later in Q3, particularly in areas of recent strength such as travel, leisure, restaurants, and other discretionary spending.
The fiscal spend from the CHIPS and Inflation Reduction Act has caused a surge in government spending that has helped to offset some of the impacts of the Fed's tightening on the economy. This has also slowed progress within the fight against inflation, extenuating some of the demand-side dynamics that exacerbated price pressure higher.
While inflation decelerated meaningfully, we're seeing some potential signs in the price of energy, including oil, gasoline and diesel, with the chart below illustrating the positive correlation between NY Harbor diesel and US CPI year-over-year.
Real wages just pushed into positive levels after two years of negative real earnings, providing a modicum of relief to earners that are beneficiaries of this trend. Though these benefits may be at least partially offset by the increased cost of servicing debt.
Consumer spending continues to rise the most in financial services and insurance; motor vehicles and parts; housing and utilities; recreation services; and energy.
There may even be a rebound in US ISM back into expansion, particularly given the amount of business equipment and transportation vehicles being purchased over the last month.
Looking at the S&P 500, forward 12-month EPS seems to be lagging the trajectory of the index itself, which along with valuations, suggest that stocks may be expensive here.
Though the most overvalued stocks are the so-called magnificent seven. Netting them out of the index leaves us with a forward P/E of 16.6. Not terribly expensive in comparison, but we are also seeing earnings down over 7% in Q2 so far for the S&P 500, suggesting that we're in the third quarter of an earnings recession.
Positive earnings surprises have been a key theme so far, with consumer discretionary, info tech, communications, and industrials leading.
We also see consumer discretionaries, communications, industrials, and real estate leading the way for EPS growth in Q2. On the other side, energy, materials, and health care are showing strong negative earnings growth.
As we move into August, we'll start seeing July's inflation prints and they may not be as cool as those in the prior months as beneficial base effects roll off and as we've seen rising prices in energy, softs, raw materials, and services during July.
Asian export growth remains negative across China, Japan, South Korea, and Taiwan, particularly due to subdued demand for many key areas of technology such as semiconductors vs 2022 this time.
Retail sales in the US have also dropped significantly year-over-year, suggesting that consumers are pulling back in nominal terms. In real terms, however, retail spending topped out in May of 2021.
