A Sustainable Rebound?

HIGHLIGHTS:

• Stocks broke their four-day winning streak today, with communication services and materials sectors leading declines.
• Given the number of mixed market signals, investors are questioning whether this is a sustainable rebound.
• Stronger-than-expected earnings, a resilient consumer, and potentially slowing inflation are all positive factors for the recent leg upward in stocks.
• Recessionary worries, overly optimistic earnings expectations, and higher rates are all putting a damper on the party.

A recovery in stocks has quelled investor angst from markets sliding in the first half of the year. Market sentiment has cautiously grown as participants begin to think the Fed might actually get inflation under control, and while economic data has been wide-ranging, it hasn't turned completely sour just yet. As such, the S&P 500 has climbed over 15 percent from its June low, reaching back above the 4,200 level. However, after four consecutive positive trading sessions, stocks started today on uneven footing. All sectors except energy saw losses in trading this morning, led by declines in communication services and materials. Oil prices climbed to over $87 per barrel as traders expect China to boost its weakening economy. Meanwhile, bond prices fell as safe haven Treasury yields moved upward, with the benchmark 10-year heading back toward 3.0 percent. With so many mixed signals, it's been difficult to tell if this current leg upward in stocks is sustainable.

On the positive side, a few factors are fueling investor optimism. The foremost is the second-quarter earnings season results. S&P 500 companies grew their revenue by 14 percent and profit by 8 percent, surprising analysts and beating Wall Street estimates by a reasonable margin. Additionally, markets are predicting continued robust growth in earnings over the next 12 months. Another recent bright spot has been the consumer; today's July retail sales release showed shoppers remained resilient amid higher prices. Sales were flat overall, but excluding cars, retail sales grew by 0.4 percent compared to the month prior, beating the economist estimate of -0.1 percent. That resiliency, and the fact the US economy is driven primarily by the consumer, has kept forecasts for GDP growth in positive territory for 2022, despite the negative prints in the first half of the year. Last but certainly not least, the Fed may be getting inflation under control as rates increase and prices have shown declining signals, including a potential peak in the inflation rate.

Now we get to the tough stuff—the negative side. Those same forecasts for robust earnings growth for large companies may be a little too optimistic, with earnings projections that may seem unrealistic given the current headwinds for businesses and the economy. Economic data has been sour in a few areas outside the labor market. Just this week, the Empire Manufacturing survey for August came in at -31 compared to predictions for 5—which would have been at least somewhat positive. That decline in manufacturing sentiment could be combined with the negative GDP prints in the first and second quarter; when reviewed by the National Bureau of Economic Research, it could spell out an official recession, or at least one on the way. Similar to the positives, one of the largest factors is also a negative. The Fed has been battling inflation by hiking rates at one of the fastest paces in decades, which has led to higher borrowing costs and tighter money. Even then, inflation may be on its way down, but it's still growing at levels that worsen many people's financial wellbeing. For now, investors will be waiting on more data to have a more complete pros-and-cons list for the markets.

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