Market Digest: STZ, UTHR, NET

Summary

Halfway Home and in the Win Column: Our Monthly Survey of the Economy, Interest Rates, and Stocks The stock market is broadly higher as of mid-year. Some of the gain, particularly in top-performing sectors, relates to AI mania. Gains across the rest of the market, we believe, reflect increasing investor optimism that the Federal Reserve will finally pivot to accommodative monetary policy and enact one or more rate cuts by year-end 2024. Following slow and steady gains early in 2024, stocks were pressured in April by rising rates that hit levels last seen in October 2023. Stocks then rallied across May and June, as FOMO fever drove participation and investors anticipated lower rates. Stocks in 2024 have so far superseded the usual election-year jinx. The election is heating up, representing a challenge for the second half. AI continues to lead the market. We would like to see investors take profits in AI names, reallocate winnings, and enable improvement in sector breadth. That would be a highly encouraging sign as the traditionally slower summer months progress. The Economy, Interest Rates, and Earnings The third and final report of first-quarter GDP signaled cooling in the U.S. economy, particularly among consumers. While the consensus expects somewhat better growth in the second quarter, weakness in first-quarter GDP is a real concern and will be even more worrisome if it carries into 2Q24 and the second half. The final first-quarter 2024 GDP report showed growth of 1.4%, down from 3.4% growth in 4Q23. Ahead of the advance report release, the consensus call was for 2.4% growth in the first quarter. The increase in first-quarter 2024 GDP primarily reflected increases in personal consumption expenditures, residential and non-residential fixed investment, and state and local government spending. These gains were partly offset by a decline in private inventory investment, a category whose volatility has tracked the enormous swings in the domestic and global supply chains across 2021-24. Imports increased though not as much as initially reported; imports are a subtraction in the calculation of GDP. Personal consumption expenditures for 1Q24 increased 1.5%, down from 3.3% for 4Q23 and 2.2% for all of 2023. Spending on goods fell 2.3% in 1Q24, after rising 3.0% in 4Q23 and 2.0% for all of 2023. Durable goods spending fell a sharp 4.5% in 1Q24, much worse than the 1.9% decline initially reported; this category was up a robust 4.2 % for all of 2023. Non-durable goods spending for 1Q24 fell 1.1%. Following holiday strength in 4Q23, consumers pulled back sharply on goods spending in 1Q24 amid the withering effects of multi-year inflation. Consumer spending on services grew 3.3% in 1Q24, about in line with 4Q23 spending levels. Some of the growth in consumer services spending is driven by rent equivalent and insurance, two costs consumers cannot control and many cannot avoid. Without the rise in servicer spending, overall PCE would have been negative. The GDP report provided further evidence of the consumer under siege from multiple years of inflation. According to the Commerce Department, retail spending remains positive on an annual basis, but is growing much less than in 2023. We expect PCE within the GDP accounts to continue to send conflicting signals, with overall goods spending remaining under pressure. Non-residential fixed investment, the proxy for corporate capital spending, rose at a 4.4% annual rate in 1Q24, after rising 3.7% in 4Q23. Intellectual Property grew in high-single-digit percentages, while spending on Structures and Equipment was up in low-single digits. At least some of the growth in capital spending in the first quarter was the result of corporations facing higher costs for everything. PCE and non-residential fixed investment represent about four-fifths of gross domestic product in any quarter. In 1Q24, consumer spending added about one percentage point to GDP, while non-residential fixed investment added 0.6%. Residential fixed investment surprised with 16.0% growth in 1Q24, up from 2.8% growth in 4Q23. Although housing data in 2024 to date has been soft, Millennial demand for housing continues to intensify. With aging Baby Boomers locked into too-large homes by low mortgage rates, Millennials are turning to the new home market. An outlier data point in 1Q24 GDP was the export-import balance, which heavily favored imports. Exports grew 1.6% in 1Q24, while imports were up 6.1%. Given the higher dollar value of imports, the net exports-imports balance subtracted about two-thirds of a percentage point (65 bps) from overall 1Q24 GDP growth. We expect this category to remain volatile quarter over quarter, but we also look for exports to rebound amid global demand for U.S. technology products including AI gear. Another outlier, though less significant, was the change in private inventories. This category subtracted 42 bps from 1Q24 GDP growth, after reducing 4Q23 GDP by nearly half a percentage point. We look for private inventories to maintain the excessive volatility in this series that has prevailed since the pandemic. Overall government spending was up 1.8% and added one-third of a percentage point to overall growth. Federal spending declined 0.2%, while state and local government spending grew 3.0%. The price index for gross domestic purchases increased 3.1% in 1Q24, compared with an increase of 1.9% in 4Q23. And the PCE price index jumped to 3.4%, up from 1.8%, while the core PCE index reached 3.7% in 1Q24 from 2.0% in 4Q23. Outside the GDP accounts, indicators generally suggest deceleration, although growth continues at a subdued level. The consumer economy continues to send mixed signals, with sentiment in the tank and retail spending weak – yet jobs and wages still growing. The U.S. economy shocked with 272,000 new payroll jobs in May, well above the consensus call of 185,000. May’s increase in payrolls and revisions in March and April combined took the three-month average to 249,000, above the 12-month average of 232,000. The unemployment rate rose to 4.0% for May from 3.9% for April, in line with the level the Fed would prefer to see before beginning its rate-cutting campaign. Average hourly earnings increased 14 cents month-to-month for April and were 4.1% higher year-over-year. May annual wage growth rebounded from 3.9% for April, which represented the first sub-4% growth since June 2021. Annual wage growth continues to run above inflation, but the premium has narrowed. Retail sales in May were tepid for the second straight month. Retail sales for April, originally reported as unchanged from March levels, were revised to down 0.2% month over month. Economists expected a 0.3% recovery in May from weak April levels; instead, retail sales edged up just 0.1%. On a year-over-year basis, retail sales were up 2.3%; that is down from consistent mid- to high-single-digit annual growth across 2023. By contrast, industrial production showed recovery strength in May. Industrial production rose 0.9% month over month, much better than the 0.3% consensus forecast and up from 0.0% in April. Manufacturing output rebounded to 0.9% growth after declining 0.3% in April. And May Capacity Utilization was 78.7%, still below the long-run average but up half a point from April. Offsetting weakness in mining output, utility output should keep overall industrial production strong through the hot summer months. Straddling the commercial and consumer economies is housing. Notwithstanding the (possibly misleading) residential fixed investment data from 1Q24 GDP, the housing economy continues to struggle. Based on SAAR (seasonally adjusted annual rate), existing and new home sales are currently running at less than two-thirds of peak levels achieved in the immediate post-pandemic period. Existing home sales, which reached a peak SAAR of 6.6 million in January 2021, fell to a SAAR of 4.11 million for May 2024. New home sales, which reached a peak SAAR of 1.03 million in October 2020, dropped to 634,000 as of April 2024 – also running at 62% of peak levels. The upside of the depressed housing economy had been that consumers were spending elsewhere in the U.S. economy. Multi-month weakness in retail sales suggests that consumers are strained even without the costs accompanying home ownership. Given the realities in the present environment, Director of Economic Research Chris Graja, CFA, lowered the Argus forecast for 2024 GDP growth to 1.7%, from a prior 2.0%. Looking at the cadence for the year ahead, Chris expects quarterly GDP to grow in the sub-2% range across the first three quarters. Argus is then modeling 2.0% growth for 4Q24 as the first rate cuts lift spirits. Our expectations for 2025 GDP growth are in the 2% range. Given the overhang of high prices and interest rates, and with the consumer weary from years of inflation, our GDP growth forecasts for 2024 and 2025 are likely to remain volatile. We also continue to believe the U.S. economy can avoid recession in 2024, as it did in 2023 and 2022. The central bank started its rate-hiking campaign in March 2022 well behind the inflation curve. More than five percentage points later, the Fed halted in July 2023. At its mid-June FOMC meeting, the Fed voted to hold the fed funds rate steady at the 5.25%-5.50% tendency, as it has done for seven straight meetings since July 2023. In May, the FOMC statement noted ‘a lack of further progress toward the Committee’s 2 percent inflation objective.’ The language in the June FOMC report, by contrast, noted ‘modest further progress toward the Committee’s 2 percent inflation objective.’ On the downside, the Fed issued a new dot-plot that appeared to signal the likelihood of just one rate cut in 2024. Minutes from the June FOMC meeting sent a mixed message. The Fed’s preferred inflation gauge, the core PCE price index, rose 0.1% in May and was up 2.6% year over year. That was the lowest annual rate of change since March 2021, which was also the first time in the current economic cycle that inflation topped the Fed’s 2% target. The core PCE data confirmed inflation inputs from May CPI and PPI reported earlier in June. The May all-items CPI was unchanged on a month-over-month basis from April; on an annual basis, May all-items CPI at 3.3% was 0.1% better than expected. On a month-over-month basis, May core CPI was up 0.2%, the lowest level since June 2023. The annual change in core CPI was 3.4%, beating both the 3.5% consensus call and the 3.6% level from April. The producer price index also contained good news from further up the pricing pipeline. The all-items PPI unexpectedly fell 0.2% from April levels, much better than expectations for a 0.1% increase. The year-over-year change in all-items PPI was 2.2%, again much better than the 2.5% consensus. Excluding food & energy, the monthly change in PPI was 0.0% (vs. 0.3% consensus); and the annual change was 2.3% (vs. 2.4% consensus). Goods inflation has come off markedly, reflecting strained finances particularly for middle-income to lower-tier consumers. Everyone is being hit by still-high inflation in services categories such as car insurance – unavoidable for most people trying to get to work. Shelter costs are also persistently running ahead of the general inflation trend, rising 5.4% annually in the May CPI. If you take the current annual change in CPI and subtract the shelter component, the current inflation rate would be right at the Fed’s 2% target. Overall improvement in inflation is allowing market rates of interest to move down from spring peaks, even though they remain above optimistically low levels at the beginning of 2024. The 10-year Treasury yield was 4.29% at the end of June, down from 4.41% at the end of May and peak levels of 4.63% as of the end of April. The two-year Treasury yield was 4.70% as of the end of June, down 4.82% at the end of May and the peak level of 4.96% as of the end of April. The two-year Treasury yield has maintained its 40-basis-point (bps) premium to the 10-year yield. Our forecasts now call for twos-10s inversion to end in the first quarter of 2025 as the Fed implements its first rate cut; we had previously expected twos-10s inversion to end during 2024. Despite the Fed shifting from two projected cuts to possibly just one, Argus Fixed Income Strategist Kevin Heal continues to model two quarter-point rate cuts in 2024: once at the September meeting prior to the election, and again at the December meeting post-election. Each cut is expected to be 25 basis points, bringing the Fed’s central tendency to the 4.75%-5.00% level by year-end. As of the final trading day of June 2024, the CME Fed Watch tool shows a 60% probability of the Fed cutting the fed funds rate by 25 bps at the September FOMC meeting. By the December FOMC meeting, the Fed Watch Tool shows just a 5% probability that the fed funds rate will not be cut at all in 2024. Despite packing in two rate cuts in the final four months of 2024, the Fed is expected to proceed cautiously next year, according to Kevin Heal, with just two additional quarter-point rate cuts in 2025. Since the early part of 2023, the three Es – employment, economy, and earnings – have all been rising, superseding concerns about the two Is – inflation and interest rates. First-quarter 2024 earnings outpaced expectations, but continue to run below the double-digit growth that prevailed in the pandemic and immediate post-pandemic era. First-quarter 2024 S&P 500 earnings from continuing operations rose in mid- to high-single-digit percentages, according to our vendor survey. FactSet calculates that 1Q24 EPS were up 7%; and Refinitiv calculates 11% EPS growth. Bloomberg’s estimate was for 8% growth. Just over four-fifths of S&P 500 component companies exceeded 1Q24 earnings expectations. That is better than the five-year trend of 77% and the 10-year trend of 74% beating expectations. The magnitude of the beat is also above expectations. On average, companies reporting positive earnings growth have topped the 1Q EPS consensus by 8%; that is toward the top of the 5%-8% range of the past 10 years. The best earnings sectors for 1Q24 earnings season were in Communication Services, Information Technology, Utilities, and Financials; all rose in double-digits year over year. Utilities 1Q24 growth reflects an easy comparison against 1Q23, which was unseasonably warm. Sectors with moderate growth include Consumer Staples, Industrials and Consumer Discretionary. Sectors that have posted negative quarterly comparisons in 1Q EPS season include Materials, Energy, and Healthcare. We look for the Healthcare sector to snap back to growth in the remaining quarters of 2024. Based on the low level of earnings warnings from most parts of the economy, some estimate compilers are now looking for low-double-digit EPS growth in 2Q24. Yet recent earnings reports from companies exposed to the consumer retail economy have been disappointing; these include reports from Target, Nike, Levi Strauss, and others. Given that caution, Argus continues to model high-single-digit EPS growth for 2Q24. Argus then looks for low-double-digit earnings growth in 3Q24 and 4Q24. Overall, we look for high-single-digit EPS growth for both 2024 and 2025. This pace of EPS growth is built into our valuation model for the S&P 500. According to Argus President John Eade, our stock-bond barometer is near equilibrium. Given declining inflation growth and interest rates along with our forecast for high-single-digit EPS growth for 2024 and 2025, the total-return outlook for the S&P 500 is better than it has been since pre-pandemic days. A key risk to valuations would be earnings growth failing to meet the market’s targets and/or inflation or interest rates ticking higher. Any of those factors would result in elevated valuations and increase the risk of a selloff. Domestic and Global Markets Growth stocks sectors began to pull away from the broad market in May and extended that leadership in June. Wilshire Large Cap Growth is up about 24% in 2024, leading all indexes as investors continue to seek ways to play AI. The growth-heavy Nasdaq extended its advantage over the S&P 500, rising 18.6% as of mid-year. That put it more than three points ahead of the 15.3% year-to-date gain for the S&P 500. In the clearest sign of leadership change, Wilshire Large Cap Value lost ground in a rising market during June. Large-cap value was up 7.2% at mid-year, after being up 7.8% at the end of May. The equity market still shows signs of diversification, but breadth could be at risk in the second half. With investors focused on the giants, small-caps continue to underperform. The Russell 2000 was up less than 2% as of mid-year 2024. The DJIA is also lagging while rising just under 5% for the year. IPO prices are not exploding higher; M&A pric

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