July is another possible crossroads for the major indices, bringing a fresh round of earnings, worries about virus caseloads in parts of the country, and questions about whether government stimulus will stick around.
Early July could be choppy as market remains headline-sensitive to virus news
The market’s long recovery gained momentum for most of June before another virus-related stumble. Despite that, major indices remained close to 40% above the bedrock lows of late March, displaying healthy resilience in the face of new challenges.
July, though, brings its own set of question marks and possible cracks in the pavement as investors continue to nervously watch virus numbers and sift through what’s likely to be a dismal data landscape. The market is likely to remain headline-sensitive in the first half of July before earnings season as traders look for something to hang their hat on.
Sometimes, that ends up being the latest COVID-19 statistics, as we saw when nerves flared and the market plunged one day in late June in response to caseloads rising in Florida, Texas, and other southern states.
Possibly making matters rockier, July marks the end of several government programs that some analysts believe helped the economy maintain some equilibrium in these unprecedented times.
July also brings another round of earnings, and analysts think it could be the worst of the entire pandemic cycle. Companies will be reporting on results for the April through June period when much of the economy was shut down. The numbers will get a glance, as always, though investors might be more interested in outlooks for the second half and beyond. Last time out, guidance basically fell off the map. Will it make a comeback?
Geopolitics could also be in the mix this coming month as U.S./China relations grew more unsettled in June, the U.S. threatened new import duties on Europe, and OPEC continued its attempts to bring down crude production.
Last month in this column, we mentioned that an investor who’d gone away with no internet or TV and came back now could glance at volatility and crude to get a sense of how the market did. As of late June, the Cboe Volatility Index (VIX) hovered in the mid-30s, while U.S. crude clawed back above $40 a barrel for the first time since early March.
The VIX remains elevated compared with historic levels, but crude made a nice comeback in June—possibly a sign of better demand. That doesn’t mean July’s path is smooth, by any stretch of the imagination. Where will VIX and crude be in a month? Again, that could tell the story.
In sum, July finds Wall Street at a bit of a crossroads. There’s a tug-of-war going on between investors who see recent reopenings in an optimistic way, and people who are concerned about growing virus caseloads in many U.S. states that have some businesses—including big ones like Apple (AAPL)—closing doors in a few spots.
Basically, the search is on for who the winners and losers will be when things get back to some semblance of normal, and you can see that in the daily fight between “stay at home” and “reopening optimism” stocks.
It’s unlikely this trend will end in July, and at this point it’s the “stay at home” folks who seem to be pulling ahead. The Nasdaq (COMP) rose above 10,000 recently for the first time ever as major tech stocks—members of the NYSE FANG+ Index such as AAPL, Microsoft (MSFT), Amazon (AMZN), and Netflix (NFLX)—all hit new highs (see chart below).
FIGURE 1: TECH SURGE. After the last mini-selloff in May, the NYSE FANG+ Index ($NYFANG—candlestick) handily outpaced the broader market S&P 500 Index (SPX—purple line). Data sources: S&P Dow Jones Indices, ICE Data Services. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
So one thing to potentially watch for in July is more of this kind of action where the $1 trillion market cap stocks like AAPL and MSFT make big gains while most other sectors run in place.
When this happens, the major indices might not tell the real story. In a healthy market, it’s best to see strength across many sectors at once. There was some of that in early June as a few of the so-called “cyclical” stocks like Financials and airlines got a nice bid, but that didn’t really hold up through the entire month. It would be nice to see a more broad-based rally resume in July.
Whether the rally starts getting more democratic could depend in part on the force many investors love to hate: Washington, D.C. The initial mailing of $1,200 checks to many Americans might have helped support retail sales in May. Now there’s debate on Capitol Hill how and whether to send a new round of checks and whether to extend the current program of regular $600 payments to people who lost jobs. That additional payment program expires July 31.
Tenants of apartment buildings financed by a federally backed mortgage, such as Fannie Mae or Freddie Mac, couldn’t be evicted for failing to pay rent for 120 days, a grace period that ends July 25, under the CARES Act, USA Today noted. The Paycheck Protection Program (PPP) that provided forgivable loans of up to $10 million to about 4.5 million businesses, is also set to end by mid-July.
President Trump has said he’s interested in another round of checks for workers, and Congress has been debating possible stimulus, too.
The extension of these and other programs could affect consumer spending. People worried about their next paycheck or how to pay rent aren’t likely to purchase big-ticket items. That has ramifications across just about every S&P 500 sector, with more than 20 million Americans still unemployed even as some businesses start to come back. It also means a chance that economic data, which has trended mostly better lately, could start to slump again. We’re not out of the woods yet.
We’re also not out of the woods on the COVID-19 epidemic. Cases spiked in many U.S. states in June, and those headlines initially smacked the market with a 6% daily drop for major indices one day around mid-month. Things quickly came back, with the COMP making new highs as tech stocks gained. Cyclicals and small-caps, however, haven’t really regained the power they had a few weeks ago.
Toward the end of June, focus centered on negative virus news even while overlooking some positive developments. While stocks cratered June 24 amid worries about rising caseloads in Florida, there’s been a lot of improvement in major cities like Chicago and New York that were early hot spots, and now those cities are starting to reopen more. The question is whether they’ll also have setbacks the way areas in the southern U.S. seem to be having now.
The answer might not be known for several weeks, because that’s how long scientists say it can take for cases to show up after exposure. So mid-July— like in mid-June when southern states had been open for a few weeks—could present another reckoning point.
The pandemic is likely to take a huge toll on earnings, something investors will start seeing up close and personal in mid-July when Financial firms kick off Q2 reporting season. The Financial sector took a major hit from the pandemic in Q1 when big banks had to set aside huge amounts of money to protect their businesses from possible loan defaults, and there’ve been hints lately that more of this could be coming. For instance, shares of Wells Fargo (WFC) slid 8% in mid-June after the company’s CFO said WFC would have to divert more profits to loan-loss reserves in Q2.
Another brake on bank earnings could be net-interest income, which has been in the dumps ever since the Fed took interest rates down to zero in March as the central bank tried to prop up the economy. Despite this stiff headwind, it’s possible bank earnings could bring some positive news if some of the major bank CEOs sound sunny about the second half, so consider tuning in for earnings from JP Morgan (JPM) and others.
Speaking of rates, the bond market gave up some of its huge gains in mid-June as investor optimism stirred, then went right back to where it was before. The benchmark 10-year Treasury yield was on pace to end June barely changed, near a historic low of 0.7%. It had flirted with 0.9% a few weeks ago, and any move back toward that level in July could be a sign of new hopes for the economy.
It’s understandable if you’re getting tired of hearing about the sputtering economy after so many months of weakness. However, keep in mind that the abruptness and severity of the economic shutdown was one that can’t be restarted at the flick of a switch. All those moving parts need to be manually restarted. That takes time, and likely means more terrible data in July. There has been some improvement in the numbers, however, particularly for the housing sector.
June payrolls data kicks off the new month one day earlier than usual on Thursday, July 2 (it usually comes out on Fridays, but July 3 is when things shut down for Independence Day). The May report brought a welcome surprise with 2.5 million jobs added to the economy and an unemployment rate of 13.3% (though actually unemployment might be higher due to the pandemic’s impact on the Department of Labor’s collection methods). Could unemployment kick up in June to reflect those who didn’t get counted in May? We’ll find out July 2.
The report also could provide insight into whether reopenings in May and June led to more people getting hired back. It’s a little alarming to see some businesses shutting down again in places like Florida, though it’s unclear how much this might have hit jobs growth or if it will be reflected in the payrolls numbers.
For investors wondering if July can continue this long rally that’s brought the S&P 500 Index (SPX) up more than 40% from its March lows and the Nasdaq (COMP) above 10,000 for the first time, there are positive signs. For instance, some professional money managers say there’s still plenty of cash on the sidelines, potentially meaning less chance of another meltdown like a few months ago.
At that point, fear of the unknown—the pandemic—drove most of the selling and pushed major indices well below support levels as many investors sought “safety” in cash and bonds. Today, while there’s still no virus cure or vaccine, COVID-19 is more of a known quantity. That doesn’t mean investors can get sanguine about a pandemic that has killed so many, nor go “all in” on stocks at this point.
There’s just a growing sense that the pandemic’s biggest impact on the economy may be behind us, though suffering continues across much of the country. Another thing fueling those thoughts is that every recent market hiccup, including the one earlier this month that saw the SPX fall nearly 6% in one day, has met “buy the dip” sentiment.
While past isn’t necessarily predictive, having all the money built up on the sidelines—along with the so-called “Fed put,” in which the Fed has made clear it’s using all its tools to support the economy—could mean the market is fundamentally a little healthier now than when the crisis first hit. Also, the Fed’s constant chipping away at rates has left yields low across so many investable assets that stock market yields might entice some investors.
Some counter that valuations—especially in the tech sector—have gotten way out of whack. By most historic measures, that’s a pretty fair assessment. However, if you consider where interest rates are, some analysts think traditional measures of valuation don’t necessarily apply as much as in the past.
There is a chance, obviously, that all the stimulus could create inflation. When and how much is the question, though we’re unlikely to get the answers in July considering how weak the economy remains.
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