Stocks advanced again in May, but the rally may be running out of steam. The S&P Composite 1500 rose 3.0%.
Large caps (specifically the megacaps) led the way. The S&P 500 gained 3.5%, but the Mid-Cap 400 lost 1.8% and the SmallCap 600 lost 2.5%.
The end of May pullback, which took the S&P 1500 down 2.1%, reversed course on May 31. Stocks gapped up on June 12 in reaction to a positive report on CPI inflation. The rally lost momentum as June came to a close, but it has resumed in the first trading days of July.
Market breadth has flattened out. Advancing vs. declining issues and volumes have been balanced over the past few weeks. Both the MidCap 400 and the SmallCap 600 have traded sideways for several months.
The S&P 500 remains in an uptrend, but its performance has been driven almost entirely by the 20 largest megacap stocks (and more specifically by the Mag 7).
In June, the 20 largest stocks gained 6.8%. With their market cap weighting of 36.8%, they contributed 2.5 percentage points (PP) to the S&P Composite 1500’s overall return of 3.0%.
By comparison, the remaining 1480 or so stocks in that index, which account for 63.2% of its market capitalization, rose 0.8% and contributed 0.5% to the Composite 1500’s overall 3.0% return.
The importance of the megacaps’ contribution to the index’s total return is evident in the quarterly and YTD figures. In 24Q2, the megacaps accounted for more than 100% of the Composite 1500’s 3.2% return, as the rest of the index posted a combined loss (from April’s correction). YTD, the megacaps contributed 10.5 PP or 78% of the Composite 1500’s price return of 13.5%.
By sector, Info Tech led the way in June with a 9.0% gain, but even excluding AAPL, MSFT, NVDA, AVGO and ORCL, the rest of Info Tech posted an impressive 7.8% return, accounting for all of the gain in the rest of the S&P Composite 1500 (and more).
Besides Info Tech, the four sectors with positive returns included Comm Services (up 4.6%), Consumer Discretionary (up 3.9%), Health Care (up 1.7%) and Real Estate (up 1.3%). The returns in three of those four sectors were driven by megacaps. (This can be seen clearly by comparing the second and third columns in the table to the left.)
Communication Services benefited from GOOG and META; Consumer Discretionary from AMZN and TSLA; Health Care from LLY and UNH (but not JNJ which posted a slight loss).
Real Estate delivered a 1.3% gain in June. That sector has no megacaps. Returns were fairly broad-based, with gains of 1.3% in large cap real estate stocks, 1.9% in mid-caps, but a 0.3% decline in small caps. Expectations that the Fed would begin lowering interest rates sooner than previously anticipated helped drive those gains.
Technicals. With the June rally extension and the uplift so far in July, the Index remains in an uptrend. It has established new record highs in each of the past three months. Given the narrowness of the rally, however, with the increasing reliance on a small set of megacap stocks, the lack of breadth and slowing upward momentum, the downside risks are increasing.
Fixed Income markets advanced by about 1.0% on average in June, as measured by broad-based indices like the Bloomberg Aggregate and ICE US Broad Market Index. By sector, U.S. Treasurys rose 1.0%, mortgages gained 1.2%, investment grade corporates increased 0.6% and high yield corporates were up 1.0%.
Longer duration securities outperformed once again. Among U.S. Treasury ETFs, the 20+ Year (TLT) gained 1.8%; the 7-10 year (IEF) rose 1.2%, the 3-7 year (IEI) increased 0.9% and the 0-3 year (SHY) was up 0.4%.
Volatility was elevated during the month. Bonds rallied sharply on the heels of the positive CPI print, with TLT up 5% at its peak on June 13. But after trading sideways for most of the rest of the month, bonds fell sharply in the final three trading days to close with only modest gains. They have since rallied sharply in the first seven trading sessions of July.
The Economy. Despite the resilience of the U.S. economy, more signs of underlying weakness are starting to appear. Most economic indicators point to slowing economic growth.
As of July 3, FRB Atlanta’s GDP Now report estimates 24Q2 annualized real GDP growth of 1.5%, down from 3.1% at the beginning of June. This decline was due primarily to reduced expectations for real personal consumption expenditures growth. FRB New York’s Fed Now tracker pegs annualized 24Q2 real GDP growth at 1.8% as of July 5, down from 1.9% on June 7. As of late May, the consensus of Blue Chip forecasters (via the Atlanta Fed) projects 24Q2 GDP growth of 1.4% to 2.6%, modestly below the previous range of 1.5%-3.0%.
Economic Activity. Personal income rose 0.48% in May and at an annualized three-month average (A3MoAvg) rate of 5.1% (up from 4.3% in April). This was a modest pickup from April but lower than the average in the first three months of the year. The A3MoAvg growth of employee compensation was 5.9%, even with April’s revised 5.8% rise.
Excluding employee compensation, the rates of change in other categories were mixed. Rental income’s A3MoAvg growth rate was 6.9%, slower than the double-digit increases seen earlier in the year and likely to slow further in June. Net personal current transfer receipts were up 6.0%, slower than April’s revised 8.3% on an A3MoAvg basis, as the rate has slowed steadily since January. Proprietors’ income was up 0.6%, and receipts on assets up 3.4%, both on an A3MoAvg basis. Non-employment based income accounts for about 38% of total personal income.
Personal current taxes increased at a slower pace than personal income in May, so the A3MoAvg growth rate of disposable personal income was 4.9%, higher than April’s 3.8%. Real disposable personal income was up 2.4%, higher than April’s revised 0.2% gain on the same basis.
Personal consumption expenditures rose 0.25% in May, faster than April’s revised 0.14% increase. The A3MoAvg rate of increase was 4.3%, down from April’s 5.6% The personal savings rate was 3.9% in May, up from 3.6% in April.
On balance, the slight pick-up in personal income growth and the persistently high growth in employee compensation, well above the current rate of inflation, should be a source of continuing concern for the Fed. June’s payroll data, discussed below, suggests that wage growth is easing, however, which is a positive sign. If the economy continues to slow as expected, personal income growth should ease in the months ahead.
Payroll Employment Growth Slowed in June, But Household Employment Turned Positive. BLS reported that payroll employment increased by 206,000 positions in June, slightly above economists’ expectations. Previous estimates for March through May were revised downward by 174,000. Household employment was estimated to have risen by 116,000. The unemployment rate increased to 4.1% from 4.0% in May. The labor force participation rate ticked up by 0.1 PP to 62.6%, but was unchanged from a year ago.
May’s average hourly wage increased 0.29% to $35.00, slower than May’s revised 0.43%. On an A3MoAvg basis, the average hourly wage rose 3.6%, down from 4.0% in May. Average weekly hours were unchanged at 34.3. Thus, average weekly earnings rose at an A3MoAvg rate of 2.4%, the slowest increase this year.
Until recently, payroll employment was running hot, but the pace of increases has slowed considerably over the past few months. In its analysis of the data, the New York Times and WSJ both noted that job increases in recent months have come from the healthcare and government sectors, which are not primary sources of employment, like manufacturing, that are key drivers of job demand in other sectors of the economy.
Readings for unemployment claims (from the Dept. of Labor) have been trending higher in recent weeks, but remain below year-ago levels. Continuing claims have risen to their highest level since November 2020. This suggests that those who have filed unemployment are finding it harder to get a job. Job cut announcements, as estimated by Challenger Gray & Christmas, declined 23.6% in June to 48,786 from 63,816 in May. So far this year, announced job cuts are down 5.1% vs. 2023. Even so, CGC said that hiring announcements are the lowest since 2016, which adds to the difficulty of finding work.
The ISM’s May Manufacturing PMI was 48.5, down 0.2 PP from 48.7 in May. This was the third consecutive reading below the neutral level of 50, signaling a slightly faster rate of contraction. The primary cause of the decline was a contraction in production, but the rate of contraction in new orders slowed considerably, which may temper the downside risk in manufacturing.
Industrial production was increased 0.9% in May after being flat in April. Among the major market groups, final products increased 1.0%, driven by a 1.3% increase in consumer goods; nonindustrial supplies production rose 0.6%; and materials increased 0.8%. Among the major industry groups, manufacturing rose 0.9%, mining 0.3% and utilities 1.6%. Year over year, industrial production was up 0.4%.
Railroad traffic rose 3.8% in June vs. last year, with carloads down 1.7%, but intermodal units up 8.7%. Total traffic is up 2.2% YTD, with a 4.5% drop in carloads more than offset by an 8.7% rise in intermodal units. The decline in railroad carloads, due entirely to coal, slowed in June. The rebound in intermodal is due to increased port activity (mostly rerouted containers from the Panama Canal) and gains vs. trucking. These trends have been evident all year. Although June was better than May, the gain in railroad traffic appears to be driven mostly by market share gains and not improved economic activity.
The seasonally adjusted annualized rate (SAAR) of Existing home sales declined 0.7% in May (vs. April) and was also down 2.8% YOY. YTD, sales are down 0.6%.
The median price of existing homes sold was estimated to have risen by 3.1% (from April) to $419,300 and 5.8% YOY. The average price increased 2.5% month-to-month and 7.5% year-to-year. The increase represents mostly a shift in the mix of sales to higher priced homes.
Unsold inventory of 1.28 million units rose 6.7% month-to-month and 18.5% year-to-year. The supply of inventory on the market was 3.7 months of sales, higher than April’s 3.5 months and the 5-year average of 3.0 months. The increase in inventories is helping sales of higher priced homes and is expected to ease the upward pressure on house prices, if it continues.
First-time buyers accounted for 31% of sales, up from 28% a year ago. Average days on the market were 24 vs. 18. All-cash transactions equaled 28% of sales, up from 25% last year. Individual investors and second home buyers accounted for 16% of sales, up from 15%. Distressed sales were 2%, unchanged from last year.
The NAHB’s Housing Market Index, a measure of builder sales sentiment, slipped two points in June to 43 (from May). Among its components, sentiment about current sales declined three points to 48; buyer traffic dropped two points to 28; and the outlook for sales six months out decreased three points to 47. Readings below 50 indicate that sales are expected to contract.
The seasonally-adjusted annualized rate (SAAR) of single-family housing starts declined 5.2% to 982,000 in May (from April). The SAAR of single-family permits decreased 2.9% to 949,000. Single-family completions were estimated at 1.03 million, down 8% from 1.12 million in April.
YTD, total housing starts are down 3.6% vs. last year, with single-family starts up 18.8% and multi-family starts down 39.3%. Single-family completions are down 0.4% YTD.
The SAAR of single-family houses under construction was estimate at 679,000, down 0.6% from April and down 2.0% YOY.
The estimated SAAR of new home sales decreased 11.3% to 619,000 in May (from April). However, the pace of sales for April was revised upward by 64,000. (February and March estimates were also raised.) Estimated actual (i.e. not seasonally-adjusted) sales of new homes are down 0.3% YTD. It is important to note that new home sales measure signed contracts, while existing home sales tally actual closings.
The Fannie Mae Home Purchase Sentiment Index (HPSI) increased 3.2 points in June (from May) to 72.6. The Index has been trending higher since October 2022; but is still well below its pre-pandemic peak of 92. 19% of consumers think that now is a good time to buy, up from 14% in May. Fannie Mae economists believe the HPSI is at a plateau. Sales should rise as mortgage rates decline, which Fannie Mae forecasts. However, consumers still believe that house prices and mortgage rates will continue to rise, which probably limits upside potential.
The Conference Board’s Consumer Confidence Index slipped 0.9 points to 100.4 in June. The present situation component increased from 140.8 to 141.5, while the expectations component fell 1.9 points to 73.0. Consumers were less certain about current and expected future business conditions. They were slightly more positive about the current jobs picture, but less certain about future jobs. They were also more uncertain about their income prospects. More said that their family’s current financial situation is good, but their outlook for the future was unchanged. Expectations for a recession declined.
More Good News on Inflation. The month-to-month change in headline CPI was 0.56% in May, the second best reading of the year. Core CPI increased 0.49%. Those readings brought the A3MoAvg rates to 4.9% for headline, down from 6.8% in April, and 4.1% for core, down from 5.7% in April. The easing of inflation was helped by declines in energy costs, non-food and non-energy commodities and non-energy services. Shelter costs, a persistent driver of inflation, eased slightly in May, as did medical care services costs and transportation services costs. Year-over-year, headline CPI inflation was 3.5% and core CPI inflation was 3.8%.
No matter how you view it, CPI inflation is still running well above the Fed’s 2.0% target. Given the persistence of shelter price increases and the recent bounce back in energy prices, I do not expect much improvement in June’s CPI, headline or core, when the figures are released tomorrow on July 11. The current consensus view of a 0.07% increase in headline CPI and 0.28% increase in core CPI, as compiled by FRB Cleveland, appear optimistic to me.
The personal consumption expenditures (PCE) price index increased 0.01% in May, compared with a 0.26% increase in April. The A3MoAvg increase in headline PCE was 2.4%, down 1.4 PP from 3.8% in April. The A3MoAvg rate for core PCE, which excludes food and energy, was 2.7%, down from 3.5% in May. Energy costs declined sharply in May. Housing costs are still increasing at a 5.00%+ clip; but services inflation, excluding energy and housing services, has fallen from around 5% to 3.25% in May.
Changes in commodity prices were mixed again in June. The CRB index declined 1.3%, reversing May’s 1.0% rise. Prompt month futures prices for crude and heating oil increased 5%-6.%, while gasoline futures rose 3%. The price of natural gas drifted up by 0.4%. Outside of energy, agricultural commodity prices were mixed, with rising prices for coffee (up 2.3%) and sugar (up 11.1%). Prices fell for corn (down 5.7%), soybeans (down 8.4%) and wheat (down 15.5%). Gold rose 0.3%, but platinum and silver declined 2.7% and 2.9%, respectively. The price of palladium increased 7.1%. Lumber and copper declined by 11.1% and 4.6%, respectively.
The Treasury Yield Curve. U.S. Treasury yields declined across the intermediate to long maturities in June. 1-month and 3-month T-Bill yields are little changed, but yields from 6-months to 30-years declined by 13 bp on average. The declines, especially on the shorter-end of the curve, reflect expectations that the Fed will begin cutting rates sooner than previously anticipated. Treasury yields have fallen another 8 bp on average in July (through July 10). The 10-year Treasury yield ended June down 15 bp to 4.36% and it has fallen another 8 bp so far in July to 4.28%, its lowest level since February.
Unsurprisingly, bonds prices and yields have fluctuated with inflation. After rising to the 3.40%-4.00% range in 22H2, on the tail end of the pandemic, the 10-year yield has traded between 3.90%-4.90% over the past year. It is now in the middle of that range. In a steady state economy with continued fluctuations in inflation, bond yields should continue to be rangebound. Developing economic weakness could lead to lower interest rates, as long as the value of the dollar does not decline sharply.
Handicapping a Possible Turn in the Financial Markets. Having led the stock market higher this year, many of the Mag 7 stocks are technically overextended: either at or near overbought levels. It seems likely that this excessive outperformance will eventually reverse, allowing the broader market to outperform the Mag 7 until a proper and more sustainable balance is restored. Whether that is achieved through sector rotation—where declines in the Mag 7 are partially or perhaps mostly offset by gains in the remaining stocks—or through a broad-based market decline—where the entire market falls, with greater declines in the Mag 7—remains to be seen.
Trends in the economy and exogenous catalysts, such as geopolitical events, will determine which of the two paths the market takes. Given the long duration of this economic upcycle and the high deficit spending that is now becoming embedded structurally into the economy, it seems likely that there will eventually be an extended period of economic weakness—a recession or worse; yet it is also possible that the economy can continue to grow, but with a higher rate of inflation.
For now, the subdued performance of the broader equity market, excluding the Mag 7, suggests that the economy and financial markets will continue to muddle along. Downside risks are increasing, however. I am not willing to bet on the continued outperformance of the Mag 7. I am also inclined to become more defensive in my stock recommendations. Bond prices, as noted, may continue to fluctuate with inflation; but bond yields are above the rate of inflation and so offer decent returns with less downside risk (especially in intermediate duration securities). If the economy decelerates at a faster pace, bonds across all maturities, should have upside potential, as long as inflation does not accelerate and the dollar does not drop sharply.
American Water Works (AWK) is flat on the year, compared with the S&P 500’s 18% total return. The stock and its water utility peers have suffered valuation multiple compression since the Fed began to raise interest rates. Despite this underperformance, the company has reaffirmed its long-term annual EPS growth guidance of 7%-9%.
The stock bottomed in mid-April with the rest of the market when interest rates peaked, and then surged nearly 20% over the next three weeks until early May. During that stretch, AWK’s stock also outperformed its peers. From a technical viewpoint, the stock has not yet broken its downtrend decisively.
As a result of that multiple compression, I lowered my price target from $150 to $142. The PT implies a forward valuation multiple of 25 times projected 2025 EPS of $5.67. That is in line with its current one-year forward EPS multiple, but above the peer group average of 21. The $142 price target represents a potential total return of 10.6%, including the stock’s 2.5% dividend yield. Accordingly, I am maintaining my performance rating on the stock of “2” (outperform).
Campbell Soup Company (CPB) The company has completed its acquisition of Sovos Brands, whose flagship is Rao’s premium pasta sauces (and related products). With the $2.9 billion acquisition, it has updated its fiscal 2024 financial guidance. It now anticipates 2024 sales growth of 3%-4%, up from –0.5% to +1.5% previously. Organic sales are expected to decline by 1-2 PP. Adjusted EBIT growth is anticipated to be 6.5%-7.0%, up from 3%-5%. Adjusted EPS is expected to be $3.07-$3.10, down from its previous guidance of $3.09-$3.15.
Updated for 24Q3 results and guidance, I now project fiscal 2024 GAAP EPS of $2.32 (down from $2.72), due mostly to higher than anticipated restructuring and acquisition costs, and non-GAAP EPS of $3.08 (up from $3.00). For fiscal 2025, I anticipate GAAP EPS of $2.65 and non-GAAP EPS of $3.23. My fiscal 2024 projections assume meaningful operating margin improvement—about 300 bp—on Sovos Brands’ historical results, as well as a 50 bp operating margin increase in Campbell’s base business.
Campbell’s stock is up about 8% YTD, about half of the S&P 500’s gain, but much better than peers’ average 6% decline. Based upon that improved relative performance and my projections, I have raised my price target from $50 to $52. The new price target equates to a one-year forward multiple of 19.5 times projected fiscal 2025 GAAP earnings of $2.65 and 16.0 times projected non-GAAP earnings of $3.23 (which is below the peer group average of 16.5). The revised price target equates to a potential return of 17%, including the stock’s 3.5% dividend yield. Accordingly, I am maintaining my rating of “1” (buy).
This is the full text of the M&P Monitor monthly newsletter (#18), published on July 11, 2024. Since the newsletter was published, the BLS issued its CPI report for June. The report showed that headline CPI increased 0.034% in June (from May) on a non-seasonally adjusted annual basis and core CPI increased 0.12%. On an A3MoAvg basis, headline CPI increased 2.38% and core CPI 2.44%, their best showings since November 2023. The report was much better than I had anticipated, but the financial markets sold off on the news, driven mostly by declines in Mag 7 stocks. Sectors that had been lagging, such as small caps, rebounded sharply.
July 13, 2024
Stephen P. Percoco
Lark Research
839 Dewitt Street
Linden, New Jersey 07036
(908) 975-0250
admin@larkresearch.com
© 2015-2024 by Stephen P. Percoco, Lark Research. All rights reserved.
This blog post (as with all posts on this website) represents the opinion of Lark Research based upon its own independent research and supporting information obtained from various sources. Although Lark Research believes these sources to be reliable, it has not independently confirmed their accuracy. Consequently, this blog post may contain errors and omissions. Furthermore, this blog post is a summary of a recent report published on this subject and that report provides a more complete discussion and assessment of the risks and opportunities of any investment securities discussed herein. No representation or warranty is expressed or implied by the publication of this blog post. This blog post is for informational purposes only and shall not be construed as investment advice that meets the specific needs of any investor. Investors should, in consultation with their financial advisers, determine the suitability of the post’s recommendations, if any, to their own specific circumstances. Lark Research is not registered as an investment adviser with the Securities and Exchange Commission, pursuant to exemptions provided in the Investment Company Act of 1940. This blog post remains the property of Lark Research and may not be reproduced, copied or similarly disseminated, in whole or in part, without its prior written consent.