Weekly Hard Asset Insights
By David McAlvany
Earnings, FOMC, and the Weight of Expectations
Asset markets delivered another volatile week to close out the month of July. While the volatility didn’t match the extremes of the prior week, the S&P 500 still offered a bit of a rollercoaster ride to thrill the crowd. The S&P sold off early, then rallied to yet another all-time high before more weakness on Friday sealed a lower close for the week. Once again, we saw some of the fingerprints of fear on Friday. Friday featured selling in stocks, especially tech, and most metals, while the VIX, the dollar, and bonds rallied with a risk-off bid.
Despite trading lower on Friday, gold was positive for the week. In addition, this week, the gold complex offered a notable change in character from the recent past. Since the June “hawkish” FOMC meeting that triggered an aggressive sell-off in precious metals, the mining stocks were disproportionately hammered lower, dramatically underperforming physical metal. This week, however, we saw a meaningful reversal to that trend as the HUI gold mining index outperformed physical by 5%. While it’s entirely possible that the relative strength in the mining stocks could soon reverse again, the character change bears watching, and may well be a hint that the metals complex is ready to wake up a bit. Some of the character change in metals may reflect a slight change in the perception of FED messaging in the wake of the FOMC meeting this week.
In that meeting, Chairman Powell seemed to place more emphasis on the need for more labor market recovery improvements than on inflation risks. Mr. Powell also displayed greater concern for the increasing risks to economic growth posed by the Delta variant in the second half of this year. This combination was quickly interpreted as dovish, as these risks seemed to outweigh any inflation concerns. The implication for market participants trying to read between the lines was a wiggle back into the direction of expecting low interest rates and stimulus for longer. For market participants, the perception of a FED most focused on an elevated level of labor market concerns and growth risks translates to a longer expected wait for the “substantial further progress” the FED wants before pursuing tapering.
Moving right along to other market happenings, it’s earnings season again and we’re now into the meat of corporate reporting. At about halfway through earnings reports, with the notable exception of several big tech names, the results have been very positive. Thus far, as has been the case for the last several quarters, analysts have substantially underestimated corporate performance. According to data firm Refinitiv, earnings are coming in 18% above expectations. That performance is well above the historic norms of 3% to 5% above estimates. Corporate revenues are outperforming as well. So far, revenues are coming in 4.6% above expectations, which is four times the historical average of 1.1% above estimates.
A widely held view among economists and market participants in 2021 has been that economic activity and earnings growth would peak in the second quarter. So far, however, analysts again appear to be underestimating the strength of the continued corporate recovery of the first half. The better-than-expected results are already triggering a momentum-based wave of analyst revisions higher for corporate performance in the second half of the year. The positive analyst estimate revisions are also now bleeding into 2022. According to Nick Raich of The Earnings Scout, “…estimates for the second half are rising on a daily basis, and the 2022 numbers will likely go up as well…the estimates are still too low.”
This momentum towards positive corporate earnings revisions for the second half of the year and into 2022 creates an interesting dynamic given that we’ve been seeing an opposite trajectory in GDP and GDP estimates. Just this week, data released by the Commerce Department showed that America’s economy is recovering at a slower-than-anticipated pace. GDP during Q2 rose at a brisk 6.5% pace, but that was a big miss, coming in substantially under analysts’ estimates of an 8.4% growth rate. The number is only slightly better than Q1’s revised GDP growth of 6.3%, and indicates a distinctly slower growth rate that now appears poised to decline.
Throughout the Covid recovery, we had been seeing among economists a consistent trend of upwardly revised 2022 GDP forecasts, but even before this week’s GDP release, the trend had stalled at about 4.1% and appeared poised to turn downward. This week’s big GDP miss will likely translate into a slew of negatively revised forward GDP estimates as economists pick up on the increasing evidence of a decelerating rate of growth that’s now at risk of turning negative. At the same time, CPI inflation forecasts for 2022 have been accelerating rapidly in recent months.
The incendiary combination of increasing corporate earnings expectations, decreasing GDP forecasts, and rapidly rising inflation expectations paints a very interesting dynamic for the stock market through the end of 2022. The dynamic suggests the risk that corporate earnings may be perfectly teed-up to disappoint, as growth drops and costs rise in the face of blue sky expectations in the current mind of the market. If that scenario indeed plays out, it suggests an added 500-lb weight on the back of a market already carrying record high valuations and record high macro risks. This scenario would similarly place a seriously complicating heavyweight brick on the back of a FED attempting a perilous tightrope walk.
As for weekly performance: The S&P 500 closed the week down 0.37%. Gold was higher by 0.85%, and silver was up 1.27% on the week. Platinum was off to the tune of 1.27%, while palladium was lower by 0.23%. The HUI gold miners index had a good week, up 5.71%. The IFRA iShares U.S. Infrastructure ETF was up 1.97%. Energy commodities were mixed on the week. Oil rallied by 2.61%, while natural gas prices backed off by 2.73%. The CRB Commodity Index was up 2.13%, and copper was up 1.82%. The Dow Jones U.S. Real Estate Index ended the week up 0.35%, while the Dow Jones Utility Average Index added 0.32%. The U.S. Dollar Index lost 0.80% to close the week at 92.19. The yield on the 10-year Treasury lost 6 bps to close the week at 1.24%.
Have a great weekend!
Best Regards,
David McAlvany
Chief Executive Officer
MWM LLC
