Markets finished with strong gains garnered over a month which featured stellar earnings releases. Tech stocks overcame overvaluation fears over most of this period. However, profit taking and portfolio reshuffling toward the latter half of July meant that investors had to give up on some of these windfall gains. Most economic data released during this period was encouraging even as the Fed refrained from raising rates. On the flip side, attempts to push through a new healthcare law failed, casting aspersions on the Trump administration’s ability to implement its pro-growth agenda.
For the month, the Dow, the S&P 500 and the Nasdaq increased by 2.5%, 1.9% and 3.4%, respectively. The Dow’s great run was supported by excellent second-quarter earnings released during the month. Leading companies which posted better-than-expected earnings include the likes of AT&T (T - Free Report) , McDonalds (MCD - Free Report) , Boeing (BA - Free Report) , Verizon (VZ - Free Report) , Facebook (FB - Free Report) and Caterpillar (CAT - Free Report) .
However, the Nasdaq and the S&P 500 lost out on some of the gains made earlier in the month. Tech stocks initially gained on strong tech earnings expectations which were expected to justify high valuations for the sector. Gradually, investors took profits off the table by selling off tech stocks and this weighed on the broader markets, curbing gains for these two benchmarks.
Also, the Trump administration’s inability to repeal Obamacare hurt investor sentiment. Following this development, market watchers lost their faith in Trump’s ability to bring about tax reforms and increasing spending on infrastructural growth among other items on his pro-growth agenda. Moreover, the Fed’s call to leave rates unchanged aided rate-sensitive industries and helped in broad-based gains.
Bullish Domestic Data
The majority of the economic data released in July indicated that the economy was on a firm footing. The ISM Manufacturing Index increased to 57.8 while the ISM Services Index increased to 57.4 in June. Industrial production moved up 0.4% in June. Notably, durable orders rose by 6.5% in June, which represents the largest increase since Jul 2014. Also, the Leading Indicators Index increased by 0.6%.
On the negative side, factory orders declined by 0.8% in May while retail sales slipped 0.2%. CPI remained unchanged in June while core CPI gained 0.1%. PPI and core PPI gained 0.1% each.
GDP Rises in Q2
As per the advance estimate released by the Bureau of Economic Analysis on Thursday, the real gross domestic product (GDP) increased at an annual rate of 2.6% in the first quarter of 2017. This was higher than analysts’ estimates of an increase of 2.5%. Further, it is nearly double the downwardly revised 1.2% pace of growth recorded in the first quarter.
A rebound in consumer spending helped boost overall economic growth. Consumer outlays grew 2.8% in the second quarter as Americans spent more on healthcare, groceries and clothes. Spending rebounded during the quarter, buoyed by an uptick in household finances, in turn powered by a buoyant labor market. Disposable income adjusted for inflation saw the best back-to-back quarters this year since the first half of 2015. (Read: US GDP Crosses $19TN for the First Time: 5 Best Gainers)
Housing Sector Improves
Overall, data on the housing sector was bullish in nature. Housing starts increased by 8.3% from May. This represents a 2.1% annual increase, the highest recorded in four months. Building permits also increased, by 7.4%. Pending home sales increased by 1.5% in June, ending three successive months of losses. New home sales increased by 0.8% in June, representing the second successive month of gains.
On the negative side, existing home sales lost 1.8% in June, following a record spike in home prices. More significantly, the NAHB Housing Market index lost 2 points to touch 64 in July. This is the lowest level recorded since Nov 2016. A spike in building material prices, particularly lumber was believed to be responsible for the decline.
Job Additions Rise, Unemployment Inches Up
According to the U.S. Bureau of Labor Statistics the U.S. economy added 222,000 jobs in June, much higher than the consensus estimate of 174,000. The addition of 222,000 jobs marked the second-biggest job gains of the year.
Meanwhile, unemployment rate increased marginally from 4.3% to 4.4% in June, as more people came into the labor force searching for jobs. The "U-6", considered to be a broader measure of the unemployment as it includes those workers who are working part-time for purely economic reasons, increased to 8.6%.
Payrolls data also showed that average hourly wages increased 0.2% to $26.25 against the consensus estimate of a rise of 0.3%. Hourly pay has experienced an increase of 2.5% over the last twelve months. Additionally, the labor force participation rate for June increased marginally to come in at 62.8%.
Earnings Expectations Power Tech Rebound, Volatility Persists
Tech shares began to rebound early in the month, with the Technology Select Sector SPDR (XLK) advancing by 1.2% on Jul 7. Investors regained their faith in tech shares after the sector suffered several setbacks following concerns over exorbitant valuations. Powering these gains were expectations of a stellar earnings show from big tech names. Market watchers believe that such a strong performance would justify the valuation levels of tech stocks.
Ultimately, Intel Corp (INTC - Free Report) Microsoft Corporation (MSFT - Free Report) and Facebook’s earnings surpassed estimates and delighted investors. In contrast, Amazon.com, Inc. (AMZN - Free Report) posted a disappointing performance. As of Jul 28, we have Q2 results from 66.1% of the technology sector’s total market cap in the S&P 500 index. Total earnings for these Technology companies are up +18.8% from the same period last year on +8.4% higher revenues, with 87.1% beating EPS estimates and 87.1% beating revenue estimates.
Consequently, the Technology Select Sector SPDR is up 4.5% and leads gains for the S&P 500’s sectors. However, overvaluation concerns have returned to haunt tech stocks on occasion, raising volatility levels for the sector.
Q2 Earnings Likely to Set New Record
The Q2 earnings season, which has crossed the half-way mark already, reconfirms the positive earnings picture that emerged as a result of the preceding reporting cycle. With results from 286 S&P 500 members out as of Jul 28, total earnings are up +11.3% from the same period last year on +6.1% higher revenues, with 74.5% beating EPS estimates and 69.2% beating revenue estimates.
Total Q2 earnings for the index are currently expected to be up +9.2% from the same period last year on +5.0% higher revenues. At the start of the quarter, the expectation was for earnings growth of +7.9%, which came down as the quarter unfolded, reaching as low as +5.6% just ahead of the start of the reporting season.
Since plenty of results are still to come, the actual Q2 earnings growth could very well go above +10%, which will follow the +13.3% earnings growth in the preceding quarter. The deceleration in Q2 earnings growth notwithstanding, the quarter’s earnings tally is on track to reach a new all-time quarterly record, surpassing the 2016 Q4 level, as you can see in the chart below. (Read: Q2 Earnings Season Past the Halfway Mark)
Minutes of June 13-14 Federal Open Market Committee meeting were released during the first week of the month. Minutes showed that “several” officials supported paring back of Fed’s $4 trillion-plus bond portfolio within a “couple of months”.
Meanwhile, several Fed officials raised concerns over the impact of Fed’s policy measures on financial markets. Officials indicated willingness to hike key interest rates further this year despite recent soft readings on inflation. Even though inflation is still short of central bank's target of 2%, Fed officials believe inflation will reach its targeted level by 2018.
Fed Leaves Rates Unchanged
The Fed opted to leave interest rates unchanged at the end of its two-day policy meeting on Jul 26. The Fed maintained the benchmark lending rate and hinted that it will start trimming its $4.5 trillion balance sheet in "relatively soon". Market watchers believe that such language indicates that the Fed will begin the process of unwinding in September. Additionally, the central bank’s statement dropped the word “somewhat” from its June statement instead choosing to directly state that inflation continued to remain "below 2%".
This only represents a slight shift but is significant because it acknowledges a negative view on one of the Fed’s key objectives. The Fed’s recognition of low inflation levels bodes well for rate-sensitive sectors.
5 Star Performers for July
I ran a screen on Research Wizard for companies with the following parameters:
(Click here to sign up for a free trial to the Research Wizard today):
- Percentage price change over the last 4 weeks greater than or equal to 20%
- Forward price-to-earnings ratio (P/E) for the current financial year (F1) less than or equal to 20. This picks out stocks that are good value choices
- Expected earnings growth for the current financial year greater than or equal to 20%
- Zacks Rank less than or equal to 2: This ascertains stocks that have shown above-average returns over the last 26 years.
(See the performance of Zacks’ portfolios and strategies here: About Zacks Performance).
Here are the top 5 stocks that made it through this screen: (As of 31st July, 2017)
Applied Optoelectronics, Inc. (AAOI - Free Report) designs, develops and manufactures advanced optical devices, packaged optical components, optical subsystems, laser transmitters and fiber optic transceivers.
Price gain over the last 4 weeks = 58.8%
Applied Optoelectronics has a Zacks Rank #1 (Strong Buy) and its expected earnings growth for the current year is more than 100%. The stock’s forward price-to-earnings ratio (P/E) for the current financial year (F1) is 19.69x.
SSAB AB SSAAY engages in the provision of steel and construction solutions and is based in Stockholm, Sweden.
Price gain over the last 4 weeks = 42.9%
SSAB has a Zacks Rank #2 (Buy) and its expected earnings growth for the current year is more than 100%. The stock has a P/E (F1) of 17.86x.
xG Technology, Inc. is engaged in developing communications technologies for wireless networks
Price gain over the last 4 weeks = 40.5%
xG Technology has a P/E (F1) of 2.29x and its expected earnings growth for the current year is more than 100%. The stock holds a Zacks Rank #1.You can see the complete list of today’s Zacks #1 Rank stocks here.
Tosoh Corporation TOSCF is a chemical company, based in Tokyo, Japan. Its primary products include ethylene, polyethylene, caustic soda, vinyl chloride and fine chemicals.
Price gain over the last 4 weeks = 36.1%
Expected earnings growth for current year = 14.4%
Tosoh Corp holds a Zacks Rank #1. The stock has a P/E (F1) of 9.66x.
KEMET Corporation (KEM - Free Report) , along with its subsidiary companies, is the world's largest manufacturer of solid tantalum capacitors and one of the world's largest manufacturer of multilayer ceramic capacitors.
Price gain over the last 4 weeks = 32.9%
KEMET Corp holds a Zacks Rank #1 and its expected earnings growth for the current year is more than 100%. The stock has a P/E (F1) of 18.65x.
Will Gains Continue in August?
Investors can breathe easy now that tech stocks have mostly overcome overvaluation fears. Strong earnings performances from leading tech names have gone a long way toward dispelling such doubts. Meanwhile, the Fed’s call to leave rates unchanged has also been welcomed by market watchers. Economic data has also mostly been bullish.
The only likely downside for stocks at this point is the Trump administration’s failure to push through its pro-growth agenda. However, given the predictability of such reverses, investors are likely to price in this factor sooner rather than later. In any case, these developments have had little material impact on the month’s proceedings. This is why gains for stocks are likely to continue in August, powered primarily by stellar second-quarter earnings numbers.
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