- Weekly market focus
- U.S. factory orders expected to fall back and remain weak
- Expectations for Fed policy remain extremely dovish even though Brexit concerns die down
- Q2 earnings season starts next week
- Brexit concerns die down as markets realize it will be a long haul
Weekly market focus — The markets this week will focus on (1) the continued fall-out from Brexit as the UK tries to move towards a negotiating position and in the meantime tries to contain the economic and financial damage, (2) whether this Friday’s U.S. payroll report can recover to the expected level of +175,000 and dampen concerns about a U.S. hiring slowdown, (3) continued strong demand for U.S. Treasury securities as the 10-year yield last Friday matched the record low of 1.38% originally posted in mid-2012 in the wake of the financial crisis and Eurozone debt crisis, and (4) Q2 earnings season which unofficially starts this coming Monday with Alcoa’s report.
This week’s U.S. economic schedule is busy. Key reports include (1) Wednesday’s May U.S. trade deficit (expected a bit wider at -$40.0 billion versus April’s -$37.4 billion), (2) Thursday’s June ADP employment report (expected +160,000 after May’s +173,000), and (3) Friday’s June unemployment report. The June 14-15 FOMC meeting minutes will be released on Wednesday, but those minutes are largely moot given that the meeting occurred before the surprise Brexit vote on June 23. The Treasury on Thursday will announce the details of next week’s sale of 3-year, 10-year, and 30-year securities.
U.S. factory orders expected to fall back and remain weak — The market is expecting today’s May factory orders report to show a -0.8% decline, falling back after April’s increase of +1.9%. Factory orders ex-transportation in April showed a smaller increase of +0.5%. Expectations for a decline in today’s May factory orders report are based in part on the recent news that durable goods orders in May fell by -2.2% and by -0.3% ex-transportation. Durable goods orders account for more than half of the factory orders series.
Factory orders have been weak in the past 1-1/2 years due to the strong dollar, weak overseas demand for U.S. manufacturing exports, and the recessions in the petroleum and mining industries. However, there is some hope for an improvement in U.S. factory orders based on the ISM data. The June ISM manufacturing new orders sub-index rose by +1.3 points to the fairly strong level of 57.0, indicating that optimism is growing among manufacturing executives about new orders flow.
Expectations for Fed policy remain extremely dovish even though Brexit concerns die down — The markets remain extremely dovish about Fed policy even after Brexit concerns died down and global stock markets partially recovered. However, Fed policy expectations could easily turn more hawkish if this Friday’s payroll report is stronger-than-expected, putting the Fed back in the position of leaning toward a rate hike due to domestic macroeconomic conditions.
The federal funds futures market is currently discounting the chances of a Fed rate hike at zero for the next two FOMC meetings on July 26-27 and Sep 20-21. The market is discounting the chances at only 12% for a rate hike by the end of this year. The market is not discounting a 100% chance of the Fed’s next rate hike until September 2018, which is more than two years away.
Q2 earnings season starts next week — This will be a light week for earnings reports with only two of the SPX companies scheduled to report. However, Q2 earnings season then kicks off next week with Alcoa reporting on Monday. The market consensus is for Q2 SPX earnings growth to fall -4.0% y/y, the fourth consecutive quarter of negative earnings growth. The consensus is then for the earnings recession to end in Q3 with earning growth of +2.0%, followed by a substantial improvement to +9.5% in Q4.
On a calendar year basis, the market consensus is for SPX earning growth in 2016 of only +0.5%, which would be the second year of negligible growth after only +0.2% growth in 2015. The market consensus is then for earnings growth to jump to +14% in 2017, but those expectations are likely to be dialed back to a much more modest figure in the single digits as 2017 approaches. U.S. corporate per-share earnings growth continues to be supported mainly by stock buy-backs while total profits continue to be hurt by weak overseas growth, lackluster U.S. economic growth, and a generally strong dollar.
Brexit concerns die down as markets realize it will be a long haul — Brexit concerns last week died down as the markets recognized that Brexit will be a long and drawn out process. In addition, the markets were pleased by the fairly aggressive resolve shown by BOE Governor Mark Carney and UK Chancellor of the Exchequer George Osbourne to cushion the effects of Brexit on the UK economy. Mr. Osbourne over the weekend even floated the idea of cutting the UK corporate tax rate to 15% from 20% to encourage businesses to stay in the UK and perhaps to even attract new businesses to the UK.
Regarding Brexit, the UK’s first order of business is to name a new Conservative Party leader and prime minister, with that announcement expected by early September. Home Secretary Theresa May is currently in the lead by far with Ladbrokes giving her odds of 1/3 (75% probability) of becoming the new PM. Ms. May is seen as a pair of “steady hands” for guiding the Brexit process. She has said she would be in no rush to initiate the Brexit process and would not trigger the Article 50 Brexit notification before the end of this year. Meanwhile, Brexit-leader Michael Gove’s chances of becoming the next Prime Minister tanked last week with odds now of only 12/1 (8%). Andrea Leadsom moved ahead of Mr. Gove in the PM sweepstakes with odds of 3/1 (25%).
