Equity Overview

Consistent with the recent trend, growth stocks outpaced value stocks, and earnings surprises continued to drive superior stock performance.  All sectors in the S&P 500 recorded gains, except for telecom stocks.

Second quarter earnings reported in July were outstanding.  Since earnings are a prime driver of stock prices, our view is that these results explain the strong performance of equities in July. With 57% of S&P 500 companies reporting, the blended growth rate for Q1 earnings was 9.1%, well above the 6.6% rate projected at the beginning of the quarter.  In addition, 73% of companies reporting beat consensus earnings expectations, compared with the 70% one-year average.  Remarkably, 73% of companies reporting beat consensus revenue estimates, compared with the 56% one-year average.  If this number holds for the balance of the reporting season, it will be the highest percentage of revenue beats in 9 years.  As we have pointed out previously, earnings beats in recent years have often been driven by cost-cutting and automation rather than by increased sales, so the continuation of significant revenue gains in the second quarter is encouraging.

Macro Overview

Economic statistics reported in July were generally positive.  Manufacturing, durable goods orders, and consumer confidence were strong.  Employment growth rebounded with 222,000 new jobs versus expectations of 170,000.  The Commerce Department initial estimate of second quarter growth was 2.6%, in line with expectations and substantially better than first quarter growth of 1.2%.  However, retail sales were lower and existing home sales disappointed.  And a potentially troubling data point arose in the area of consumer credit, as the charge-off rate (the ratio of outstanding debt that U.S credit card issuers write off as a loss) increased in the second quarter to 3.29%, its highest level in four years.

The Fed kept interest rates unchanged and confirmed plans to begin downsizing its bond holdings soon.  It also noted that inflation remains shy of its 2% target (latest consumer price index was flat) but said that it expected an uptick.

The administration’s plan for the economy is in tatters, but the markets seem unconcerned.  The effort to “repeal and replace” Obamacare died in the Senate and is unlikely to be resurrected.  Headlines late in the month announced a “deal” on tax reform between Republicans in Congress and the White House, but specifics were noticeably absent—except that it definitely will not include the border adjustment tax on imports previously advocated by House Speaker Ryan.  Pronouncements that a broad tax reform bill would be passed this year were dismissed by commentators in terms ranging from optimistic to impossible.  Infrastructure investment has moved to the back burner, as the president’s recent press conference on the subject devolved into a defense of his widely decried comments on the Charlottesville violence.  And Congress will have a full plate when it returns in September, as it must pass a budget and increase the debt limit before the month-end deadline.

In international news, the recovery in Europe was highlighted in a lengthy article on Spain in the New York Times.  It pointed out that after a decade of economic catastrophe, the Spanish economy has returned to its pre-crisis size and is growing at the rate of 3% per year.