The Heat is On

Summer is in full stride. People are out and about, and vacation mode seems to be setting in. Major League Baseball just had its All-Star game, also referred to as the Midsummer Classic. The Junior Olympics for Water Polo is in full throttle at Stanford. And the largest recreational swim meet in the country takes place in Moraga, California next week. Americans are at the beach, at the lake, some overseas, and others just taking a break from the daily grind. It’s Summertime USA.

It’s normal for things to heat up in July. The seasonal calendar dictates that. Things generally slow on Wall Street, but it was anything but slow this week. Summer 2022 has brought what feels like a standout Summer sizzle.

The Stock Market heated up this week. Tuesday was the explosive day, with the S&P up 2%. The Tech-heavy NAS was up 3%. Advancing volume was 96%. It was a Stock Market sizzle. That was the largest percentage of advancers since the Covid lows in 2020. The rally was very broad based, which we want to see. The Dow, S&P and Nasdaq are all moving above their 50-day moving averages for the first time since April. That’s something. It’s not insignificant.

The Tech-heavy NASDAQ soared 9% so far in July, heading into Friday. It was tracking its best month since 2020. It gave some of it back heading into the weekend. Importantly for risk appetites, the NAS has now outperformed the S&P by greater than 5% since late May. It had been left for dead. It was down over 30% at the lows. Tech has not been that cold since the Dot-com bubble burst. The NASDAQ Composite has dominated the Digital Age, with innovative growth companies seeing their stocks surge. Investors were jubilant, partying like it was 1999. Then things reversed hard as the Fed pulled the punch bowl. The crowd went from absolutely loving Tech for over a decade to fleeing it in panic in 2022. Equity outflows have been building. That’s generally when opportunity presents itself, when towels get tossed.

It’s the middle of Earnings Season. Expectations got pretty low. So far, earnings are coming in as expected, which is important for now. They are not worse. Remember, for the Market, it’s all about expectations. It’s not whether it’s good or bad. It’s better or worse. Growth has taken over Value at this stage of the Bear rally. The high beta, Growth areas fared the best this week. They have suffered the most in this Bear. Small Caps and Technology caught a bid. Health Care and Consumer Staples stalled. They’ve done much, much better in this Bear. They’ll do well again. On Friday, they already did.

Advertising budgets are getting cut. It’s a critical sign of corporate caution. Management cuts advertising first when concerned about an economic slowdown. Then they cut jobs. Weaker housing data earlier this week further highlighted that housing is leading the US Economy into a recession. Housing in America was white-hot. It’s not anymore. When people’s houses are worth more, they tend to feel wealthier and spend more. The opposite is true too.

The Bond Market has been rallying as it anticipates this economic slowdown will lead to a recession. The Market is looking past the Fed rate hikes and actually factoring in rate cuts in 2023. The 5-Year forward inflation rate is back down to 2.1%, exactly what the Fed wants to see to feel confident in its attempts to whip inflation. Looking backwards, inflation is hot. Out ahead of us, it looks much cooler.

Global warming is front and center again, with record heat in Great Britain, raging wildfires in Spain, a heat dome in the Midwest and rogue waves in Hawaii. London registered a temperature above 40 degrees Celsius for the first time in recorded history. That’s 104 degrees Fahrenheit. Considering London was founded in 47 AD, this first-time event seems sort of significant. Another thing to keep in mind, London is further north than any city in the Continental United States. Further south in Europe, Spain and Portugal saw temperatures reach 47 degrees Celsius (117 degrees Fahrenheit). The National Climate Assessment estimates 20-30 more days over 90 degrees Fahrenheit each year in most American regions by mid-century. I’m no meteorologist. But it sure does seem like Planet Earth is telling us something.

British inflation came in hotter than expected, hitting a fresh 40-year high of 9.4% on a continued surge in food and energy prices. Gas prices are sky high in Europe. They’re up 6X since the invasion of Ukraine. The main pipe for Russian gas to the European Union, known as Nord Stream 1, has been offline for most of the past 2 weeks due to its regular annual maintenance. Russia resumed gas flows to Europe this week. European leaders still expect Moscow to continue to weaponize energy exports. It’s only at 40% capacity right now. That can change quickly, in either direction, especially ahead of Winter when Europeans have depended on Russian gas to heat their homes. They will want the heat on. The clock is ticking on that.

Many were concerned it wasn’t going to be turned back on. Europeans use natural gas for everything from heating and cooking to electricity and power generation. Russia supplies Europe with roughly 40% of its natural gas imports. In Germany, it’s closer to 60%. This week Vladimir Putin said that Gazprom, which is the pipeline operator’s majority shareholder, has “always fulfilled its obligations.” But he also warned that sanctions could impact future flows. Everyone knows, Putin runs Gazprom.

Gas shortages have already undermined the Euro currency. It hit parity with the Dollar for the first time in 2 decades. It reflects the increasing risks of a European recession. Realistically, it’s already in one. The European Commission plans to press member governments to increase their energy conservation campaigns. Countries would be expected to reduce consumption by at least 15% over the next 8 months, while switching from natural gas to other energy sources like nuclear and coal. I say it often, the World still runs on Crude.

Chevron and Google teamed up this week with a substantial investment in a nuclear energy deal. They are backing a startup that is working on a nuclear fusion solution for sustainable and renewable energy. Nuclear fusion has been referred to as the “holy grail” of clean energy. If successful, it is believed to have the potential for unlimited emission-free energy without the toxic radioactive waste. As I understand it, fusion is the elemental process that powers the stars and the Sun, but has proven too difficult to sustain in a controlled reaction on Earth. Scientists have been trying for decades. Traditional nuclear energy is fission, which occurs when a larger atom is split into 2 smaller atoms. That releases the energy. Nuclear fusion reverses that process. Energy is produced when 2 smaller atoms are forced together, forming one larger atom. Google has been providing this startup with artificial intelligence and computational power for nearly a decade. This week marked Google’s first cash investment, which Chevron participated in too.

Back to the Market: The Dow, S&P and Nasdaq are all back above their 50-day moving averages for the first time since April. Calls for a Market bottom are already in. Panic subsided a bit. There’s nothing like price to change people’s attitudes. Bear Market rallies tend to do that. Just when you think everything is collapsing, a reversal higher takes place and sucks people back in. We definitely liked the price action this week. We just don’t think the Market is out of the woods yet and still consider this a Bear Market rally.

To be sure, things got so washed-out and sentiment has been beyond sour longer than any time in recorded history. That’s usually a recipe for bottoms. The problem here is earnings growth continues to slow. The Economy is slowing too. And the Stock Market is coming off some seriously inflated levels reached last year. I was reminded this week, 6-month Bear Markets, preceded by an asset bubble, do not exist. A firm bottom will come when the Market senses that growth stops going down while inflation stops going up. Key to this will be the Fed getting out of the way. The slowing earnings and economic growth are providing the data the Fed wants to see. They just need to see a sustainable trend which takes time. The Market seems to be in waiting mode for a big pickup in earnings activity. That won’t happen until 2023. But the Market will sniff that out well in advance.

Next week will be massive for Market activity. Half the S&P report earnings next week. Companies like Apple and Amazon, Coca-Cola and Exxon, Microsoft and Alphabet release their report cards. It’s going to be big. It will be led by the Tech Titans. What these companies release will go a long way to dictate the path forward. Then there’s this: The Fed holds its last meeting on monetary policy until September. What they say and what they do will move markets. This Summer volatility will most certainly continue. The rally ahead of these events could be setting up for a sell-the-news situation. You could hear and see the sizzle this week. You could feel the heat. We shall see if it’s sustainable. Keep those belts buckled.

Have a nice weekend. We’ll be back, dark and early on Monday.


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