Conviction Stymied Amid Mixed Consumer Data

The U.S. equity markets headed into the weekend lower, snapping a three-week winning streak in the process, as investors weighed mixed reads on the all-important U.S. consumer, which appeared to add some uncertainty about the robustness of the economic expansion. June retail sales bounced back from the prior month's fall with help from clothing, restaurant, and online sales, but a preliminary read on consumer sentiment from the University of Michigan surprisingly fell amid the continued concerns about increasing inflation pressures. A revved-up Q2 earnings season and Fed Chief Jerome Powell's pledge of the central bank's focus on fostering a further recovery in the labor market in his testimony to Congress this week also remained in focus. Meanwhile, the persistent spreading of the Delta coronavirus variant may have also had a hand in keeping conviction in check. In earnings news, Alcoa Corporation bested Q2 forecasts and offered a positive outlook, while Alaska Air Group raised its Q2 guidance. Treasuries were little changed, and the U.S. dollar ticked higher. Gold dropped and crude oil prices nudged to the upside. Overseas, Europe finished mostly lower as some heavyweight sectors in the region saw some pressure, while markets in Asia finished out the week mixed.

The Dow Jones Industrial Average fell 299 points (0.9%) to 34,688, the S&P 500 Index declined 33 points (0.8%) to 4,327, while the Nasdaq Composite lost 116 points (0.8%) to 14,427. In moderately-heavy volume, 961 million shares were traded on the NYSE and 4.0 billion shares changed hands on the Nasdaq. WTI crude oil ticked $0.16 higher to $71.81 per barrel. Elsewhere, the gold spot price decreased $17.50 to $1,811.40 per ounce, and the Dollar Index—a comparison of the U.S. dollar to six major world currencies—rose 0.1% to 92.72. Markets were lower for the week, snapping a three-week winning streak, as the DJIA shed 0.9%, the S&P 500 moved 1.0% lower, and the Nasdaq Composite tumbled 1.9%.

Alcoa Corporation (AA $33) reported adjusted Q2 earnings-per-share (EPS) of $1.49, topping the $1.29 FactSet estimate, as revenues grew 31.9% year-over-year (y/y) to $2.8 billion, exceeding the Street's forecast of $2.7 billion. The company said it continues to expect a strong 2021 based on the continued economic recovery and increased demand for aluminum in all end markets, and it noted that the 2021 shipment outlook for all segments is expected to improve. AA added that in Q3 it anticipates continuing inflationary pressure on raw materials and energy. Shares were lower.

Alaska Air Group Inc. (ALK $56) raised its Q2 outlook, noting that operating cash flow results were better than expected as a result of strength in demand for future travel, improvements in affinity partner cash flows as consumer spend levels surpassed 2019, and other working capital tailwinds. Shares traded lower.

Q2 earnings season has kicked into high gear, and Schwab's Chief Investment Strategist Liz Ann Sonders delivers her latest article, Whole Lotta Love: Sentiment's Potential Warning, noting how investor sentiment has remained quite elevated over the course of the market’s 16-month advance. She adds that while we aren't seeing the broad-based euphoria that preceded the coronavirus crash in early 2020, several metrics underscore that investors are very optimistic in both their attitudes and positioning. Liz Ann points out that that has been the case for a considerable portion of the current bull run, and throughout that time, we would argue that strong breadth has shielded the market and prevented any choppiness from transforming into something more sinister. However, she notes that some short-term breadth metrics have started to weaken but, thus far, longer-term breadth is still healthy, with more than 90% of stocks in the S&P 500 above their 200-day moving average.

She concludes by saying, "Aside from wholly unpredictable virus-related factors, some negative catalysts could emerge in the form of hits to profit margins, a dialing back in future earnings estimates, and/or a faster-than-expected maturation of the business cycle. As we've continued to argue, the best preparation will continue to be discipline around diversification—not just related to sectors, but factors as well—and periodic rebalancing."

Find all our market commentary on our Market Insights page, including our latest podcast, Debt Ceiling Disruption: Volatility Ahead?, at www.schwab.comand follow us on Twitter at @SchwabResearch.

Retail sales stronger than expected, consumer sentiment due out after the opening bell

Advance retail sales (chart) for June unexpectedly rose by 0.6% month-over-month (m/m), versus the Bloomberg consensus forecast of a 0.3% decrease, while May's figure was adjusted lower to a 1.7% decline. Last month's sales ex-autos gained 1.3% m/m, compared to expectations of a 0.4% increase and May's figure was downwardly revised to a 0.9% decrease. Sales ex-autos and gas were up 1.1% m/m, topping estimates of a 0.5% gain, and May's reading was adjusted lower to a drop of 1.0%. The control group, a figure used to calculate GDP, rose 1.1% m/m, versus projections of a 0.4% rise and May's negatively-revised 1.4% decrease.

The Census Bureau said sales for clothing and at department stores rose solidly, along with sales at food services and drinking places, while nonstore retail sales—which included online activity—also gained ground. Sales of autos and parts, building materials, and furniture all declined.

The July preliminary University of Michigan Consumer Sentiment Index (chart) fell to 80.8 versus the Bloomberg estimate calling for an increase to 86.5 from June's 85.5 reading. The index fell to the lowest level since February as both the current conditions and the expectations components of the index deteriorated. The report noted that inflation has put added pressure on living standards, especially on lower- and middle-income households, and caused postponement of large discretionary purchases, especially among upper income households. The report also noted that consumers' complaints about rising prices on homes, vehicles, and household durables reached an all-time high. The 1-year inflation forecast jumped to 4.8% from June's 4.2% rate, the highest since August 2008 and above forecasts of 4.3%, and the 5-10 year inflation forecast ticked higher to 2.9% from the prior month's 2.8% level.

Rounding out the economic calendar, business inventories (chart) rose 0.5% m/m in May, matching forecasts, and following April's upwardly-revised 0.1% gain.

Treasuries were nearly flat after a rally as of late that saw yields decline sharply. The yields on the 2-year and 10-year notes were little changed at 0.23% and 1.30%, respectively, while yield on the 30-year bond ticked 1 basis point higher to 1.93%.

Schwab's Chief Fixed Income Strategist Kathy Jones discusses in her latest article, If the Economy's So Strong, Why Are Bond Yields Falling?, how the steep drop in yields has defied conventional wisdom. Kathy notes that it looks to us like the market moves reflect the view that the peaks in growth and inflation in this cycle have passed, and the prospect of tighter policy by the Fed would dampen the outlook for the economy. She adds that while we agree with that assessment longer term, we believe yields are now too low relative to the economic outlook and are likely to rebound later this year.

With inflation garnering high scrutiny and fostering some volatility in the markets, Schwab Center for Financial Research Fixed Income Director Collin Martin, CFA, discusses Treasury Inflation-Protected Securities: FAQs about TIPS. He points out that they can be a buffer against long-term inflation, but TIPS investing isn't always straightforward.

Europe mostly lower, Asia mixed to close out the week

European equities were mostly lower, as strength in the Consumer Staples and Real Estate sectors were overshadowed by weakness in the heavyweight Financials, Materials and Energy sectors. Information Technology and Consumer Discretionary stocks also traded lower to weigh on markets in the region. Investors sifted through economic data that showed U.S. retail sales in June came in much stronger than anticipated, but U.S. consumer sentiment for July unexpectedly fell amid near-term inflation concerns. In economic news in the region, Eurozone consumer price inflation rose in June, but decelerated from the prior month, and the region's new car sales were up 10.4% in June but did slow from May's 53.4% pace. The markets remained skittish, grappling with the implications of the spreading Delta coronavirus variant. The euro was little changed and the British pound lost ground versus the U.S. dollar, while bond yields in the Eurozone and the U.K. traded to the downside.

Concerns also remain regarding the implications of the Delta coronavirus variant and Schwab Chief Global Investment Strategist Jeffrey Kleintop, CFA, offers his latest article, Lockdown Leadership Unlikely To Last, discussing how in the last few weeks, stock market leadership reversed back to lockdown-era defensives as the stock market made new all-time highs. He adds that the defensive turn by investors may be prompted by the rapidly spreading Delta variant of COVID-19, but stresses how this year's swings between cyclicals and defensives, value and growth, and international and U.S. stocks exemplify the importance of holding a diversified portfolio to help reduce overall portfolio volatility. Jeff examines the potential causes of this rotation and if it will last or if cyclical stocks might make a comeback in the second half of the year.

The U.K. FTSE 100 Index was down 0.1%, France's CAC-40 Index fell 0.5%, Germany's DAX Index declined 0.6%, Spain's IBEX 35 Index traded 0.2% lower, and Italy's FTSE MIB Index lost 0.3%, while Switzerland's Swiss Market Index gained 0.4%.

Stocks in Asia finished mixed to finish another choppy week that saw the global markets pay some attention to more signs of rising inflation pressures in the U.S. and the counterintuitive response in the bond markets as yields continued to decline. Also, U.S. Fed Chief Powell provided two days of Congressional monetary policy testimony in which he acknowledged inflation pressures but continued to stress that they believe it will be transitory and it remains focused on the recovery in the labor market. In other monetary policy news, the Bank of Japan held its stance unchanged after reducing its GDP growth forecast. The markets also digested June trade figures from India, which showed export growth slowed but remained robust, after decelerating to a y/y pace of expansion of 48.3% following May's 69.4% gain.

With monetary policies in focus Schwab's Kathy Jones and Senior Fixed Income Research Analyst, Christina Shaffer discuss in their latest article, What’s Next for Emerging-Market Bonds?, noting that the landscape is changing for emerging market bonds, as China pushes harder on the brakes for new credit growth and a Fed policy change could potentially be a seismic event.

Japan's Nikkei 225 Index declined 1.0% even as the yen softened late in the session, and China's Shanghai Composite Index decreased 0.7%. The Hong Kong Hang Seng Index and India's S&P BSE Sensex 30 Index both finished little changed, while South Korea's Kospi Index dipped 0.3% and Australia's S&P/ASX 200 Index finished 0.2% to the upside.

Stocks mostly lower for the week as markets play a little defense

U.S. stocks ended a weekly winning streak at three, declining mostly as the markets contended with uncertainty regarding whether peak earnings and economic growth rates were registered in the first half that led to double-digit gains for stocks to start 2021. Moreover, the festering Delta coronavirus variant across the world also seemed to stymie conviction. The markets paid close attention to the two-day Congressional monetary policy testimony from Federal Reserve Chairman Jerome Powell, which came as the economic calendar continued to deliver signs that inflation is running hotter than anticipated, with June reads on consumer and producer prices topping forecasts again. Powell held the line, acknowledging higher inflation pressures but reiterating that the Central Bank sees this as transitory and the more pressing need from the Fed is continued support for the labor market. The Treasury yield curve continued to flatten as it seems the markets continue to buy into the transitory characterization of inflation and are focusing on the prospect for decelerating economic growth, which could be exacerbated if the Fed has to taper monthly assets purchases and then raise rates sooner than anticipated. The U.S. dollar moved higher on the week, and gold nudged to the upside. Crude oil prices fell sharply on the potential that oil supply could be ratcheted up as U.S. production may be on the verge of rebounding and amid reports that OPEC and its allies, known as OPEC+, may have reached a deal—after talks broke down last week—to increase production in the coming months.

Q2 earnings season kicked into gear, courtesy of banking sector heavyweights delivering results that were mostly better than expected amid strong investment banking and wealth management revenues. However, stocks shrugged it off amid the continued decline in bond yields, and as trading revenues were down noticeably from the extreme volatility seen in the same period of 2020. Moreover, lending activity outside mortgages has yet to heat up even as key U.S. consumer balance sheets remained robust. Although early and these rates are likely to change, of the 39 S&P 500 companies that have reported thus far, roughly 85% have topped revenue forecasts, and approximately 87% have bested earnings estimates, per data compiled by Bloomberg. Compared to the same period last year, sales are tracking to be up nearly 13.0% and earnings are so far about 139% higher.

As such, the markets took on a defensive tilt amid the continued flattening of the yield curve, the growth and Fed tapering timing uncertainties, and noticeable drop in crude oil prices. The Utilities sector outperformed and were among the few that posted positive figures, along with Consumer Staples and Real Estate stocks. However, Energy issues fell decisively and led the downside move, along with Consumer Discretionary, Materials, Industrials and Financials. The Information Technology sector was little changed in choppy trading after a recent rally that fostered a string of weekly gains and fresh record highs for the Nasdaq and the S&P 500.

Next week, earnings season in likely to continue to garner more market attention as it shifts into a higher gear, and with the Fed going quiet for the week ahead of the July 28 monetary policy decision. The economic calendar will also offer some data points that could foster a market reaction. Housing will be on display and will likely be scrutinized as the recent drop in interest rates bolsters affordability but this has been countered by extreme housing supply issues that has resulted in red-hot home prices. The July NAHB Housing Market Index will get the ball rolling and offer a read on homebuilder sentiment, followed by the June housing starts and building permits report, and will culminate with June existing home sales. Jobless claims for the week ended July 17 and the Leading Index for June may draw some attention, while the week will end with timely July preliminary reads on manufacturing and servicessector activity from Markit.

For a look at how the current market environment could impact the major market sectors, check out our video Sector Views: Tailwinds and Headwinds, and for analysis of our ratings of these sectors and our recent downgrade of the Energy sector read our latest commentary Energy Sector Turmoil: What Happened and What's Next?

Next week's international economic calendar will be headlined by a host of July preliminary Manufacturing and Services PMIs out of Australia, the Eurozone and the U.K., along with the European Central Bank's monetary policy decision. Other reports that are due out and deserve a mention include Japanese and Eurozone trade figures, Eurozone consumer price inflation statistics, and U.K. retail sales.

Important Disclosures

Schwab Center for Financial Research ("SCFR") is a division of Charles Schwab & Co., Inc. The information contained herein is obtained from third-party sources and believed to be reliable, but its accuracy or completeness is not guaranteed. This report is for informational purposes only and is not a solicitation, or a recommendation that any particular investor should purchase or sell any particular security. The investment information mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinions are subject to change without notice in reaction to shifting market conditions.

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Conviction Stymied Amid Mixed Consumer Data

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