Stocks (NYSE: SPY) sold off on good news Friday, with an upgrade to Q1 GDP reported, and after banks were cleared by the Fed to do what they like with their capital. Still, stocks (NYSE: VTI) sold down all day, led by the valuation questioning of rich technology stocks (Nasdaq: QQQ). As we close out the first formal trading week of summer, it appears to me investors will begin to walk away for the season.
The news was priced into banks fully this week, as the Fed cleared big banks like Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), Bank of America (NYSE: BAC), Citigroup (NYSE: C) and Wells Fargo (NYSE: WFC) to do what they like with their capital. They can act on 100% of their intended dividends and share repurchases, which is the good news for shareholders. But there was an implicit message also for the economy, as banks (NYSE: XLF), free now to do what they like with their capital, are also freer to lend. As fully employed borrowers seek credit, this is a tangible catalyst for consumer spending (NYSE: XRT), home purchases (NYSE: XHB), etc. I believe the market should have continued to celebrate, but it did not.
If the economy is doing well, then the Fed is free to tighten monetary policy. As the cost of credit increases for corporate creditors, their cost of debt and equity both increase. The valuation extended among U.S. stocks are therefore due a reevaluation, and cash flows are not going to be discounted back as richly as they previously were. I believe this is the reason why a true sector rotation will occur here, whether you think Facebook (Nasdaq: FB), Amazon.com (Nasdaq: AMZN), Alphabet (Nasdaq: GOOG) and Netflix (Nasdaq: NFLX) deserve their multiples or not. I also have a tangible reason for investors to look out for a market correction this summer that I’ll speak about in a dedicated report shortly within my column here at Seeking Alpha.
Today’s Data Catalysts
The Personal Income & Outlays Report for May headlines the list of market-moving data today, and is easily the most important data point of the week. I covered the report for April, which should serve as (This Report Matters Big Time For Stocks) a good prep for this month’s data. This time around, economists expect personal income rose 0.3%, versus the 0.4% increase in April. Look for compensation inflation here; I will be. I’m expecting a pickup in inflation to be borne out of finally growing compensation on labor tightness. If we see more evidence of it here, it should matter to markets. However, the media and market tends to focus its attention to the other portions of this report.
Consumer spending is unfortunately seen gaining by just 0.1% this month, versus the 0.4% increase a month ago; note that gasoline (NYSE: UGA) prices were lower in May, but even lower in June. Still, the market needs to see healthy spending and would not be enthused by an inline reading here. Yesterday’s upgrade to GDP included an important improvement marked in consumer spending. If that is confirmed by fresh data here, the market should celebrate it. Still, I expect capital will flow out of valuation rich growth names (NYSE: XLK) nonetheless (read sector rotation).
The most important data out of this report for most will come in the form of the Core PCE Price Index. The Fed’s favored inflation gauge is expected to show just a 0.1% monthly increase, versus the 0.2% increase reported in April. On a yearly basis, the Core PCE Price Index is up just 1.5%, short of the Fed’s 2.0% target. I think we’ll see a healthier increase this month than expected, which is good for banks and bad for tech.
Inflation is your guide to the day and perhaps the month moving forward. To be quite honest, I’m not sure how a reading of 0.2% here would impact stocks. A reading short of that might serve stocks, and certainly tech stocks, as it would signal less aggressive Fed tightening. However, it also raises uncertainty, because the Fed is on record with somewhat steady plans and expectations for a pickup in inflation ahead. If that pickup is shown starting in May’s data, then stocks will likely sell off on concerns of inflation short of adequate economic growth, though the data appears to be improving.
All the other data today would normally not matter, but if the Chicago PMI data shows positively, it might help quell some concern. It’s a regional measure though, so its impact is limited. Economists see a 58.2 mark for June, down from 59.4 in May. Readings above 50 reflect economic expansion.
Before all is said and done Friday, all could be done for energy investors (NYSE: XLE) – I don’t think so. You can bet your life money managers won’t leave their desks for the beach or mountains until after the Baker Hughes Rig Count data is reported and market reaction is assessed. Big rig count (NYSE: XOP) gains are bad for energy markets, and could drive capital flows elsewhere again. But last week’s data showed a lighter rig addition, though still an addition.
Recently lower oil prices (NYSE: OIL) served to remind investors that there is a floor where new rig addition must ebb. Oversold oil, plus that fact, helped stir new bidding for the commodity and the sector. Still, the rig count figure cannot be too robust, or it will temper the fresh enthusiasm.
In conclusion, factors behind sector rotation seem to be embedding into this market, and so valuation rich ideas should continue to come under threat. Seasonal factors continue to weigh against equities more broadly, but healthier economic data can serve to curb their bad effects. I am risk averse here through the close of summer and suggest investors hedge risk through global asset diversification, cash holding and value seeking. For more of my work on markets, readers are welcome to follow the column here at Seeking Alpha.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.