Energy Boost: Early Strength Reflects Surprise Increase In GDP Estimate, Micron Earnings, Bank Stress Tests

(Thursday market open) As the second quarter and first half of the year wind down, stocks have a firmer tone early Thursday after a surprise upward adjustment to the government’s Q1 Gross Domestic Product (GDP) estimate.

The government raised its third and final estimate for Q1 GDP to 2% today, from the previous 1.3%. That’s rare, as usually these final estimates don’t depart much from the second one. The revision primarily reflected upward revisions to consumer spending and exports, the Bureau of Economic Analysis (BEA) said. While a stronger economy sometimes raises worries about rate increases, currently the market seems to be treating good news as good news.

Today’s early strength could also partially reflect solid earnings released late Wednesday by semiconductor company Micron MU. Shares are up across the chip space in premarket trading. In addition, financials stocks are getting an early lift from yesterday’s news that major banks passed the Federal Reserve’s “stress test.” More on both below.

The S&P 500® Index (SPX) is up more than 4% this month and 14% this year—but prospects of higher rates and even a potential recession could keep a lid on rallies approaching July 4 and earnings season. The SPX finished lower in six of the last eight sessions. Volume was well below normal yesterday, however, which could imply lack of conviction.

Morning rush

• The 10-year Treasury note yield (TNX) rose 3 basis points to 3.74%.
• The U.S. Dollar Index ($DXY) slipped to 102.83.
• Cboe Volatility Index® (VIX) futures were steady at 13.51.
• WTI Crude Oil (/CL) climbed to $69.57 after a larger-than-expected U.S. weekly supply draw.

Just in

Weekly initial jobless claims fell to 239,000—well below expectations for near 265,000 and down from 265,000 the previous week. This follows three weeks of elevated claims that led to ideas that the labor market might be slowing. The 239,000 number is still up from under 200,000 earlier this year, so the higher trend remains in place.

Eye on the Fed

Futures trading indicates an 82% probability that the Federal Open Market Committee (FOMC) will raise rates 25 basis points at its July meeting, according to the CME FedWatch Tool. That’s up from around 75% earlier this week.

Federal Reserve Chairman Jerome Powell spoke on a panel of central bankers yesterday and raised eyebrows when he wouldn’t rule out consecutive rate hikes (see more below). Powell also appeared to alarm markets by saying “policy hasn’t been restrictive for very long … we believe there’s more restriction coming,” and that the fight against inflation could take another couple of years. Regional bank shares were among the worst performers yesterday.

Passed the audition: On the positive side of the ledger, the Fed took some “stress” off financials sector investors on Wednesday. It declared that every major bank successfully weathered annual stress tests that subject the institutions to a hypothetical worst-case scenario to check how they’d function in such an event. The Fed called the banking system “strong and resilient” after banks passed an even worse scenario than what the Fed put them through last year.

Typically, though not always, some major banks raise dividends and buy back shares after these stress tests, so keep an eye out for any announcements of that sort over coming days. Passing the test makes the financials sector appear stronger heading into earnings season—whether or not banks actually reward investors.

What to Watch

Inflation update: Tomorrow features May’s reading on Personal Consumption Expenditures (PCE) prices, the inflation metric most closely watched by the Fed. The last PCE update—for April—showed an annual increase of 4.4% in the overall rate and 4.7% in the core rate, which excludes food and energy prices.

For May, monthly headline PCE prices are seen up just 0.1%, but the more important core reading is expected to rise 0.3%, according to analyst consensus from Briefing.com. Both rose 0.4% in April. Analysts predict a year-over-year increase of 4.7% for core PCE, unchanged from April. That would imply that “sticky” inflation remains an issue.

Overall PCE has been falling, but core PCE has been stuck near 4.7%, notes Kathy Jones, Schwab’s chief fixed income strategist. Fed Chairman Powell says some of this “stickiness” is due to timing effects, especially for rent costs, and that eventually core PCE will slide. Until that happens, rate hike fears could persist.

Factory floor: Last week featured disappointing manufacturing data from Europe and Japan, hurting markets. Now, China and the U.S. enter the spotlight. It starts this evening at 9:30 p.m. ET with China’s official June PMI. U.S. manufacturing data will be released on Monday.

China’s PMI unexpectedly fell in May to 48.8, from 49.2 in April. That’s contractionary and a five-month low. Output, new orders, and export sales shrank. Since then, China’s added some monetary stimulus, but it’s unlikely it’s had enough time to filter through the economy in a way that would affect tonight’s number. Analysts expect the June PMI to remain in contractionary territory below 50, according to a Reuters survey.

Stocks in the Spotlight

Micron MU shares got a boost late Wednesday from better-than-expected earnings. This could provide a lift for the chip sector, which slipped yesterday amid fresh worries about U.S. relations with China. Micron, in a press release, said it believes the struggling memory chip segment has “passed its trough in revenue,” and that it expects margins to improve as the supply and demand imbalance is “gradually restored.” The company also stressed what it called its “competitive positioning” in artificial intelligence (AI).

Nike NKE ties up the laces on its quarter after the close today. The company’s last earnings report easily beat analysts’ estimates, but margins came under pressure as inventories rose 16% year-over-year.

Listen for anything executives say about the situation in China as it emerges from last year’s pandemic shutdowns. China’s recent economic struggles aren’t good news for companies like Nike with heavy exposure there. China’s recovery, or lack thereof, could also have a big impact on info tech companies as they prepare to report over the coming weeks.

CHART OF THE DAY:  GAP NARROWS: One of the widest chart gaps this year has been between sizzling semiconductor stocks (SOX—candlesticks) and ice-cold real estate stocks (IXRE–purple line). The gap narrowed just slightly over the last week as real estate enjoyed a couple of strong days while chip stocks took a powder. Data source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Thinking cap

Ideas to mull as you trade or invest

Pause in the “Pause?” Fed Chairman Jerome Powell didn’t deliver much news in yesterday’s panel discussion, but he did momentarily move markets when he declined to rule out the possibility of rate increases at consecutive meetings. That raised eyebrows because he recently spoke of how the Fed has been slowing the pace of rate cuts, first by taking them down from 75 basis points to 50 basis points to 25 basis points a meeting, and then by not hiking them at all at the meeting earlier this month. While market participants build in firm chances of a rate hike in July following the June pause, the next meeting in September remains an open question. The most likely probability is a 25-basis-point increase in July followed by another pause in September, according to the CME FedWatch Tool. It builds in just a 19% chance that the Fed would raise rates in July and repeat in September. That’s up from 15% a week ago. Keep an eye on the September outlook in coming days, especially as this week’s inflation and next week’s jobs data hit the tape. Powell’s words likely raise chances that September becomes a “live” meeting with chances of rates going up. A higher probability for September rate hike would likely mean increased upside pressure on short-term Treasury yields just as the government tries to replenish its coffers by auctioning more debt.

Pacific Rim: Yesterday’s dip in semiconductor stocks like Nvidia NVDA and Advanced Micro Devices AMD demonstrates how geopolitics remain a huge factor for this industry as relations ebb and flow between the United States and China. The sharp rally in semiconductor and other tech stocks so far this year seemed to be removed from these concerns, but there’s no sign of the Biden Administration backing away from the previous U.S. administration’s economic pressure campaign. In some ways, it’s tightening the vice. Yesterday’s report of more U.S. sanctions came after a salvo from China last month against chips from Micron. Meanwhile, tech companies like Micron, Apple AAPL, and Applied Materials AMAT are investing to shift some manufacturing to India or improve what’s there already. If this trend continues, the costs could show up in bottom lines.

Still in the tank: Crude oil prices heated up Wednesday after a larger-than-expected weekly U.S. supply draw. This gave the energy sector a boost, but that sector remains one of the worst on Wall Street this year. Even with crude’s gains yesterday, futures prices remain 17% off their early-2023 highs amid lackluster demand and a Chinese recovery that’s been less robust than many economists had expected. Keep an eye on Chinese manufacturing data tonight to see if there’s any improvement. If so, crude might get more traction.

Calendar

June 30: May Personal Consumption Expenditures (PCE) prices, May Personal Income and Personal Spending, and Final June University of Michigan Consumer Sentiment

July 3: June Chicago PMI, June ISM Manufacturing Index, and May Construction Spending, and markets close early ahead of the holiday.

July 4: Independence Day holiday, no U.S. trading.

July 5: May Factory Orders

July 6: June ISM Non-Manufacturing Index and May JOLTS job openings

TD Ameritrade® commentary for educational purposes only. Member SIPC.

Image sourced from Shutterstock

This post contains sponsored content. This content is for informational purposes only and not intended to be investing advice.