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Growth Team Weekly Investment Insights

1) Hard Landing Fears

Volatility increased last week (and has continued at the time of writing this) due to concerns that the US may not thread the soft-landing needle. While the market is hoping for the economy to cool down in order to bring down inflation, the weak economic data of late has investors concerned that things are deteriorating faster than expected.

First, the Institute for Supply Management’s manufacturing index registered a July reading of 46.8, down from 48.5 in June.

 

 

 

 

 

 

 

 

 

 

 

 

Second, the July employment numbers showed weak job creation of 114,000 versus expectations of 175,000 and the highest unemployment rate since October 2021. While the jobless rate is still low, the 0.6% rise from the low of 3.7% in January is flashing warning signals. Worth noting, however, is part of the recent rise in the unemployment rate is due to the labor force expanding by 420,000 people.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Looking at returns since July 10 (the day before June CPI results were released), the S&P 500® Index ended the week down 5%, but the information technology sector ended down 13% and the semiconductor industry ended down 21%. Small cap outperformance also took a hit as investors believe the case for small caps is dependent on falling rates AND a resilient economy. However, they remain ahead of large caps.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2) What is the Sahm Rule?

The latest unemployment reading has triggered the “Sahm Rule,” which is an economic indicator that states when the three-month average of the unemployment rate is 0.5% higher than the 12-month low, the economy is in recession. The latest three-month average of 4.1% is officially 0.5% higher than the rolling 3-month reading of 3.6% reached last August.

 

 

 

 

 

 

 

 

 

 

 

 

The measure is named after economist Claudia Sahm. Interestingly, she is dismissing the current reading of her own indicator, sending CNBC a message on Friday saying, “We are not in a recession now—contrary to the historical signal from the Sahm rule—but the momentum is in that direction."

3) Diverging Monetary Policy

The three largest countries within the MSCI AC World Index have made different monetary policy decisions.

For the United States, the Fed’s decision was to do nothing and continue monitoring the data until the September meeting. As we covered above, markets are worried that this may end up being a bad decision and the committee is not reacting quick enough to weaker economic conditions.

For the United Kingdom, the Bank of England’s Monetary Policy Committee cut rates from 5.25% to 5% amid inflation running at the target level for back-to-back months. However, this does not necessarily mean there will be more cuts coming. Services inflation remains concerning, and the committee warned that the rate reduction should be seen only as a tentative first move, not the start of a pre-determined series of rate cuts.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Lastly, in Japan, the Bank of Japan increased interest rates to 0.25% and outlined plans to cut its monthly bond purchases in half, given the country’s economic strength. Core inflation, which excludes volatile food prices, rose 2.6% from a year earlier in June, exceeding the BOJ’s 2% target for 27 consecutive months. Also, Japan’s jobless rate fell to 2.5% in June from 2.6% in May. Tight labor markets continue to support rising wages.

Given expectations of falling US rates and rising Japanese rates, the yen has strengthened rapidly after hitting a nearly 40-year low in July.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

4) Hyper-Scaled Capital Spending

We have now received earnings results from Amazon, Microsoft, Alphabet and Meta. One of the common themes has been the continued investment in artificial intelligence (AI). Combined capex spending in Q2 2024 was $52B, up 61% from Q2 2023.

To put this into context, total 2024 spending is on track to exceed $200B. Only 35 stocks in the Russell 1000® Index have a TOTAL MARKET CAP greater than $200B.

This massive spending indicates that the pick-and-shovel providers (chips, networking, energy, cooling, etc.) should continue to experience a spending tailwind. However, the increased investment also raises the bar for the return required from AI productivity gains to justify the cost.

 

 

 

 

 

 

 

 

 

 

 

5) Amid the Chaos, Fundamentals are Delivering

While the market seems to be falling apart at the time of writing, this might simply be investors taking a breather after a strong start to the year (especially AI beneficiaries) and a market valuation that may have gotten a bit ahead of itself. Under the hood, companies continue to generate decent earnings in Q2.

The most recent S&P 500® Index earnings update from FactSet indicates:

Overall, 75% of index constituents have reported, and of these companies, 78% have reported actual EPS above estimates. That is above the 5-year average of 77% and above the 10-year average of 74%.

 

 

 

 

 

 

 

 

 

 

 

 

 

The index currently has higher expected Q2 earnings growth versus a week ago and at the end of last quarter. Earnings growth for the second quarter is currently expected to be 11.5%. This compares to 9.8% last week and 8.9% at the end of the second quarter (June 30). If 11.5% is the actual growth rate for the quarter, it will mark the highest year-over-year earnings growth rate reported by the index since Q4 2021.

 

 

 

 

 

 

 

 

 

 

 

 

 

Artisan Partners Growth Team manages portfolios that held securities issued by Alphabet, Microsoft and Amazon as of 6/30/24.  Portfolio securities are subject to change.