Blog

Ok, it was another good week for stocks (and bonds for that matter) but we may be seeing some cracks in the Summer rally. Bonds bounced hard on the lower inflation stats coming out of the U.S. but, unlike the rest of Wall Street, we were not completely impressed with the numbers. According to Briefing.com, June Inflation rose 0.1% versus a -0.4% in May. Call us crazy but that is an increase, not a decrease, and when you look at the Core Rate it also rose 0.1% in June. Meanwhile, the price of oil has been creeping up this month, rising from $70 at the end of June to over $75 on Friday. That is going to tickle come August after the refineries process it and deliver it to the gas stations.

Turning to earnings, three of the biggies reported today and while JP Morgan knocked it out of the park, Wells Fargo and Citigroup sort of laid an egg as they bolster loan loss provisions ahead of potential further rate hikes. Banks historically make more money as interest rates rise, but that assumes a slow, methodical climb in response to stronger economic growth. This time, it’s different… Ok, it is always different, but at the record pace pushed by the Fed we have already seen three banks collapse; as credit conditions tighten, more dominoes could fall. The conservative banks are therefore “setting aside” profits to offset potential future loan losses. Actually, it’s a win/win for them: They shelter income now and, if losses materialize, it won't hurt future profits. If the losses don't materialize, the banks re-book the loan provisions into next year’s earnings - making them look even more profitable.

However, if the Fed hikes rates at the end of the month (and we think they will), more funds will likely come out of stocks and migrate into money market funds. At 5% daily interest, it is something to think about. Meanwhile, the analysts start to cringe as they factor in the higher risk-free rate into future cash flows to drive their stock forecasts. Right now, we believe there exists a bit of “suspension of disbelief”. Investors may dismiss lower profit margins as temporary and assume that by early next year, interest rates will be back down leading to higher profits. We don’t understand this line of thought, especially with Jay Powell stating that they don’t anticipate reaching their 2% inflation target until 2025. A lot can happen between now and 2025...not all of it good.

Bottom line? An avalanche of earnings hits the street in the next two weeks, so cross your fingers most don’t miss the analyst's estimates.

Stay safe and happy trading.

Steve Bokor and the Ocean Wealth Team.

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