The first week of earnings season was dominated by better-than-expected results from the major banks, pushing the second quarter year-over-year anticipated growth rate to 69 percent, according to Factset. There was some weakness in lending, but capital markets activity was generally strong. And, of course, the release of loan loss reserves helped. Nevertheless, the BKX bank ETF fell 2.4 percent, contributing to an overall decline of 1.0 percent in the S&P 500® index. It was the third straight week of declines for the banks, and fifth week in the past six. From its peak on June 1, the BKX is lower by 9.9 percent. The banks were exceeded on the downside last week by energy stocks, which fell almost 8 percent. Consumer discretionary and materials were lower as well. Defensive groups were higher, including utilities, consumer staples, along with real estate.

Cyclicals Underperform; Economic Growth Cools 

The underperformance by cyclicals last week continues a pattern that extends back several weeks. Just as the banks peaked six weeks ago, and sit on the edge of a correction, we see that same pattern reflected elsewhere in economically sensitive parts of the market, as questions have been raised about the pace and duration of the current expansion. Energy stocks (XLF) peaked on June 15 and have since declined by 13.4 percent. The materials sector (XLB) peaked on May 17 and has subsequently fallen 8.9 percent. Since the start of June, the Russell 1000 Growth index has outperformed the Value index by 10 percent. The Russell 2000 small cap index peaked on the March 15, the Ides of March, in a portent of an ensuing 8.3 percent decline. 

And perhaps due in part to the same questions about the pace of economic growth, since June 1, the yield on the ten-year Treasury note has fallen to 1.29 percent from 1.60, despite the rise in inflationary pressure. Those pressures make it more difficult for the Fed to fend off criticism that policy is too accommodative, while it waits to see further progress toward its full employment objective. Last week’s drop in the University of Michigan’s consumer sentiment survey was less than encouraging. And, although the absolute numbers of new coronavirus infections are comparatively low, the percentage increases in recent days is concerning.

Markets are Arguably Overdue for a Correction, But Upside Trends Remain 

But the slowdown in the so-called reflation trade represents only part of the story. Other parts of the market have been making new highs. Last week alone, technology, communication services, consumer discretionary, and real estate each made a new high. Healthcare did the same two weeks ago. The S&P 500 set another closing record high on Monday, its 39th of the year, before giving some of it back as the week unfolded. These five sectors account for two-thirds of the index weight. Elsewhere, the CRB RIND index of raw industrial commodities closed last week at a ten-year high. Credit spreads are at or near record lows. And the monthly Wall Street Journal survey of economists anticipates second quarter GDP of 9.1 percent, followed by roughly 6 percent growth in the second half, and remaining above 3 percent for the first half of 2022. 

As the economic cycle matures,  growth will likely remain healthy but slow over time. Earnings growth will do the same. The Fed is expected to eventually announce, and then commence, the tapering of its bond purchases, followed eventually by a series of interest rate hikes. The timeline for this scenario accelerated in the minds of investors after the June dot plot was released by the FOMC. But by how much? It would seem premature to suggest that the rally in stock prices is stalling, even as the Fed ponders its next move. Slower growth is still welcome, especially if it remains above potential in the intermediate term. Earnings can continue to grow in such an environment as well. Stock price gains can be expected to moderate after the initial surge from the lows of last March, and market leadership may change. Nor can a perhaps somewhat overdue market correction be ruled out along the way. But for now, the upside trend remains in place. 
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In general, equity securities tend to have greater price volatility than debt securities. The market value of securities may fall, fail to rise or fluctuate, sometimes rapidly and unpredictably. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole.

The 10 Year Treasury Rate is the yield received for investing in a US government issued treasury security that has a maturity of 10 years. 

The Michigan Consumer Sentiment Index (MCSI) is a monthly survey of consumer confidence levels in the United States. It is a statistical measurement of the overall health of the economy as determined by consumer opinion. It takes into account people's feelings toward their current financial health, the health of the economy in the short-term, and the prospects for longer-term economic growth, and is widely considered to be a useful economic indicator.

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