Market 07/25: GDP growth dispels recession fears but what about interest rates?

Q2 GDP unexpectedly rises 2.8%, smashing all forecasts

• Q2 GDP growth hits 2.8% QoQ, double the 1.4% of Q1 and higher than the 2.0% forecast

• The 2.8% figure blows away all Wall Street forecasts, only 1 forecast was accurate at 3.0%

• At this level, first-half 2024 GDP growth hits 2.1%, lower than 3.1% in 2023 but still impressive.

• GDP growth largely comes from improvement in private investment and expansion of public investment from the government

  • Private investment up +8.4% QoQ, highest since Q3/2023

  • Public investment from government rises to +3.1% from +1.8% in Q1

• Consumption also improves significantly, growing 2.3%, higher than 2.0% expected and 1.5% in Q1 → continues to be the main driver of GDP

• Private goods spending grows at 2.6%

• Changes in GDP report components:

• Components contributing to Q2 GDP +2.8% figure:

  • Consumption 1.57% from 0.98% in Q1

  • Infrastructure investment 0.64% down from 1.19% in Q1

  • Inventory goods +0.82% from -0.42% decline in Q1

  • Trade -0.71%, flat with -0.65% in Q1

  • Public investment +0.53% from 0.31% in Q1

→ Q2 economic growth continues to come from government spending based on newly issued debt, plus improvements in spending by tech businesses and consumers during the shopping season.

Q2 GDP overview compared to Q2/2023

Inflation rate in GDP basket conversely supports rate cuts

• This morning's GDP report does not diminish hopes for rate cuts

  • Prices in the GDP product basket only up 2.3% QoQ, lower than 2.6% expected and down significantly from 3.1% in Q1

• However, core PCE up 2.9% quarterly, higher than 2.7% expected but lower than 3.7% from Q1

  • Need to wait for PCE MoM and YoY numbers tomorrow

Difference between GDP basket prices (GDP Price Index) and PCE:

• Prices in the GDP basket measure the aggregate of goods and services in the economy, excluding imports.

• PCE measures goods and services consumed by households, including both exports and imports

→ Although economic growth is still hot, the pace of price increases has slowed somewhat, helping today's headlines support rate cuts. However, the important PCE index will be released tomorrow.

Goods demand collapses in June

• Durable goods orders index unexpectedly plunges -6.6% MoM vs +0.3% expected and +0.1% previous month

  • Pulling durable goods orders growth to extremely low -11.1% YoY

• Core index still grows steadily at +0.5% MoM, higher than +0.1% expected, improving from -0.1% in May

  • Core orders exclude aircraft

• Defense orders up +6.1% while private down sharply -22.4%

• Most of the decline comes from aircraft orders, mainly due to Boeing

• Machinery and materials orders up +1% MoM, higher than +0.2% expected

  • Similar to GDP report on private investment growth

Unemployment claims at the highest level in 32 months

• Initial unemployment claims fell to 235,000 from 245,000 in the previous week

• Improvements across all states with the impact of Hurricane Beryl in Texas also gradually improving

• Continuing claims remain at the highest level in 32 months

$44 billion 7-year bonds sold successfully

Today's session overall much better than yesterday, largely due to lower auction size and market fears pushing when-issued yields slightly higher in yesterday's session.

• High Yield: 4.162% (market yield: 4.276%)

  => Stop-through: 1.14bsp

  • Successful bid ratio at High Yield: 68.69% (previous session: 43.69%)

• Bid-to-Cover: 2.64

Competitive award components:

• Dealers: 8.87%

• Indirect bidders: 74.38%

Earnings reports: Chipotle, Ford, American Airlines, Raytheon

Chipotle: Overcoming pricing challenges by optimizing operations

• Revenue $2.97 billion vs 2.94 billion expected, +17.5% YoY

  • Same-store sales +11.1% YoY, extremely impressive

• Earnings $0.34/share vs $0.32 expected

• Operating margin 19.7%, up from 17.2% YoY

• CEO: “Margins continue to face pressure and may persist but these factors are seasonal and can be overcome by optimizing operations”

Steve: Extremely outstanding Q2 for when compared to other fast food chains or competitors in an environment where consumer spending is starting to contract. Expansion into the high-income customer segment with healthier products than traditional fast food chains is a good advantage. However, even after the split the stock price is more accessible to investors, current valuation remains quite high for the sector, plus CEO's outlook on potential future margin compression. Steve would be more comfortable with at $43.

Ford: Mistake with electric vehicles

• Revenue $44.81 billion below expected $44.90 billion

• Earnings $0.47/share much lower than expected $0.68

• Model E EV division lost $1.1 billion in Q2 alone after losses of -$1.3 billion and -$1.5 billion in Q4

Steve: drops -13% after earnings report, deepest since 2008 crisis. Overall this traditional automaker has clearly shown no ability to innovate and EV development ambitions now a money-burning furnace for the company. Steve doesn't think it's a long-term investment

American Airlines: Back to COVID lows

• Earnings $1.09/share, $1.06 expected

• Operating revenue $14.33 billion, $14.35 billion forecast

  • Passenger revenue $13.2 billion, $13.21 expected

• Cuts full-year earnings guidance to $0.7-$1.3 from prior $2.25-$3.25

• Unit revenue +20.27 cents, down 6.2% YoY

• Cost per seat mile $17.21, up +0.8% from the same period last year

Steve: This report is really not good at all, especially when the decline in air travel demand and the increase in labor costs will continue in the future. Cutting the full-year 2024 earnings forecast is quite bad but Steve thinks this cut is quite deep helping market expectations to be extremely low. With the current price already near the COVID bottom, Steve thinks around $10/share for the risk/reward ratio.

Raytheon: Continues up with the cycle

• Earnings $1.41/share, higher than $1.29 expected

• Revenue $19.72 billion, higher than the expected $19.31

• Raised full-year 2024 earnings forecast to $5.35-$5.45 from $5.25-$5.4

• Free cash flow +$2.2 billion in Q2

• Orders: $206 billion from $202 in Q1, with $24 billion new orders in Q2

Steve: This cycle continues with strong demand in the defense sector, even after this morning's macro report. and continue to be 2 stocks worth holding if you can buy in at about 10% lower than current prices.

Market: Shorts-Cover Rally with SPX successfully defending 5400

After a strong panic in yesterday's trading session, market sentiment improved significantly at the start of this morning when the GDP report both dispelled fears of economic recession and gave investors hope for rate cuts.

SPX's new put wall formed at level 5400 as expected, however still quite weak so early this morning SPX dipped to 5390 in a strong margin call/liquidation wave.

For now, SPX must hold level 5400 tomorrow to continue reducing expectations of volatility range, pull VIX down, and stabilize market flows. Current volatility is overextended compared to the past year but most hedging demand is short-term. A decline in volatility will certainly create shorts-cover rallies like today.

Internals are generally more stable, but most investors still want to sit out, quite understandable with the important PCE index tomorrow ahead of FOMC next week.