Stocks Keep Climbing Despite Macro Headwinds: What’s Driving the Rally?

Markets are pushing to report highs despite macro headwinds with earnings, labor data, and the Fed all shaping the investor outlook. Joining us now is Brett Kenwell, U.S. Investment Analyst at eToro to break it all down for us. Thank you so much for being here, Brett. Yeah, thanks for having me. Of course. Tell us what are some of the biggest macro headwinds really impacting markets right now and how are investors also responding to them with so much going on around the world and in the markets today? Yeah, that's such a good question and I think to answer the second part first momentarily, I think investors are actually responding to the backdrop really, really well. Equities continue from an index perspective, continue to handle this back, this really kind of tricky backdrop really well. You know, sort of take out the geopolitical side of things and even, you know, take out the like elevated interest rates, elevated yields. Take that out of the conversation for a minute and just focus on some of the true macro numbers you see. Disappointing jobs data, back to back months. We had the retail sales report on Friday was the biggest miss. It was a surprise negative read. It was the biggest miss in multiple years. You know, the GDP report below expectations. The only in line number we've gotten recently has been the inflation report and that's well above the Fed's target. So, and I say all this as a bull market guy, as an optimist by nature, and I think it's fair to say that the economy is not firing all cylinders, but investors are handling the news pretty well and earnings remain really strong. That's really the backbone of this rally right now. Yeah, I mean, you mentioned earnings there right in the middle of earnings season here. What are you seeing in the results so far and what are the really biggest bright spots again, especially against this backdrop that's maybe not so bright that you've been describing? Yeah, I mean, the main point that keeps getting reiterated is the resilient consumer. Now, some of this recent macro data has, I think, maybe put that observation to the test. But again, this week now we're going to hear from the Walmarts, the Home Depots, the TJXs of the world. That's going to give us a really good insight into the consumer. The commentary we're going to get around that I think will be really, really helpful. But nevertheless, the broader theme is that the consumer has remained resilient this year despite elevated inflation, despite some of these bigger worries on the macro level. And then, of course, the earnings growth has been really strong. I think when you look at the Q2 numbers, we're really getting a reiteration that we got from Q1. The only difference really being that the expectations going into Q1, there's a lot of uncertainty and that served as a really major catalyst for markets. This time coming into Q2, though, that hurdle was already really high. So those expectations were different than we had in Q1. And that's why we maybe haven't seen some of the upside rallies that investors would want to see out of what has really been a lot of strong reports. Yeah, with all of those reports coming out, it is interesting to look at what's going on with Q1 versus Q2 and seeing what's going to happen as we head into the rest of the year. I mean, we saw new all-time highs, really, despite a lackluster labor market print. Why did investors really respond so positively to that data? Yeah, I think we're kind of back in that rhetoric of, you know, when is bad news, bad news, and when is bad news, good news, right? And so there's been this really over this last couple of months, we've shifted from the idea of rate cuts to no change to now rate hikes with what's gone on with inflation and energy prices. But anything that can chip away at that narrative for higher rates is going to be viewed positively by the market right now, even if it's not necessarily good economic news, right? So disappointing labor data, disappointing GDP, that retail sales miss even, I think, added a little bit to the argument that the Fed should just stay on hold. So any little number that can chip away at that argument for higher rates is having an impact on markets right now. Yeah, I mean, it definitely is. I mean, thinking about that kind of weaker labor data, increasing the odds potentially of Fed rate cuts. But again, we still don't know what's going to happen. We still have Kevin Warsh's speech coming up. Talking about all of those kind of different factors playing into that here. How much of that expectation do you think is really already priced into stocks that we're seeing now? Yeah, I mean, for all this talk of a resilient consumer, I think it's hard not to talk about a resilient stock market, right? I mean, this is a market that it did come under pressure in Q1 with energy ripping due. Oil was like $100 a barrel. Of course, that's going to be a short-term headwind or a short-term hurdle for markets. But investors looked through that pretty quickly, drove markets to all-time highs, led by semiconductors at the time. We've since seen a rotation, a broadening out of the rally from semis into some of the other more value-oriented sectors, which is a positive sign. Earnings has remained strong. So I think when we look around, that backdrop, the fundamental backdrop remains strong. And I think maybe the biggest clue to the whole interest rate situation is small caps. The Russell 2000 remains the best-performing U.S. stock index so far year to date. Ordinarily, if we were going into a rate-hiking cycle, there's more concern around interest rates. Small caps would not be the beneficiary. This is not where you'd want to hide out. So to me, it's the market's way of saying, the Fed may hike once or twice, but we're not worried about it. Yeah. And that kind of certainty there, at least with so much other uncertainty going on, is a positive beacon, at least a little bit here as we move through Q3. What else are you really watching most closely to determine whether this market rally has room to run or not, depending as we move forward now? Sure. I think the most important thing at the end of the day, we're going to be, we're always bombarded by headlines, right? Whether it's going to be geopolitical, it's going to be the midterms here soon enough. We're going to have to continue to get through this dilution of headlines. But at the end of the day, earnings growth is really the driver of the market. And we've seen that pan out this year. We do have a tricky couple of months to get through. There's no getting around it. We're contending with this idea of rate hikes from the Fed. August and September, historically, are a seasonally difficult stretch. Not even to say that we're also in a midyear election cycle, which also tends to be tricky for the market. So we do have this potential to slip here in the next couple of months or next couple of quarters. But as long as that earnings outlook for the remainder of this year, first half of next year, as long as that remains strong, I think equities will find ways to rebound out of that and resume the rally. Yeah, those earnings staying strong is so important. And in thinking about that, which sectors or industries are standing out most to you this earnings season? And where are you seeing the most concerning signals on the other side of that? Sure. I think one of the more interesting pieces of the earnings story right now is actually in tech. Maybe not a surprise. Everyone loves talking tech. But in Q2, it was the semiconductors driving the whole story. And now we've seen not only a but we've also seen a really strong rotation within tech. And to us, that is where we're really putting a lot of focus. When we look specifically at mega cap tech, the mag seven names have sat out most of the rally this year, save for these last few weeks. We finally saw a positive reaction to Microsoft's numbers, Amazon's numbers, initially not Alphabet, but eventually Alphabet's numbers were viewed positively. I think that says investors look at these big CapEx spends on the AI build out and are starting to see some tangible growth coming out of those numbers. And now they're rewarding the Microsoft's, Amazon's, Alphabet's of the world. To us, that could mark a pivotal quarter in bringing this group back into the rally. Remains to be seen if this is going to be a multi-quarter rally or if it is just sort of a little bit of a rebalance. But that's really the most interesting storyline that stands out from Q2 so far. Yeah, it really seems like the kind of tech piece of things that we all always are keeping our eye on to a degree is really so important now moving forward as we think about what's happening with them and what will be happening the rest of the year. Finally, as we kind of look towards the rest of Q3 and the rest of the year, what are the biggest risks that you really think could derail the markets momentum from here? Is it inflation, labor weakness, Fed policy, valuations? What are you really looking at here and what should investors be keeping their eye on as we move into the rest of the year? Yeah, I think the valuation argument, to your point, is a really interesting component to this because as we have these, right now we have these really big, strong, inclusive rallies going on, but we also have the earnings growth to back it up. We have it across all the sectors right now. Obviously, certain areas are more standout than others, and that being kind of semiconductors and the hardware space really standing out now, and it's not just the NVIDIAs and the Broadcoms, it's really some of those – they're not so small necessarily, but some of those smaller names that hadn't gotten the love a couple years ago when we did see the big moves in Broadcom, NVIDIA, et cetera. But I think really that valuation component is interesting because rarely is valuation in a bear market, it's rarely the reason stocks stop going down, and in a bull market, it's rarely the reason when they stop going up and start coming down. But when you add the valuation component, that does become a risk when we have a rally that's not backed up by the growth. So if we start to see that growth or those margins come under pressure, valuation quickly becomes a risk, and that's when we can see things shift around really, really quick. We're not there yet, not seeing it yet, but it is a risk to watch going forward. Yeah, it definitely is, and we appreciate you giving us so much to keep our eye on here and so much to keep in mind as we move forward. Brett Kenwell, U.S. Investment Analyst at eToro, thank you so much for being here today. Yeah, thanks for having me.