Time for a Pullback

US stock indexes are mostly lower this month, taking a breather. The Dow is off by about 450 points, the S&P 500 is down 2.6% and the Nasdaq is about 4.4% lower. The media have offered some reasons for the selloff—soft economic data in China, credit downgrades by Fitch and Moody’s, a few disappointing earnings announcements—but I’m not really buying them. I agree with CNBC reporter Bob Pisani; this is a “buyer’s strike.” Exchange volumes are light and signs of panic are absent. The stock market has run hard this year and it’s time for a brief pullback.

China’s economic recovery from the Covid era has been rather uneven. New data show that exports—traditionally the growth engine of China’s economy—fell 14.5% y/y in July. Yesterday Bloomberg News ran an article titled, “China Now Sells Fewer Goods to the US Than Mexico or Canada.” What’s more, domestic demand seems a little soft. Imorted goods fell 12.4% y/y. Both figures were worse than expected. The real estate sector in particular looks like a slow motion train wreck. This week a large property developer called Country Garden Holdings apparently joined several of its peers by defaulting on a bond interest payment. Not surprisingly, the company’s Hong Kong-traded shares plunged, and its other bonds are now trading at pennies on the dollar. Weak home sales and higher borrowing costs in China have put over-leveraged developers in a tough spot.

Moody’s Investors Service cut credit ratings for a slew of mid-size US banks, resulting in a selloff across the entire financial sector. The agency lowered credit ratings on 10 banks and said it will review six more banks for possible downgrade. Another 11 banks were assigned negative credit outlooks. All remain high-quality, or “investment grade” issuers, however, and no bank was identified as an immediate default risk. Moody’s cited lower profit margins as the primary concern, brought on by higher funding costs and customers moving cash out of deposit accounts to invest in CDs and bonds. This should not come as a surprise to investors. These problems were brought into sharp relief last March during the liquidity crisis that destroyed Silicon Valley Bank. The stock market has already priced-in the additional risk. Whereas the Dow Jones Industrial Average is up about 7% this year, the SPDR S&P Bank ETF (KBE) has fallen 9%. That’s a big disparity; bank stocks are trading at bargain basement prices.

About 450 of the S&P 500 companies have reported second quarter results. Aggregate sales growth slowed to just .3% from year-ago levels, and earnings fell about 8%. While not terribly inspiring, results were largely better than expected. Nearly 80% of companies beat Wall Street earnings forecasts. More importantly, we didn’t experience a massive wave of profit warnings for the balance of the year. It’s clear that business activity and profit margins sagged this year, but we seem to have avoided what Zacks Investment Research calls the “long-feared ‘earnings cliff’ narrative.” And in fact, “Outside of the Energy sector, estimates are very stable and are actually going up for some sectors.”