QQQ - Stocks Get A July Jolt New Leadership Emerges IWF A Hold

2023-07-31 16:00:12 ET

Summary

• The S&P 500 saw its third consecutive positive month, with value and cyclical sectors leading the market instead of tech.
• Energy sector benefited from strength in oil prices, while optimism about the banking sector boosted Financials.
• Small-cap value outperformed large-cap growth, with iShares Russell 2000 Value ETF surging 7% in July compared to iShares Russell 1000 Growth ETF's 3% return.
• I have a hold rating on IWF due to shifting momentum trends as Q3 presses on.

The S&P 500 (SP500) notched its third consecutive positive month, but its leaders were not the usual suspects. Instead of mega-cap tech powering higher, the value and cyclical sectors led the market. Strength in oil prices lifted the Energy sector, while optimism that the worst of the banking turmoil is indeed behind us bolstered the Financials space.

Energy Bulls Pumped Up, XLE Leads SPX In July

Also, a sudden jolt of life into some beaten-down healthcare names, including UnitedHealth Group (UNH), aided the price-weighted Dow Jones Industrial Average at times, but XLV was still the weakest-performing sector in July. UNH, however, was still perhaps the biggest contributor to the Dow’s 13-day winning streak – its best stretch since 1987. Still, that rally in the DJIA was only good for about 5% in terms of total return (much less than the 11% advance in January ‘87).

DJIA: Nearly Made it 14 in a Row

All told, the S&P 500 rose a solid 3% in July, matching the DJIA’s (DJI) return. Major relative strength was indeed seen in the more sector-diverse Russell 2000 – the iShares Russell 2000 ETF (IWM) closed up 6% with dividends included. The Invesco QQQ Trust ETF (QQQ) posted another sporty monthly climb, up 4% for its 16th consecutive positive July. Foreign equities were likewise higher by 4%. Bonds, meanwhile, were flat as nearly half a percentage point of income return was offset by rising interest rates, detracting from the aggregate fixed income market’s performance.

Small Caps, Value Lead. Large caps, Growth Up, But Not as Strong.

July was undoubtedly a terrific month for the bulls. A goldilocks economic outcome appears more likely than not, given robust jobs growth amid cooling inflation trends. Along with retail sales and durable goods orders that are both hanging in there, it is small wonder that sell-side economists’ outlooks for upcoming real GDP growth are on the mend.

Perhaps no measure is a better signal as to the resilience of the domestic economy than the Citigroup Economic Surprise Index ((CESI)). The CESI currently rests near its highest marks since March 2021. That tells me that folks have simply been too dour about the strength of consumer spending and business investment.

Surprise! Economic Data Coming In Strong.

Just last week, the Bureau of Economic Analysis issued its preliminary Q2 U.S. real GDP growth figure. At 2.4% (q/q, SAAR), it was easily better than the consensus forecast of just 1.8%. Driving the big beat was, yes, robust consumer spending activity, but also a surprisingly hefty amount of private business investment. To a lesser extent, the government sector contributed to economic expansion, while housing and net exports were minor detractions.

Q2 US Real GDP Growth Much Better Than Expected

So, the growth situation is better than feared. But what about the state of inflation? More good news. June CPI verified below what economists were anticipating while PCE figures for Q2 and for June, key since that is what the Federal Reserve looks at, were both soft. What’s more, while we are rolling off the 2022 peak in commodity prices (June last year), food, shelter, and used car prices should all be rather favorable in the second half of 2023 compared to year-ago levels. To wit, Goldman Sachs expects that those three factors will help slow Headline CPI to 2.9% by year-end.

Inflation Forecasts Turning More Sanguine

With the Fed’s dual mandate being to promote maximum employment while maintaining price stability, risks for yet another rate hike are not all that high. According to the CME FedWatch Tool, there is only about a 1-in-3 probability of a policy rate increase, perhaps at the November meeting. Also bear in mind that come November, we will be just 12 months from the important U.S. general election – the last thing policymakers in control will want to do is pressure economic growth lower, particularly if inflation is generally in good order.

The Fed Might Be Done

Shifting gears, a macro trend I have been keeping a watchful eye on is price action within the commodities space. This could throw a wrench into the Fed’s plans and make the Biden administration none too pleased as it approach the election season.

By the end of July, the prompt-month price of WTI crude oil had topped $81 for the first time since April. Also, RBOB gasoline is near $2.90. As a rule of thumb, you can tack on $0.90 to the current RBOB cost to arrive at the expected national average pump price in a few weeks. As kids head back to school, the cost of sitting in that long drop-off line will be a bit more pricey.

RBOB Gasoline Points to Pump Prices Near $4/Gallon Later in Q3

As you can imagine, that is benefiting oil & gas companies and their share prices. XLE was the top sector last month, underscoring a potential shift that has been ongoing for two months now in favor of value. That’s not to say that growth has endured selling pressure, but today I am putting a hold rating on iShares Russell 1000 Growth ETF (IWF). This is technically an upgrade from a sell rating I made in August of last year.

According to iShares , IWF seeks to track the investment results of an index composed of large- and mid-capitalization U.S. equities that exhibit growth characteristics. The ETF offers investors exposure to U.S. companies whose earnings are expected to grow at an above-average rate relative to the market. Given momentum favoring cyclicals, IWF’s 43% weight into the growth-heavy Information Technology sector, and nearly nil exposure to Energy and Materials, I assert that going overweight value over the second half will keep working as the bull market broadens out.

IWF has a low 0.18% annual expense ratio , and it trades with a high 32.5 price-to-earnings ratio. With more than $72 billion in assets under management and a low 0.7% dividend yield, tradability and liquidity are high while the income return is low compared to high-distribution-rate value stocks. Seeking Alpha’s quant ETF grades give IWF an A for momentum , but relative momentum, which I will detail later, has been softer.

IWF: Growth Heavy, Value Light, Inexpensive Index Fund

For July, IWF was not a loser by any stretch of the imagination. Large-cap growth investors earned a 3% return but compared to the opposite space on the Morningstar Style Box, small-cap value iShares Russell 2000 Value ETF (IWN) surged 7%. So, there was negative alpha going on with IWF. While large-cap growth is up by about one-third so far in 2023, the last two months have seen IWN outpace IWF by about 14 percentage points. Given more favorable valuations and momentum with IWN, I believe that trend continues in the coming weeks and months.

IWF: Underperforming Small-Cap Value Last 2 Months

Finally, seasonal data reveals that IWF has tended to trade sideways from August through early to mid-October, with July being its best month on the calendar when analyzing tendencies over the last 20 years, according to data from Equity Clock .

IWF: August & September, A Sometimes Shaky Stretch

The Bottom Line

The bull market presses on, but new leadership has emerged. I have a hold rating on IWF, as I see it as still performing adequately, but I would rather be overweight in other more cyclical spots of the market as economic optimism improves.

For further details see: