"Life is not a matter of holding good cards, but sometimes, playing a poor hand well." ~ Jack London

Good evening:

July was good for the markets. The S&P 500 and the Nasdaq both rose for the fifth consecutive month, and the Dow saw one of the longest daily winning streaks in its history. August began on a different note, though Tom Lee, Fundstrat’s Head of Research, sees promising signs in how the month opened. “Strangely, the odds of August turning into a good month are determined by the first three days. If you're up 15% year to date, which is the case (through the end of July) and the first three days of August are down, then the probability of being up from Day 4 to the end of the month is 78%,” he revealed during our weekly research huddle. 

Or to look at it another way, Lee suggested: “To me, I'm thinking that if August is a washout, we've already done a lot of that upfront – we frontloaded the washing out.” 

“It’s hard to conclusively tie headlines to market moves,” Lee noted, but Fitch downgrading the U.S. credit rating was likely a major contributor to a tough Wednesday. “I think investors were remembering what happened to markets in 2011 after the S&P downgraded the U.S. credit rating – stocks recovered from an initial selloff, then fell to new lows. But we had a much shakier market back then, so I think that investors overreacted this time.”

That might be partly due to August seasonality. August is a month when many Europe and US-based investors take a holiday, so there is a tendency for market depth to weaken. “That means that the impact of idiosyncratic news can become amplified,” he pointed out. 

Seasonality is important to Head of Technical Strategy Mark Newton’s view on the markets as well. “Looking back in pre-election years over the last 90 years, August does tend to be somewhat negative, even moreso than most other months and August in other years.”

Newton views the week’s market action as consistent and “right on schedule” based on his examination of cycles, sentiment, and other indicators. “We saw this breadth and momentum divergence,” he noted. “Price went higher while momentum actually fell. The same thing with breadth. These kinds of divergence normally raise concerns that prices are getting a little bit too stretched.”

But right now, Newton sees the market’s broader up trend as remaining intact, objecting to predictions of a major correction due to the market being overbought. “I don't even look at the regular S&P or Qs [QQQ]. I look at equal-weighted, and that's nowhere near overbought. So to all of these people discussing why markets should fall, I still see a very strong trend. Breadth has expanded very positively and now that we're pulling back that's going to create a decent chance to buy dips.”

“We could actually pull back down here to 4400, and it wouldn't even cause a dent in the ongoing trend just since March alone,” he pointed out.

Still, Newton is not worry-free. “The elephant in the room is the combination one-two punch of the higher supply of Treasuries as well as the BOJ [Bank of Japan] yield-curve control issues. That has caused a pretty dramatic spike in rates across the board not only in the US, but also in Europe.”

“So yields for the 10-year climbed to around 4.18% earlier in the week. That's a rise of about 40 bps just since the middle part of July, a very sharp move. I think yields are going to stop and start to roll over again, but psychologically, breaking the 4% mark did serve to spook the stock market when it first happened earlier this week. This recent acceleration in my view does tend to set off these algos – rates are screaming higher at a time when interest rate costs of the overall US have spiked dramatically in servicing those costs, and that’s a pretty big deal.”

Lee shares those concerns. “The obvious things to watch are yields and VIX,” he said. “Both moved in an unfavorable way this week as a surge in yields and a surge in VIX are negative for equities,” he said, “and what they do in coming weeks matters.” Lee acknowledged that the week has been “dicey,” but he pointed out that “positive catalysts are coming into the picture. Friday’s July non-farm payroll report from the Bureau of Labor Statistics came in softer than the Street expected (187K vs 200K expected), reinforcing the picture of a softening but still healthy labor market. Perhaps more importantly from a Fed perspective, of the top five industries that added jobs, only one (food services) is influenced by monetary policy.” 

This was, in Lee’s view, “good enough for markets to find some footing” before the July CPI numbers arrive next Thursday. “That will be a huge deal,” he noted. “I'm still in the camp that Core CPI is going to come in pretty light and that it’s going to be another positive surprise.” His rough roadmap for the markets, near term, is shown by our Chart of the Week:

“I’m not saying we stop being wary,” Lee stressed, “but in the near-term, any panic selling likely marks a ‘buy the dip’ moment.”

Newton observed: “My timetable echoes Tom's – I think that my cyclical date for a possible turn this month is around the 7th to the 9th of August.”

Other observations from this week’s huddle:

• Tom Lee on earnings: “Earnings are fine. People are saying earnings are down. That’s true, but it’s because Energy is down. Energy is down about 45%, but excluding Energy, second-quarter earnings are +0.7%. So actually earnings are positive.”
• Mark Newton on Defensives: “I find it fascinating that even with the decline we've seen in the last week, look at what's underperformed the most – it's been Utilities, it's been REITs, it's been Healthcare. These are all defensive groups. So we aren’t seeing a flight to fear where everybody's buying the Defensives, and that's another reason to be positive.” 
• Tom Block on the Fitch downgrade: “August is slow in Washington because the Congress is on vacation. And I think that this Fitch downgrade would have been a bigger deal if every Congressman was back in town. I think there would have been a lot more news created by that.”

Elsewhere 

Cybersecurity researchers found “virtually unlimited” ways to bypass content moderation safeguards on AI chatbots like OpenAI’s ChatGPT, Google’s Bard, and Anthropic’s Claude. The researchers, from Carnegie Mellon University and the Center for AI Safety, said they could not find a way to fix the so-called jailbreaks, meant to keep users from using the chatbots to generate harmful content such as hate speech or advice on committing crimes.

China announced numerous measures aimed at boosting domestic consumption as its post-lockdown recovery shows signs of faltering. They include subsidies to boost auto trade-in purchases and home renovation projects; reduced admissions fees at major attractions to boost tourism; and various VAT-related (value-added tax) exemptions for small businesses. Plummeting real-estate prices and high youth unemployment have led to weak domestic demand and consumer confidence in China.

Eurozone countries reported stronger-than-expected Q2 economic growth this week, following a similarly better-than-expected GDP report from the U.S. the previous week. In the eurozone, GDP grew 0.3%, led by Spain and France, versus 0% growth in Q1.

The U.S. has brought a brand-new nuclear reactor online for the first time in more than three decades, as Plant Vogtle’s Unit 3 reactor began supplying electricity to customers of the Georgia Power Co. Unit 3 came online seven years after it was originally scheduled to be completed and construction costs ended up 150% over budget. Unit 4 is scheduled to enter commercial operation in March 2024.

Typhoon Doksuri has killed at least 21 people in China and forced the evacuation of almost a million people, including around 31,000 from Beijing. The storm dumped as much as 29 inches of rain in the Chinese capital over just two days, the heaviest rainfall the city has seen in 140 years.

The Bank of England raised its base rate for a 14th straight time, up 25 bp to 5.25%. This is the highest they’ve been in the United Kingdom since April 2008.

Phoenix’s daily high dipped under the 110-degree mark for the first time in a month on Tuesday, though the high of 108 degrees was scant cause for celebration. At least 25 Phoenix residents (and possibly as many as 250 people) have already died as a result of the heat wave. Daily highs have since resumed their residency above the 110-degree mark.

And finally: Researchers in Spain have discovered a naturally occurring bacteria that can partially prevent the parasite that causes malaria from inhabiting mosquitos’ digestive systems, from where the disease is frequently transmitted to humans. The bacteria, Delftia tsuruhatensis TC1, therefore shows promise in the fight against malaria, which still kills 600,000 people (mostly young children) around the world every year.

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