Markets Focus on Fed and Earnings 

Adam Phillips, Managing Director, Investments 

This week could be one of the most consequential of the summer for investors as markets focus on two major events: the Federal Reserve's latest policy meeting and earnings reports from roughly 175 S&P 500 companies. While the economic backdrop remains constructive, elevated investor expectations and several developing risks continue to reinforce the importance of maintaining a diversified investment approach.

Although inflation concerns have resurfaced, the Federal Reserve is widely expected to leave interest rates unchanged. One factor helping ease inflation pressure is the recent decline in oil prices, which have fallen nearly 15% from last week's highs as geopolitical tensions in the Middle East have moderated. Even so, the discussion surrounding higher interest rates is far from over.

The economy continues to demonstrate surprising resilience. Initial jobless claims recently reached their lowest level since 1969, economic reports have consistently exceeded expectations, stock prices remain near record highs, and credit markets continue to function well. Taken together, these indicators suggest today's interest rates have not significantly slowed economic activity, giving the Federal Reserve flexibility should inflation remain persistent.

Earnings season will also command investors' attention this week as several technology leaders—including Microsoft, Meta, and Amazon—release quarterly results. Beyond headline earnings, investors will be closely watching whether years of heavy investment in artificial intelligence are beginning to generate meaningful profit growth.

The earnings season has started on a strong note. Through the first wave of reports, second-quarter earnings growth is tracking around 38% year over year. Alphabet contributed significantly to that figure after recording substantial investment gains tied to holdings in companies such as Anthropic and SpaceX. While those gains may not be recurring, the broader earnings picture remains encouraging. Even excluding Alphabet's contribution, S&P 500 earnings are still growing at roughly 26% year over year—marking a second consecutive quarter of better than 20% earnings growth and a seventh straight quarter of double-digit profit growth.

Interestingly, strong earnings haven't translated into equally strong stock performance. Companies beating expectations have, on average, seen little reward, while companies missing estimates have been penalized more severely than usual. That pattern suggests investors entered earnings season with exceptionally high expectations, making it more difficult for companies to impress the market.

Despite healthy corporate profits and a resilient economy, several risks remain on the horizon. Treasury yields continue to move higher, geopolitical uncertainty persists in the Middle East, and the upcoming midterm elections could introduce additional market volatility over the coming months. While none of these factors alter a long-term investment philosophy, they reinforce the value of maintaining a balanced, diversified portfolio rather than making aggressive bets based on short-term market movements.

Often quoted in major national media, Adam is a Chartered Financial Analyst (CFA^®), a CERTIFIED FINANCIAL PLANNER™ (CFP^®), and has been included on the Forbes NextGen Best-in-State Wealth Advisors 2019 list. He is a member of the CFA Society of Los Angeles and the CFA Institute. Adam helps establish asset allocation strategy as a member of the EP Wealth Investment Committee, which supports all EP Wealth Advisors and their clients. The Committee’s top-down approach to portfolio construction begins with an outlook on the economy’s likely direction, followed by the implications for different economic sectors and asset classes. This culminates in strategic selection of the individual stocks, bonds, mutual funds or other investments deemed most appropriate for each individual client’s portfolio. 

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Video Transcript: 

Adam Phillips:

Good morning, everyone.

This is shaping up to be one of the most important weeks of the summer for markets, with both the Federal Reserve meeting and a wave of earnings reports from some of the largest companies in the world.

Let's start with the Fed.

While inflation concerns have picked up again recently, a rate hike this week still looks unlikely. One reason is that geopolitical tensions in the Middle East eased over the weekend, helping oil prices fall nearly 15% from last week's highs. That takes a little pressure off the inflation outlook, at least for now.

That said, the conversation around higher rates isn't going away.

The economy continues to show surprising resilience. Initial jobless claims recently fell to their lowest level since 1969, economic data has consistently come in better than expected, stock prices remain near highs, and credit markets continue to function well. Put simply, there's not much evidence that today's interest rates are significantly slowing the economy, so the Fed has room to raise rates if needed.

The other major focus this week is earnings season.

About 175 S&P 500 companies will report results over the next several days, including Microsoft, Meta, and Amazon. Investors will be paying especially close attention to AI spending. These companies have invested heavily over the past couple of years, and now the market wants to see those investments translate into stronger profits.

With about 30% of companies reporting through last week, the second quarter earnings season has so far been encouraging.

Second-quarter earnings growth is currently tracking around 38% year over year. Alphabet deserves a lot of the credit that after reporting a very large gain in the "Other Income" category, where the company’s investments in companies like Anthropic and SpaceX generated earnings of nearly $100 billion during the quarter. Those investment gains aren't necessarily recurring and can be quite volatile, so it's always worth digging into the headlines a bit.

However, even if you exclude Alphabet, though, S&P 500 earnings would still be growing at roughly 26% year over year. That would mark a second consecutive quarter of better than 20% earnings growth and the seventh straight quarter of double-digit earnings growth. In other words, corporate America continues to deliver healthy profit growth.

What's interesting is that the market's reaction has been much less enthusiastic.

Companies beating earnings expectations have actually seen their stocks fall slightly, on average, while companies missing expectations are being punished even more than usual. That's often a sign that investor expectations have become very high. Good news isn't always enough when optimism is already priced in.

That's one of the reasons we're continuing to emphasize diversification.

The economic backdrop remains constructive, but we also see several risks worth paying attention to. Interest rates could stay higher for longer. Treasury yields have continued to move higher, with the 10-year Treasury around 4.7% and the 30-year Treasury above 5% and near its highest level in close to two decades. We still have geopolitical uncertainty in the Middle East, and we're less than 100 days away from the midterm elections, which could introduce additional volatility.

None of those developments change our long-term investment philosophy, but they do reinforce why we're maintaining a balanced approach rather than making aggressive bets in either direction.

As always, we'll continue monitoring these developments closely and keep you updated as the data comes in.

Thanks for watching, and have a great week.