This week’s U.S. news was remarkably bullish. The service sector’s PMI reading was very strong and the surprisingly solid employment report may have put an end-of-the-year rate hike back on the table. As a result, the SPYs finally broke through key resistance to make a new high.  But stocks are still expensive. And with another weak earnings quarter fast approaching, it remains doubtful equities will be able to make and hold meaningful gains. 

The ISM service’s report was very strong: the index increased 3.6 points to 56.5; activity rose 4.4 points to 59.5 and new orders gained 5.7 points to 59.9. 15 of 18 industries reported positive activity. Most importantly, the anecdotal comments were very encouraging:

• "Business is generally good and following historical seasonal patterns. Suppliers report being very busy compared to last year." (Management of Companies & Support Services)
• "Business is strong in the private sector; bidding a lot of commercial buildings." (Construction)
• "Slightly greater activity, specifically due to midyear reporting." (Finance & Insurance)
• "Oil prices seem to be stabilizing in the $48/bbl. range which has eased the panic in the industry over falling prices." (Mining)
• "Overall business appears to have flattened out. New business for the next six months looks good according to sales forecasts." (Professional, Scientific & Technical Services)
• "Steady movement with negligible fluctuations both up and down." (Public Administration)
• "Business was slow, but starting to pick up this month." (Retail Trade)
• "More new business." (Utilities)
• "Oil, gas, steel [and] coal mining continues to drag down revenues. Automotive, food, package handling and airports [are] strong." (Wholesale Trade)
• "Overall business conditions are good, even though growth is flat." (Health Care & Social Assistance)  

With the exception of oil and gas related weakness, all other sectors are growing. ISM also conducted a separate series of questions related to Brexit, where 61% of U.S. firms stated the impact was negligible; only 6% were concerned at a “high level.” 

Friday’s employment report was a welcome positive development.The headline number of 287,000 put to rest fears of an employment slowdown caused by May’s paltry 38,000 pace. All the gains came from the private sector, where total jobs increased 256,000. Increases were widespread: information services (+44,000), retail trade (+29,000), temporary help (+15,000) and professional services (+38,000) all contributed. The participation and employment rates were unchanged. While total hours worked were unchanged, earnings rose 2.6%. This report was very encouraging; it indicated that May’s report was most likely an outlier in the data.

The Atlanta Fed’s GDP now forecast is projecting second quarter growth of 2.4%; the NY Fed’s number is a slightly lower 2.1%. But the yield curve paints a different picture: the 10-2 spread is a paltry 82 basis points while the 30-2 spread is 156 BPs, indicating bond traders are far less optimistic.

Turning to the markets, the averages had a great week, with the SPYs finally breaking through the 210-212 price area that has provided upside resistance for the last year:

The other averages also made technical progress, with the IWMs and IYTs punching through resistance:

And while the QQQs are still below the 110-11 area, they also gapped higher on Friday:

But the rally increased the market’s price. The current and forward PEs for the SPYs and QQQs are 24.07/22.93 and 17.94/18.94 respectively.  And the 2Q earnings season does not offer much for the bullish argument:

Total earnings for the S&P 500 index are currently expected to be down -6.2% from the same period last year on -0.7% lower revenues, with earnings growth expected to be in the negative for 9 of the 16 Zacks sectors. The Energy sector continues to be the big drag, but Q2 earnings growth for the index would still be in the negative even on an ex-Energy basis.

In other words, we're back to our pre-Brexit scenario: the markets need earnings growth to move higher.  But that growth isn't coming.