06/05/2023 Market Strategy
Is That All There Is?
With some significant hurdles overcome more remains to be revealed
Key Takeaways
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With 495 or 99% of the firms in the S&P 500 index having reported first quarter earnings, those firms have reported profits 3.3% lower than a year ago despite revenue growth of 4.25%.
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Among the 11 sectors of the S&P 500, four are showing earnings growth while seven are seeing declines. Three sectors are showing double-digit earnings growth including industrials, consumer discretionary, and energy.
- Renewed expectations of a pause by the Fed at the conclusion of its meeting on June 14 do not in our view end prospects for further rate hikes if needed.
- Economic data released last week continued to reflect resilience in job creation while wage growth figures were constructive.
Given the recent progress on a number of concerning issues that had presented negative overhangs over the markets, traders and investors now will turn to consider what comes next with enough uncertainty remaining on the landscape to keep their attention on a day to day basis.
Q1 earnings season approaches closure this week with just five companies in the index yet to report results. The earnings season has provided enough positive surprises to counter high levels of negative sentiment toward stocks that dominated expectations for results at the start of the earnings season.
With President Biden’s signature on the legislation resolving the debt ceilingcrisis and positively concluding the efforts of negotiation by both sides of the aisle in Congress another major hurdle to economic and market nearterm progress was overcome.
Market action of late suggests that the worst of the regional bank crisis thatgripped the markets from early March has passed without that crisis turning into a systemic debacle provided some sense of relief for bullish and even skeptical market participants while elevating the consternation of the bearish contingency within the markets stateside.
Along with the passage of the aforementioned traversed hurdles that had gripped investor and trader mind share for much of the year and over the past few months, a burst of enthusiasm for the latest developments in AI (artificial intelligence) has taken at least a few technology stocks markedly higher along with the broad indices in which those leading stocks carry substantial weight or have influence over other index components.
Over the course of this week into next we look for the outcome of the Fed’s upcoming FOMC meeting to be among the top considerations for investors and traders.
The nonfarm payroll number along with other key data for the month of May released last Friday pushed market expectations of a 25bps Fed hike to its benchmark rate at the conclusion of the June FOMC meeting (June 13 and 14) back into question.
While the number of jobs added last month in the nonfarm payroll report surprised substantially to the upside and the unemployment rate rose three tenths (and well above economist expectations), average hourly earnings growth eased a tenth. The offset effect of the latter two items along with comments from Fed officials over the course of last week moved market opinion on the outcome of the next Fed rate decision to allow for the potential of a “pause” in hikes—or as some Fed officials coined the term, a “skip” of a rate hike in June, with the option to raise rates in July should inflation prove to remain sticky in the weeks ahead.
Time will tell soon enough how the Fed will execute its rate decision in June. For now we’d expect every comment made by Fed officials up until the silent period ahead of the June meeting to carry some weight as to how the markets act on a day to day basis.
Over the course of the last few weeks we have seen Fed interest rate futures go from expectations of a pause or even a rate cut to a near certainty of a hike and now to a midpoint of opinion with expectations calling for a pause.
In our view an end of a period of high accommodation in monetary policy that began with the Great Financial Crisis and with the COVID-19 pandemic resulted in a period of “free money” the ending of which remains a key objective for the Fed.
Ten rate hikes by the Fed since March of last year have brought a return to a more traditional interest rate regime in which bond issuers pay for the privilege of borrowing money and bond buyers get something back in terms of stipulated bond coupon rates that can help offset normal risks (such as inflation) that come with bond ownership.
The end of free money also raises the cost of speculative investments, challenges the existence of meme stocks, zombie companies and questionable crypto currencies. As interest rates normalize the creation of bubbles will become more challenged as the cost of money raises the cost of market player aggressive “bets” with the increased cost of margin.
A return to a more normal interest rate regime could likely increase the importance of fundamental factors in investment activity.
We remain constructive on equities and continue to favor cyclicals over defensive sectors, “growthier value” and “garpier growth” stocks.
From a diversified portfolio point of view, interest rates at closer to historically normal levels position total return opportunities attractively in equities from a combination of dividend income along with a potential for capital appreciation as well as a reintroduction of traditional asset class diversification available with improved yields in fixed income securities.
The current environment will likely remain highly transitional in the near term as the US economy moves toward sustainable growth with lower inflation.
In our view diversification, a highly selective process of investing and right sized expectations will remain key for investors to successfully navigate the investment landscape.
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