Author: Veronica Fulton, CFA
The Bulls are back. Primary catalysts for the recent moves in the equity markets have been a stronger than expected corporate earnings season and cooler inflation as measured by the Consumer Price Index (CPI). Of the S&P 500 companies that have reported, 78% reported positive earnings surprises, and 60% reported positive revenue surprises. While headline CPI appeared a tad hotter than expected, under the surface of the report we saw some signs of normalization. Namely, the major contributors to inflation–motor vehicle insurance and medical care services– are regarded as idiosyncratic and lagging, so prices in those areas are expected to recede. Additionally, last month’s reading was revised lower making comparisons more favorable to consensus. As a result, the odds of a rate cut for September as measured by the CME FedWatch Tool ticked up and equity markets rallied at the prospect of a dovish Fed stance. At present, it appears as though the “soft landing” narrative has become consensus. But before the bulls can declare victory, inflation must come down to a reasonable level without sucking the life out of the economy while doing so. A difficult balancing act.
First quarter GDP growth was below trend, and aggregate expectations for the remainder of the year are below trend as well. Economic growth in the United States rests on the health of the consumer, as consumption accounts for two-thirds of our economy. Early on, consumers were able to withstand higher prices due to excess savings accumulated from Covid-related stimulus. Now much of that has been depleted and credit card delinquencies are on the rise, which means consumers are likely growing more uncomfortable. As a result, consumption has slowed, evidenced by retail sales coming in unexpectedly flat for the month of April. However, there is a silver lining – employment. Jobs are key. Consumers overall feel better about spending as long as they are employed. Although we’re still nowhere near concerning levels, we’ve begun to see some softening in the labor market. The ratio of job openings to unemployed persons is declining as we’ve passed the “jobs are plentiful” stage of the cycle. The number of persons working part-time jobs for “economic reasons” has increased as consumers try to keep pace with higher prices and higher rates.
With the NASDAQ Composite, the S&P 500, and the Dow Jones Industrial Average at all-time highs, the market has a relatively euphoric feel while what resembles a goldilocks scenario continues to materialize. Now that earnings season is mostly behind us, we find few meaningful catalysts in sight to drive further upside. We expect to see a continued push and pull between consumer data, economic data, and inflation data being alternately worse and better than anticipated. This churning creates mixed signals and limits visibility. For these reasons, we take our cues from the bond market. Most recently ten-year treasury yields have been moving lower alongside negative economic surprises. This signals to us that we could be nearing the point in the cycle where investor focus will start to shift from moderating inflation to concerns about future growth. In that scenario, markets often behave more defensively. We continue to rely on our weight of the evidence approach while remaining vigilant and nimble as excessive optimism makes the market more vulnerable to unexpected shocks.
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