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Stocks: Back to The Top End OF The S&P 500’s Trading Range; Small Caps Large Caps for 7th Straight Week.

Download Weekly Market Commentary | May 1 2023

Volatility returned as earnings season ramped up in a big way and a flurry of economic data releases provided both bulls and bears with reasons to press their position. The S&P 500 ended the week with a 0.8% gain, but sector leadership remained quite narrow with communication services and information technology again outperforming amid some high-profile earnings beats (MSFT, FB) during the week. The small-cap Russell 2000 fell 1.2% on the week and has now underperformed the S&P 500 for seven consecutive weeks dating back to early March, a trend indicative of persistent concerns surrounding credit availability, slowing U.S. economic growth, and lackluster investor risk appetite. For us to embrace the view that the year-to-date rebound in the S&P 500 is something more than just a move back to the high end of the index’s 3,800 to 4,200 trading range, sector leadership needs to broaden-out and the relative performance of small caps needs to improve.

• The MSCI EAFE developed markets index fell 0.2% on the week and lagged the S&P 500 for a change as France, Italy, and Spain were notable underperformers, while Germany, Japan, and the U.K. turned out more modest losses. The MSCI Emerging Markets index also closed the week lower by 0.2% as India was a standout performer on the upside. While China rebounded and contributed to the MSCI EM’s modest weekly gain, South Korea and Taiwan continued to lag.
• Microsoft and Meta Platforms (Facebook) came to the market’s rescue last week, with each stock rising sharply on earnings beats, pulling the communication services and information technology sectors at-large along for the ride and stemming a tide of selling pressure mid-week. Interestingly, with 54% of the S&P 500 having posted quarterly results, just shy of 80% have topped the consensus earnings estimate, an encouraging figure in-line with what we’ve grown accustomed to in the post-COVID world. However, while 1Q23 results have so far proven better than feared, the consensus estimate for full-year 2023 S&P 500 earnings per share (EPS) ended April at $219.64, down just $0.02 during the month and valuing the S&P 500 at 19X expected full year results. For comparison, the consensus estimate for ’23 EPS stood at $228.91 at the end of December. While last week was a big one for earnings, releases will continue at a fast and furious pace this week as over 20% of the S&P 500’s market cap is set to report this week with consumer-oriented bellwethers Apple and Starbucks, along with notable reports from the health care, industrials, and information technology sectors, potentially poised to move markets.
• While the S&P 500 closed out April with a 1.6% gain, under the surface we continue to see reasons for caution. One such yellow flag is the relationship between consumer staples and consumer discretionary which we monitor for what it may be telling us regarding the state of risk appetite and sentiment. While the S&P 500 consumer staples sector gained 3.6% in April, the consumer discretionary sector lost 1.1%, a notable about-face given staples meaningfully lagged discretionary in 1Q23. Staples resurgence during April could be a function of pricing power displayed by earnings releases from companies such as Procter & Gamble and Hershey, or it could be signaling that investors believe higher prices on staples will eat into disposable income typically spent on discretionary items. This relationship remains worth monitoring.

Bonds: Mixed Messages on The Economic Front Lead to A Volatile Week in The Rates Market; Stagflation Narrative Could Gain Traction Post-GDP, PCE.

Fixed income investors remain focused on the debate over raising the debt ceiling with concerns that it may be more than political posturing this time around. The U.S. Treasury took “extraordinary measures” back in February to buy Congress time to raise the debt ceiling, but we are fast approaching the “X-date” when Treasury’s ability to fund government operations is expected to run out. Ever since Treasury stepped in back in February, the June through August timeframe has been highlighted as when the “X-date” would arrive, with the timing heavily dependent upon tax collections While we’re just two weeks removed from the April 18 tax filing deadline, tax receipts, to this point, have surprised to the upside, and may provide Congress with some breathing room before “X-date” arrives. Nevertheless, evidenced by the 3-month T-bill yielding 5.10% versus the 1-month T-bill yield of 4.35%, investors remain fearful that Congress and the White House may not be able to come to terms on a debt ceiling deal before August. Congress will ultimately get its act together, but volatility in the rates market and dislocations on the short end of the Treasury curve are likely to remain in place for some time as both sides jockey for position/leverage in the debt ceiling debate.

• U.S. economic data released last week continued to paint a mixed picture versus a dire one. On the constructive side of the ledger, durable goods orders for March surprised to the upside (+3.2% month over month vs. +0.7% expected), while initial jobless claims for the week ended April 22 came in at 230k, shy of the 250k estimate, evidence of continued tightness in the labor market. On the more concerning end of the spectrum, a preliminary read on first quarter GDP fell well short of the consensus estimate, showing the U.S. economy grew just 1.1% during the quarter versus the 1.9% consensus estimate. The most troubling aspect of the hot start gave way to a muted February and read on 1Q23 GDP is how quickly economic activity appears to have slowed as January’s a downright disappointing March as consumers appeared to scale back spending during the month in a meaningful way.
• Personal Consumption Expenditure (PCE) Deflator, the FOMC’s preferred inflation gauge, was released Friday. March headline PCE rose 0.08% month over month, in-line with the 0.1% estimate, and core PCE rose 0.28% month over month, again, roughly in-line with the 0.3% estimate. Year over year, both the headline and core readings modestly exceeded the consensus estimate. Another 25-basis point hike to the Fed funds rate remains the most likely outcome when the Committee meets this week as the PCE release provides the Fed with the necessary cover to tighten policy further, and the likelihood of a quarter-point June rate hike have also increased. The combination of lackluster 1Q GDP, an elevated core PCE reading for March, and the ongoing debt ceiling debate may embolden those championing the stagflation narrative over coming weeks, preventing bond bulls forecasting a recession and lower yields from getting too aggressive, and likely supporting Treasury yields over the near-term.

What We’re Watching:

• The Eurozone Consumer Price Index (CPI) for April is released Tuesday with a headline figure of 6.9%, in-line with the March reading, expected. Year over year Core CPI is expected to also remain static month over month at 5.7%.
• The Job Openings and Labor Turnover Survey (JOLTS) for March is released Tuesday and is expected to show 9.628 million jobs open during the month, down from 9.931 million in February.
• The Federal Open Market Committee (FOMC) concludes its two-day meeting on Wednesday and is expected to hike the Fed funds rate by 25-basis points, taking the upper bound of the central bank’s target range to 5.25%.
• The April Nonfarm Payrolls report is released Friday and is expected to show 185k jobs were created during the month, down from 236k in March, with the unemployment rate ticking higher month over month to 3.6% from 3.5% in March. Average hourly earnings are expected to rise 0.3% month over month and 4.2% year over year in April, which would fall in-line with metrics from March.