What’s Expected, What’s not

Expectations matter a lot on Wall Street, especially during earnings season, and this time around expectations have been modest. Not surprisingly, perhaps, many companies have managed to vault over this relatively low bar.

Through April 28 with about half of S&P 500 companies having reported earnings, 80% had beaten expectations, according to FactSet (CNBC, April 28). Stocks responded positively with all three of the major market indexes ending the month higher. The Dow Jones led the way, rising 2.5%, followed by the S&P, which gained 1.5% and the Nasdaq, up less than 0.1%. Europe, too, finished on the front foot, with the Stoxx 600 climbing 1.9% in April (Reuters, April 28).

Data releases for the month showed a slowing economy and modestly declining inflation. First quarter gross domestic product (GDP) climbed 1.1% compared to 2.6% in 4Q 2022 (WSJ, April 27). Consumer spending stayed robust while business and housing investment was weak. Producer prices fell in March by the most in about three years, declining -0.5% from February. Year-over-year the producer price index (PPI) was up just 2.7%, well below February’s 4.9% (WSJ, April 13).

Consumer price rises also eased, as measured by the consumer price index (CPI). The CPI was up 5.0% in March year-over year, the smallest gain since May 2021 and down from February’s 6.0% increase (WSJ, April 12). CPI rose 0.1% from the prior month, down from 0.4% in February. The core number, excluding food and energy, increased 0.4% compared to 0.5% the month before.

The March employment report offered further confirmation that the economy was losing momentum, with the Labor Department showing an addition of 236,000 jobs, the smallest gain in more than two years. Average hourly earnings rose 4.2% in the month, again the slowest annual gain in nearly two years. The unemployment rate stood at 3.5% (WSJ, April 17).
 

Oil, Gold Rise as Bonds Compete for Assets

Something not so expected was a decision by Saudi Arabia early in the month to cut oil production. That led to a one day 6.3% jump in the price of crude to just south of $85/barrel (WSJ, April 3). Gold prices moved up too, topping $2,000/ounce at mid-month, their highest level of the year (WSJ, April 13).

A Bank of America survey of global fund managers found a potential credit crunch at the top of the list of worries (Bloomberg, April 18). The banking crisis did indeed roll on, with First Republic Bank next in investor crosshairs following the failure of Silicon Valley Bank and Signature Bank. First Republic’s stock continued on its downward path in April, and the company was subsequently acquired by JP Morgan over the month’s last weekend (WSJ, May 1). Following the news, JP Morgan CEO Jamie Dimon asserted that the brewing banking crisis had abated, saying, “This part of the crisis is over,” he said (CNBC, May 1).

That sentiment, alas, proved to be premature. Markets remained volatile and shares sold off sharply on May 2, with the Dow, Nasdaq, and S&P all losing more than one percent. The SPDR S&P Regional Banking ETF fell more than 6.0%.

For their part, bonds continued to offer stiff competition to equities. An April 6 story in the Wall Street Journal noted that “stocks haven’t looked this unattractive since 2007”, citing  as evidence the equity risk premium – the difference between the yield on the S&P 500 and 10-year treasuries (WSJ, April 6).  That premium, 1.59%, was the lowest since October 2007, according to the Journal, well below the average of 3.5% since 2008. Over a longer period, the premium seems more reasonable: 1.62% since 1957, according to BlackRock.

Whatever the reason, that same BofA survey found that investor allocations to stocks relative to bonds were at their lowest level since the Financial Crisis of 2008/2009 (Bloomberg, April 18). Most of those surveyed – 63% - expected the economy to weaken, the most pessimistic reading since December of last year, and another 58% predicted that short-term interest rates would move lower.

There was, as always, a contrarian argument to be advanced, one mostly based on history. Goldman Sachs (among others) pointed out that the S&P has nearly always rallied in the 12 months following the peak in the fed funds rates, and that the peak is believed to be at hand. Since 1982, the average post-peak return has been 19% for the 12 months following, with stocks up in five of the six tightening cycles over that period (WSJ, April 16).

To be fair, Goldman has suggested that some skepticism was warranted this time around. And, of course, this cycle has been a little wonky with some arguing that it is actually muddled by two overlapping cycles – one driven by the Covid recovery, the other by the usual business fundamentals (WSJ, April 7). The former is seen in the persistent strength of the job market, the theory goes, especially in those industries effected by Covid-related shutdowns. The latter is evidenced by the impact of the central bank’s tightening policies.

It’s an intriguing theory, and there is some merit to it. But either way, we think it’s the Fed that is likely to once again have the last word.