Equity markets continue to break out of the well-established trading range, as the strong market rally is shifting investor sentiment and creating a “fear of missing out” rally. The S&P 500® Index delivered its fourth-straight weekly gain and has returned nearly 13% year-to-date. The Index has now gained 20% from the October low, technically shifting the market from a bear market to a bull market, touching the best level in more than a year. The week was notable for improving breadth and less reliance on the mega-cap technology names, with small caps and value outperforming. Volatility continues to drop, with the VIX below 14 for the first time since before the pandemic, while the MOVE Index (a measure of bond market volatility) is at a four-month low.
Economic and market sentiment has seen a notable bounce in recent weeks, with hopes for a soft landing increasing and investors viewing data with a “glass half full” mindset. Economic data has largely surprised to the upside, with Goldman Sachs reducing their recession odds to 25% from 35% and boosting their target for year-end S&P 500 to 4,500 from 4,000. Retain and institutional sentiment had been historically bearish, paving the way for a contrarian rally, but the latest AAII Sentiment Survey showed bulls (44%) at the best level since October 2021, with the second-best weekly improvement in the past decade. The CNN Fear & Greed Index hit 78 on Friday, signaling an “extreme greed” reading, less than three months from a reading of 21 (extreme fear) during the banking uncertainty. The remaining group of pessimists seems to be Wall Street strategists, with an average year-end estimate for the S&P 500 of just over 4,000, down nearly 7% from the current level.
Reactions to this week’s economic data and Q2 earnings will give us the next good signal to determine whether the underlying drivers of market behavior have changed. If reaction to this week’s data is subdued, and earnings come in strong, we may be finally past the era of pandemic and inflation-driven short-termism and into a fundamental rally – the next stage of the bull run.
Last week was largely devoid of market-moving news, as earnings season has passed, the debt ceiling debate was resolved, and the economic data slate was light. However, this week will change that with investors focused on an FOMC meeting and a reading on consumer price inflation. The Fed Futures curve embeds a 75% chance of a Fed “skip,” meaning no hike but language suggesting there may be additional hikes down the road. Fed Chair Powell said last month that given the extent to which Fed has raised rates, it can afford to look at the data and evolving outlook to make careful assessments. The curve includes one rate cut through next January, down from between three and four cuts a month ago, as the “higher for longer” camp is taking control. The forecast for CPI is for 4.1% headline and 5.2% core versus a year ago, both meaningful improvements from April. The equity market has largely shrugged following recent FOMC and CPI announcements, much different from the emotional reactions from last year.
Earnings estimates have quietly begun to improve, with the consensus estimate for S&P 500 earnings this year higher than it was at the end of March. The current forecast is for 1% growth this year, followed by 12% growth in 2024 and 2025. The outlook for second-quarter earnings shows a 6% drop, weaker than the 2% decline in the first quarter, though the estimate has been more stable than in the last three quarters. The S&P 500 currently trades at roughly 15x the 2025 estimate, below the historic average. This is skewed by the largest technology names that trade at over 40x forward earnings, with the S&P Small Cap 600® Index trading at 11x 2025E, the Russell 1000® Value Index at 12x, and the MSCI EAFE® Index at 11x.
What to Watch
The focus of investor attention this week will be on Wednesday’s FOMC meeting and Tuesday’s release of CPI. Other notable releases include NFIB Small Business on Tuesday, PPI on Wednesday, retail sales and industrial production on Thursday, and consumer sentiment on Friday.
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