Capital markets continue their surprising period of calm, a sharp contrast to the elevated volatility experienced since the onset of the pandemic. The S&P 500® Index has not experienced a directional move of more than 1% in the past six weeks, the longest streak since before the pandemic in 2019. The lack of emotional trading is encouraging, particularly given recent potential catalysts including CPI, GDP, the FOMC meeting, the release of first-quarter earnings, and the debt ceiling uncertainty. In addition to the calm equity markets, the relative calm in rates and the negative correlation between equity and bond prices signal a healthier market. Historically, a period of unusual calm has served as a “coiled spring,” resulting in a sharp move as the period ends. Given that the S&P 500 is sitting near the highs for the year, bulls are convinced that the breakout will be to the upside.
Fund managers continue to exhibit extreme caution, with banking sector disruption joining inflation, higher rates, and macro uncertainty on the list of worries, driving equity positioning to the lowest level relative to bonds since 2009. Institutions withdrew $333 billion from equities in the past year, while individuals pulled an additional $28 billion, per S&P Global. The bulk of the outflows have ended up in cash, with money market funds at a record $5.3 trillion, per ICI, more than double the pre-pandemic average, and compared with $3.9 trillion at the peak of the financial crisis. There are signs that systematic funds have been buying at the fastest pace in a decade to cover the absolute or relative shorts, but active managers remain at the lowest active positioning in a year. Cautious positioning among institutional investors remains one of the key arguments for bulls, as the group will represent buying pressure if the pendulum swings.
The market right now is frankly boring. There is a lot of negativity still priced into equities, and we haven’t seen the market shift in response to situations that would historically cause movement – such as the debt ceiling negotiations. However, it won’t take much good news to cause an equity market rally. With that in mind, the place to be right now ahead of that movement is small caps, international and value stocks.
Cracks are beginning to develop in the areas of the economy that have been impressively resilient, notably the consumer and the labor market. Retailer earnings are set to be released next week, with growing concern over the health of the consumer given macro uncertainty, fading savings, and increased reliance on credit. Jefferies notes that the end of the student loan moratorium this summer will be a hit equal to 1.3% of discretionary spending. Bank of America noted that total spending on debit and credit cards fell 1.2% from a year ago in April, the first decline in over two years, while Citigroup noted a decline of 1.0%. Initial unemployment claims have been slowly increasing, touching the highest level since October 2021.
Headlines from Washington D.C. continue to be cautionary, though equity investors have largely ignored them. Debt ceiling discussions were postponed until next week, which will be roughly two weeks ahead of the “X date” identified by the Treasury Department as the deadline. Reports are that staff discussions on energy permitting reform and government spending have been productive. Banking industry pressure remains intense, with PacWest the latest regional bank to experience extreme pressure on deposits and share price. Emergency borrowing from the Fed was little changed for the week, while the FDIC crafted a proposal that banks above $50 billion in assets pay a special assessment to replenish the fund that was depleted with the protection of Silicon Valley Bank and Signature Bank uninsured depositors.
Earnings season is winding down, with 85% of S&P 500 companies having reported. Earnings are heading for a 2% decline on sales growth of 4%, better than the 7% drop expected at the beginning of the quarter. This is an improvement from -5% in the fourth quarter but would be the fifth-straight quarter of negative operating leverage and margin compression. Nearly 80% of companies beat estimates by an average of 7%, with forward guidance at the best level in two years. The full-year estimate of $221 is down 12% since last May, but revisions have been mostly flat since February. Earnings are forecast to grow 1% this year on 2% sales growth, improving to 11% profit growth on 5% sales growth next year.
What to Watch
Retail earnings will provide a glimpse into the strength of the consumer next week. Economic data include retail sales and industrial production on Tuesday, housing starts on Wednesday, and existing home sales and leading indicators on Thursday.
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