Markets calm heading into critical earnings season

Thoughts

• The equity market rally remains in effect, with the S&P 500® Index gaining in four of the past five weeks, flirting with the best level since last August. Global markets continue to outperform domestic, with the MSCI EAFE Index up 12% year-to-date, aided by the dollar index trading off 11% since reaching a multi-decade high in September. Bulls have taken control, as banking sector fears subside. Macro data continue to provide a mixed picture, with observable data continuing to be resilient, while survey data continue to reflect pessimism. The 6% rally over the past month is the best pre-earnings rally since 2009, driven by short covering and relief from fading bank concerns. In the past three earnings seasons, results were disappointing, but the S&P 500 rallied 9%, 8%, and 6% in July, October, and January, reflecting the degree of pessimism that was embedded into expectations. Watching the market’s reaction to earnings will be critical in gauging the path forward.
• Beyond the equity market’s strength, the market’s calmness has been notable. Over the past three weeks, the average percent change for the S&P 500 has been 0.5%, less than half of what we saw since the beginning of 2022. The VIX has settled, with a reading below 20 for 13 consecutive sessions, the longest streak since 2021, and trading at the lowest level since January 2022. Risk indicators have calmed following a shock from the banking concerns, including commercial paper spreads, the TED spread, and high yield spreads. Bloomberg’s reading on financial conditions is back to neutral and CNN’s Fear & Greed Index is at 67 on a scale of 0-100. However, the bond market remains quite reactive, with the MOVE Index below the peak from a month ago but roughly double the long-term average.
• We expect this calmness to continue through 2023 since fear has subsided and some of the worst-case scenarios have already been priced into the market. I’d call our current status “The Sandwich Market” as we are in between the last few years of highly unusual market activity from the pandemic and upcoming volatility from the 2024 presidential election. Even with a debt ceiling debate coming, which we know will be disruptive, we see this 6–9-month period of relative calmness and clarity a buying opportunity.

News

• First-quarter earnings season unofficially began on Friday, with reports from JPMorgan, Citigroup, Wells Fargo, and PNC Bank. The results were mostly better than expected, with JPMorgan reporting record revenue, while Wells Fargo also benefitted from higher rates. For the S&P 500, the consensus is for a decline in earnings of 7%, modestly weaker than the -6% from the fourth quarter. Revenues are expected to decelerate to 3% from 7% in the fourth quarter, though margin compression will likely ease. The bottom-up estimate for the full year (derived from individual company estimates) is for 1% growth, with the estimate down 4% from year-end, though the top-down estimate (derived from Wall Street Strategists) is for a 5% decline.
• House Speaker McCarthy is set to address the NYSE concerning the looming debt ceiling, likely to propose a lifting of the debt ceiling for a year in exchange for limits on non-defense spending, a limit on budget growth over the next decade, and other concessions. Negotiations have stalled since McCarthy met with President Biden met in February, as Democrats have consistently said they will only accept a hike to the debt limit without concessions. The Congressional Budget Office estimates the Treasury will exhaust the current “extraordinary measures” between July and September. Analysts are reminded of the painful process in 2011 that coincided with the first downgrade to U.S. debt, and the S&P 500 saw a 19% drawdown in less than three months.
• Economic data continue to project a mixed picture of the health of the macro backdrop as we await first-quarter GDP in two weeks. The Atlanta Fed’s GDPNow model forecasts growth of 2.5%, which is higher than the average from the decade leading up to the pandemic. This week, readings on CPI and PPI calmed investor fears about inflation, with CPI up 5.0% and PPI up 2.7% from a year ago, both better than expected. Retail sales were weaker than expected at -1.0%, worse than the -0.2% in February, led by declines in gas stations, department stores, electronics, and building materials. The NFIB Small Business Index weakened, approaching the lowest level since 2013 as corporate executives remain cautious. The minutes from the recent FOMC meeting were released on Wednesday, with participants concerned that fallout from the banking disruption is likely to put the economy into recession later this year.

What to Watch

• Earnings will be the primary driver of headlines this week, as economic data takes a backseat. Data include housing starts on Tuesday, existing home sales and leading indicators on Thursday, and PMI data on Friday. There are several speeches by Fed officials that will be closely watched.