Markets move sideways in search of a catalyst

Thoughts

• Equity markets were modestly lower in a volatile week, with weakness on macro concerns largely erased by a 2% rally for the S&P 500® Index on Friday following the payroll report. The Index has spent the last five weeks in a tight trading range and sits just 1% below the high for the year. Bulls point to the looming Fed pivot, encouraging earnings, and a supportive labor environment, while bears are focused on a higher-for-longer Fed, tightening financial conditions and bank lending standards, the risk from the debt ceiling fight, and poor market breadth. Strong results from technology companies exacerbated the gap in performance of the largest names in the S&P 500 and the rest of the Index. The largest 10 companies in the S&P 500 have rallied over 30% on average this year, while the equal-weighted S&P 500 is flat.
• Institutional investors have begrudgingly been pulled into the equity market this year to close their absolute and relative shorts, though positioning remains conservative relative to history. Money market funds continue to attract record-breaking assets resulting in the best relative yield versus traditional bonds and bank deposits in decades and acting as a safe haven in a period of bank uncertainty. Domestic money market funds hit a record $5.3 trillion per ICI, adding $47 billion in the latest week, with $1.9 billion in retail funds and $3.4 billion in institutional. Since the regional banking crisis began in March, money market funds have had organic growth of nearly 7%, while Treasury funds have grown by nearly 5%, bank loan funds have lost 5% and emerging market debt has dropped 2%.
• The market is reacting differently than it has at any point up until the last five weeks. Macro data is no longer moving the needle and catalysts that we would expect to be big drivers – such as earnings, Fed data, and geopolitical instability – are not causing substantial market moves. However, since the market is up and there is money on the sidelines, we may be reaching an inflection point over the next several months where institutional investors start to shift their mindsets and reenter the market intentionally and over a sustained period of time.

News

• Earnings season will begin winding down this week, with 85% of the S&P 500 companies having reported first-quarter earnings. Results have been solidly above expectations, trending towards a decline of just 2% versus an expected drop of 7% coming into the month, as 79% of companies reported an upside surprise. The dollar was a drag, with companies that generate more than half of sales inside the U.S. seeing 3% growth, while those focused internationally saw a 10% decline, per Factset. This will be the second-straight negative quarter, representing an earnings recession, with the second quarter expected to decline before showing growth in the third quarter. The estimate for 2023 has stabilized, with a modest increase since the end of March, with a current expectation of 1% growth. Expectations are for a 2% growth in sales, with the revenue estimate at the best level since last August on resilient demand and strong pricing power.
• Macro data continue to paint a mixed picture, with hopes for a soft landing renewed following Friday’s encouraging payroll report. April saw 253,000 job gains, better than the consensus of 179,000 and 165,000 in March. The unemployment rate unexpectedly fell to 3.4% from 3.5%, the lowest level since 1969, as the labor force participation rate was flat at 62.6%. Wage growth was a solid, but not extreme, 4.4% from a year ago, roughly in line with the pace of inflation. Job openings fell below 10 million for the first time in two years at 9.6 million, though it remains well above the 5.6 million unemployed persons.
• The FOMC voted to raise the Fed Funds target rate by 0.25% to 5.25%, matching the highest level since 2001 and the most rapid tightening path since 1980. The FOMC statement again noted that “in determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” Fed Chair Powell noted in his press conference that the U.S. labor market remained tight. Labor demand still exceeds labor supply – though some progress is being made. Powell is still guarding against easing too soon and repeating the mistake of the 1970s. The FOMC meeting highlighted the wide gap between the guidance by Fed officials and the expectations from the market. Fed Chair Powell was clear that the threshold for rate cuts is high, and there is a chance of a hike in June. The Fed Futures curve shows a 10% chance of a hike in June and more than four cuts by January 2024.

What to Watch

• With slowing earnings releases and no FOMC data, inflation data will be the primary focus of investors next week, with CPI on Wednesday and PPI on Thursday. Additional data include the NFIB Small Business Index on Tuesday, and consumer sentiment on Friday.