Markets pause following an impressive rally

Thoughts

• Equity markets paused following an impressive run, with the S&P 500® Index snapping a five-week winning streak (worst week since March) and the NASDAQ Composite Index dropping for the first week since April. Following a run that saw a 24% rally since October and 6% in the first two weeks of June, a period of consolidation is not unexpected nor unhealthy. As we enter the final week in June, the S&P 500 is on pace for a fourth-straight monthly gain, with the second quarter on track for a return of 6%, following 7% gains in the previous two quarters.
• The balance of power in the equity market has shifted, with bears arguing that markets are overbought, and investors are underweighting geopolitical risk, a “higher for longer” Fed, slowing macro conditions, and inflation remains stubbornly high. Bulls continue to argue that consumers remain resilient, earnings estimates have stabilized, inflation is steadily improving, and “fear of missing out” is driving flows.
• We’re going into an earnings season that’ll be the worst since Q2 2020, the beginning of the pandemic. I can’t emphasize enough the importance of this earnings season and the commentary we’ll hear from CEOs because it will set the tone for where the market goes for the rest of the year and into 2024. Pay attention to the fourth week in July, when we’ll see a packed week for earnings along with the next GDP release.

News

• This weekend was a reminder that geopolitical risk remains, with a brief uprising in Russia led by the Wagner Group garnering attention before an agreement had the group’s head being exiled to Belarus. The lack of market reaction was notable, given there is growing uncertainty over President Putin’s hold on power. Crude prices spiked in reaction, though markets have since calmed, with WTI crude back below $70 per barrel.
• As the second quarter comes to a close, economists continue to predict a recession on the horizon. Bloomberg’s recession probability forecast shows a 64% chance of a recession over the next year, roughly unchanged since last October and similar to the findings from a recent Wall Street Journal poll. Executives are more pessimistic, with a Conference Board poll of CEOs showing that 93% are preparing for a recession over the next 12-18 months. If a recession is on the way, there is little evidence that it is here, with the Atlanta Fed’s GDPNow model forecasting 1.9% growth in the second quarter, roughly double the 0.9% expected by economists.
• Second-quarter earnings season remains a few weeks away, with estimates suggesting a decline of 6%, a deterioration from the -2% in the first quarter and expected to be the weakest since the second quarter of 2020, with a modest gain expected in the third quarter. Consumer discretionary, communication devices, and financials are expected to show solid growth, with energy, materials, health care, and technology expected to decline. The positive inflection in earnings estimates is increasingly necessary, as the S&P 500 currently trades at 19x forward earnings, above the long-term average of 17x.

What to Watch

• Economic releases scheduled for this week include durable goods, consumer confidence, and new home sales on Tuesday, final revised first-quarter GDP and pending home sales on Thursday, and the PCE deflator (the inflation metric preferred by the Fed), personal income and spending, and consumer sentiment on Friday.