Capital Market Impact

Markets stand firm amid inflation challenges and earnings surprises

May 13, 2024
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Key Takeaways:

  • Equity markets rallied for the third straight week, bringing the S&P 500 to within 1% of a record high.
  • Economic data has slowed, driven by the consumer, shifting expectations for Fed policy.
  • First quarter earnings were modestly better than expected, with the forecast for the year little changed.

Drivers of market movement

Equity markets continue their recovery from a weak April, with the three-week winning streak bringing the S&P 500® Index to within 1% of the record high from March after gaining in six of the last seven sessions. The subtle shift in market leadership continues, with small caps, developed markets, and emerging markets outperforming large-cap growth over the past month. Following a wave of data, this week lacked a substantial catalyst, though the slow move higher for equity prices has been paired with a dramatic decline in volatility, with the VIX below 13. The bond market was also relatively calm this week, with the 10-year Treasury yield breaking below 4.5% and the MOVE Index approaching the lowest level in two years.

Despite strong equity market returns in recent quarters, investors continue to allocate to bonds in reaction to higher yields, with flow data showing $18 billion of inflows in the latest week. Money market funds are also surging, adding $68 billion. Investment grade funds have seen inflows for 28 straight weeks, while corporate bond funds are on pace for over $400 billion of inflows this year. Spread products continue to outperform Treasuries, with investment-grade and high-yield spreads near the best level since before the pandemic, driven by strong corporate earnings and a surge in Treasury issuance. Bank of America data shows this is the biggest outperformance of corporate versus government bonds in over 100 years.

Economic data has slowed, with recent disappointing results for GDP, payrolls, and consumer confidence. Friday’s University of Michigan report on consumer sentiment fell sharply to 67 from 77 last month, with weakness in both current conditions and expectations. The 5-year inflation expectation rose to 3.1% from 3.0%, while the 1-year inflation expectation jumped to 3.5% from 3.2%. The escalating price sensitivity among U.S. consumers coincides with ongoing corporate earnings reports painting a highly bifurcated consumer backdrop; for example, McDonald’s stated all income levels are increasingly seeking value, Starbucks said customers are more discerning about where they spend money, and Mondelez noted increased price sensitivity. The Atlanta Fed’s GDPNow™ model is forecasting growth of 4.2%, up from 1.6% in the first quarter, but the Citigroup Economic Surprise Index has deteriorated to the weakest level since early 2023 at -19.

Earnings season has notably slowed with more than 90% of the S&P 500 companies having reported. Growth is tracking towards more than 5%, above the 3% expected coming into April, with revenue growth of 4%. The upside for the quarter was primarily driven by margin expansion, with a net profit margin of 11.7%, above the 11.2% from the previous quarter and the 5-year average of 11.5%. Estimates for the full year fell modestly through the quarter, though the 10% growth rate is little changed for the year. With earnings season largely over, companies have aggressively restarted share repurchase activity. There have been over $250 billion in announcements since April, bringing the run rate for the year to nearly $1.2 trillion versus $1.0 trillion last year.

Geopolitical tensions continue to be largely ignored by investors, while the scope of those uncertainties expands. Ceasefire talks between Israel and Hamas ended with no deal, while President Biden pledged to withhold weapons shipments to Israel due to their recent actions. The Biden administration is preparing to unveil a list of tariffs on China next week following a review of the Trump-era tariffs that began in 2018. New tariffs are expected on electric vehicles, batteries, solar cells, steel, and aluminum, while others may be eased. Additionally, the administration added 37 Chinese companies to a trade restriction list in response to the spy balloon incident from last year on concerns over national security. Finally, lawmakers unveiled legislation to make imposing export controls on artificial intelligence equipment easier.

Details on performance

Equity markets rose for the second week, with investors reacting positively to the Fed meeting, earnings, and macro data. The S&P 500 Index gained less than 1%, while the Dow and NASDAQ each added more than 1%. Growth indexes beat value, while small caps beat large caps. Leading sectors for the week included utilities, real estate, and consumer discretionary, while energy, financials, and industrials lagged. Volatility fell sharply, with the VIX again below 14, while trading volume was elevated.

Global markets continued their strong relative performance to domestic markets, with the MSCI EAFE® Index and MSCI Emerging Markets® Index both outperforming the S&P 500 this week and over the past month. Asian markets were strong on the risk-on shift, with Hong Kong up 6%, China up 5%, and Japan up 3%. European markets were mixed on encouraging earnings and mixed macro data, with the UK up 1%, Germany and France relatively flat, and Italy and Spain down 1%. Latin America was also mixed, with Brazil up 2% and Mexico down 1%. The trade-weighted dollar index was lower by 1%, driven by a 5% jump in the yen from a 34-year low.

Interest rates eased this week following a dovish interpretation of the FOMC meeting and a “Goldilocks” payroll report, with the 10-year Treasury yield down 0.17% to 4.50%. The 2-year yield dropped 0.19% to 4.80% after briefly breaching 5%, resulting in a modest flattening of the yield curve. Credit spreads remained tight. Commodity prices fell sharply this week, with the S&P Goldman Sachs Commodity Index falling 4%. Crude prices saw their sharpest weekly drop in three months on demand concerns and discussion of a ceasefire between Israel and Hamas. OPEC+ is expected to extend the recent output cut following the June 1 meeting. Agricultural commodities were mixed.

Investors have recommitted to the equity market following a brief pause, with $10 billion of inflows into global equity funds last week, $14 billion into ETFs, and $4 billion out of mutual funds. Bond funds saw inflows for the 19th straight week, adding $5 billion, driven by investment grade. Money markets continued to experience outflows, losing $2 billion. Investor sentiment has been relatively steady, with the CNN Fear & Greed Index down modestly to 40 from 42 last week, driven by deteriorating market breadth. The AAII Sentiment Survey say the percentage of bulls jumped to 39% from 32% last week, with bears down modestly to 33% from 34%.

What to watch

Inflation will be back in focus next week, highlighted by the Producer Price Index report on Tuesday and Consumer Price Index on Wednesday. Other notable data include the NFIB Small Business Index on Tuesday, retail sales on Wednesday, housing starts on Thursday, and leading indicators on Friday.

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    Except where otherwise indicated, the views and opinions expressed are those of Nationwide as of the date noted, are subject to change at any time and may not come to pass.

    Merrill Lynch Option Volatility Estimate Index (MOVE Index): A crucial gauge of interest rate volatility in the U.S. Treasury market. It is calculated from options prices, which reflect the collective expectations of market participants about future volatility.


    S&P 500® Index: An unmanaged, market capitalization-weighted index of 500 stocks of leading large-cap U.S. companies in leading industries; it gives a broad look at the U.S. equities market and those companies’ stock price performance.

    S&P Goldman Sachs Commodity Index: A benchmark for investment in the commodity markets and as a measure of commodity performance over time. It is a tradable index that is readily available to market participants of the Chicago Mercantile Exchange.

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