Markets surge despite continued uncertainty

Thoughts

• Equity markets delivered their third-straight weekly gain, continuing to exhibit remarkable resilience given continued uncertainty in the banking system, Fed policy, macro conditions, interest rates, and inflation. The S&P 500® Index saw a 3% gain, which is the best weekly result since November, as the pendulum of pessimism continues to shift back toward neutral. March saw an equity market gain for the fourth time in six months, with the S&P 500 returning 7%. The first quarter was a risk-on rally, led by the NASDAQ (+17%) and the Russell 1000 Growth Index (+14%), and the MSCI EAFE Index (+9%). Strength was also seen in Bitcoin (+70%) and long-dated Treasury bonds (+5%). The only notable area of weakness was commodities (-6%), which is a mirror image of the performance pattern from last year.
• The equity market rally since October has recovered roughly half of the drawdown experienced through the first nine months of 2022. The S&P 500 is currently above the average year-end estimate of Wall Street strategists, reflecting the surprising start to the year. This either sets the stage for upward revisions as pessimism eases or suggests the S&P 500 has gotten ahead of itself, with a valuation of 18x forward earnings. Given the strength of the technical indicators, the path of least resistance is higher. Optimists point to a potential Fed pivot, strong macro data, a resilient consumer, and improving inflation data. Pessimists argue about still elevated inflation, tightening financial conditions, the risk to earnings estimates, and rising valuations.
• As Q2 kicks off, investors are exhibiting blind faith in big tech. This indiscriminate buying of high beta names such as Tesla and Meta is proving that stocks punished in 2022 are now wearing a badge of honor – retail investors continue to buy the dip and reap the benefits. The technical tailwinds are supportive for the intermediate and long-term; however, as the market is increasingly complex, investors should look out for an indication that it may have gone too far too fast in the near term.

News

• OPEC+ announced a surprise 1.6 million barrel per day (bpd) cut to production on Sunday, with Saudi Arabia cutting 500,000, and Russia extending the 500,000 cut through year-end. The move reflects the tension between the U.S. and Saudi Arabia, with the Saudis reacting to the White House ruling out purchases to refill the strategic petroleum reserve (SPR), which is roughly half the level of most of the last decade. The rig count in the U.S. recovered from the sharp drop during the pandemic but has been declining since the November peak and is down nearly two-thirds since 2014. Crude prices surged 6% on Monday in reaction but are down nearly 20% over the past year and are flat in 2023.
• A key inflation gauge preferred by the Federal Reserve surprised to the downside in February, with core PCE up 4.6% versus 4.7% in January, and the lowest level since October 2021. Including food and energy, headline PCE rose by 5%, down from 5.3% the previous month. Compared with January, energy prices fell by 0.4%, while food prices rose 0.2%. Goods prices increased by 0.2% and services grew by 0.3%. There was a modest reaction in the capital markets to the release, with equity markets moving higher and bond values falling. Consumer spending was up 0.2% sequentially and 7.6% from a year ago, while income rose 0.3% sequentially and 6.2% year over year. Economic data remains largely benign, with the Atlanta Fed’s GDPNow model forecasting growth of 2.5% in the first quarter, and the Citigroup Economic Surprise Index near the highest level in a year.
• The banking industry had its first positive week since the disruption that saw a 30% decline in the group’s valuation, as investors’ fears subsided. Emergency borrowing from the Fed fell to $152 billion from $164 billion, with a sharp drop in borrowing from the discount window somewhat offset by an increase in the Bank Term Funding Program (BTFP). The Fed’s balance sheet resumed its decline after a two-week period of growth. However, the group is not out of the woods as Bloomberg estimates that $620 billion of unrealized losses sit on bank balance sheets. Additionally, depositors continue to withdraw deposits, choosing instead to invest in money markets, including $66 billion in the latest week to bring money market assets to a record $5.2 trillion.

What to Watch

• The beginning of April comes with a wave of important economic data. On Monday we get PMI and ISM manufacturing data, Tuesday has durable goods and JOLTS job openings, Wednesday has PMI and ISM services, and Friday has the monthly payroll report and consumer credit.