Here in the Upper Midwest temperatures were at or near record highs, in some cases near 90 degrees. While it did give us an early taste of summer, it also seemed surreal as some of the piles of snow that accumulated after a winter of abnormally high snowfall remained. The multiple warm days quickly melted the snow and while the calendar tells us we are now in the midst of spring, and summer is right around the corner, over the weekend Mother Nature did provide another shot of snow to remind us we are not completely over winter yet. With rather strong gains in the both the stock and bond markets so far in 2023 and inflation seemingly dissipating, are we finally thawing from the market “winter” of 2022?
Despite pulling back on Friday after disappointing retail sales data, the markets did manage to show gains last week with the Dow Jones Industrial Average jumping 1.2% and being higher for a fourth consecutive week while the S&P 500 gained 0.8% and the Nasdaq added 0.3%. Initial quarterly earnings reports on Friday did come in better than expected, most notably the largest U.S. banks. Inflation showed signs of moderating in March with the Consumer Price Index (CPI) climbing 5% compared to a year ago, slowing from the 6% annual page seen in February. However, core CPI, which excludes food and energy, rose 5.6% year-over-year, higher than the 5.5% reported the previous month.
Inflation is showing signs of moderating but remains above the Federal Reserve’s comfort level and odds are increasing the Fed will raise rates another quarter point at their next meeting the first week in May, only two short weeks away. The question now is whether inflation, which is a measure of price changes from the previous year, will continue to fall or remain at elevated levels. Looking deeper into the components of the inflation measure, housing costs are moderating with the cost of rent leveling off, but energy costs are on the rise. It is too early for the Fed to declare victory in their fight against inflation, but progress has been made. As of now, it appears an interest rate hike in May is likely to be the finale to an aggressive hiking cycle that has rocked markets for much of the past year. At a minimum it seems the Fed will pause after the next meeting to fully assess economic conditions and give previous monetary tightening action a chance to fully work through the system.
The stock market is generally affected most by two factors – interest rates and earnings. With the current interest rate hiking cycle possibly nearing its end, the focus is likely to shift to corporate profitability. Analysts are currently expecting aggregate earnings of the S&P 500 to drop roughly 6% from the first quarter of last year. If this comes to pass, it would be the second straight quarterly decline in year-over-year earnings growth, the first such “earnings recession” since the pandemic. But shrinking earnings may not be a tragedy and in fact might be a sign of cooling inflation. Current expectations are that corporate earnings will be pressured by shrinking profit margins and not by a drop in top-line sales. As a matter of fact, most companies are reporting continued growth in sales. During 2021-2022 when inflation was taking off, companies were able to raise prices with ease, resulting in record high profits. As price increases have slowed, companies have had a more difficult time passing along price increases to consumers, meaning profit margins are being squeezed.
Even at the “earnings recession” levels predicted by analysts, earnings per share would still be noticeably greater than any quarter in the pre-pandemic era. However, big surprise losses, or profits, that trounce expectations can affect individual stock prices and set the mood for the markets. Analyst expectations are frequently, and almost always, too pessimistic since their estimates are driven by conversations with corporate executives who typically like to underpromise on earnings and then over-deliver with a better-than-expected number, generating a nice pop in the share price.
Earnings season picks up serious steam this week with a host of bank earnings, in particular the beleaguered regional banks. On the economic front, housing data will be the focal point a week after inflation and retail sales took center stage. Housing index data, housing starts, and existing home sales, coupled with mortgage rate and application data will offer a picture of the housing market amid a rising rate environment.
Much like a late spring snowstorm, returns in the market this year have been a bit of a surprise. But unlike a snowstorm, the positive movement has been welcomed. Many analysts and investors have remained cautious since a widely anticipated recession still seems to loom on the horizon. However, the “impending” recession continues to be pushed back further into the future, leaving many to wonder if it will indeed occur. Even the most pessimistic analysts seem to be changing their tone a bit, becoming a little more sanguine. Earlier predictions about a significant drop in the stock market have not (yet) played out and with passing time it is may be less likely. The market has been trading in a range over the past 12 months, but those people sitting on the sidelines have missed out on potential gains in certain sectors and asset classes, another reminder how “time in the market” tends to trump “timing the market.”
If the Fed is indeed near the end of the interest rate hiking cycle, the peak in interest rates may already be behind us. For fixed income investors thinking they will remain on the sidelines and wait for higher interest rates, it might be advisable to consider acting sooner rather than later. Yields on shorter duration fixed income instruments remains much greater than longer duration yields but if we see rates continue to fall this could quickly change and it would be advisable to lock in higher rates now.
As we transition into the warmer months, be sure your portfolio is also adapting to changes in the market. Don’t let a surprise snowstorm catch you off-guard and also don’t miss the sunny, warm days when markets are good. If you would like to review your portfolio to discuss options to protect yourself while ensuring you do not miss out on better markets do not hesitate to contact us to discuss strategies to help you remain secure throughout your retirement.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
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