Markets in June
- Stocks were up big in June with the S&P 500 up 6.6%. However, it was the first month performance where it wasn’t only driven by the mega-cap stocks, with the S&P 500 Equal Weight index up 7.72% and the Russell 2000 up 8.1%. All 11 sectors were up for the month, but the largest gains were felt by cyclical sectors such as Consumer Discretionary, Industrials and Materials. Whereas the defensive sectors Health Care, Consumer Staples and Utilities lagged once again.
- After continuously pricing in several rate cuts in 2023, the bond market finally began to believe the Fed when they say that is not their outlook. Yields on 2- and 3-year Treasuries rose.
- The Fed decided to maintain rates at current levels but signaled there will likely be more rate hikes to come. Their published economic projections showed that they expect two more 25 bp hikes before the end of the year. They raised the year-end core PCE inflation expectations to 3.9 from 3.6 and lowered their unemployment rate projections for the next three years. They also increased their 2023 GDP expectations, while lowering the 2024 and 2025 projections.
- Economic data has continued to come in better than feared. Most economists continue to stand by their recession predictions but keep pushing back the timeline for when they believe it will begin. Most are now looking for it to begin in Q1 of 2024.
- Earnings expectations for Q2 are currently projected to be down almost 7%, which would be the third consecutive negative quarter. However, analysts are anticipating that this might be the bottom with earnings coming in relatively flat for Q3 before rebounding sharply in Q4. However, there is much debate around this outlook and wide variances in analyst projections over the next few quarters.
- GDP rose 2% in Q1 vs the previous estimate of 1.3%. Consumer spending led the charge, yet we’ve seen some of that slowing in Q2.
- The Jobs report showed 339k jobs were added in May vs 190k expected. The unemployment rate rose to 3.7%. Wages grew 4.3% below expectations.
Why It Could Keep Going Higher
- The primary driver of U.S. economic growth is the U.S consumer and Americans still have excess savings they’re able to spend. Although data shows this may run out soon.
- Employment is still strong and that has always begun to slip before a recession.
- Inflation continues to decelerate and the Fed may be close to pausing rate hikes.
- There is a lot of cash on the sidelines and investors may put it to work on the fear of missing out.
- Inflation and the Fed’s response to get it under control are still the biggest risks the economy faces currently. Fed policy impacts the economy with a significant lag so it is hard to determine what the future effects will be from the current rate hikes.
- Most foreign central banks are tightening policy at the same time, which may further amplify a global contraction.
- Employers may be forced to lay off more of their labor force to maintain margins in a slowing economy.
- The S&P 500 may be over-valued at 19 times earnings.
- Additional bank failures and commercial real estate defaults.
- Further Geopolitical tensions.
- Core PCE came in at 4.6% vs 4.7% expected.
- CPI rose 4%, with core CPI up 5.3%. Both in line with estimates.
- US Manufacturing PMI fell for a seventh consecutive month to 46.9 in May.
- U.S. Service PMI slipped more than expected to 50.3 in May.
- US manufactured durable goods jumped 1.7% in May vs expectations of a 1% decline.
- New Single Family Home sales surged 12.2% in May. Existing Home Sales was up 0.2%.
- The U.S. trade deficit widened in April as US exports fell by the most in three years.
- China’s exports plunged 7.5% in May from a year earlier.
- The ECB raised rates for the eighth consecutive time to 3.5%. Many expect that they will need to raise rates to at least 4%.
- The Bank of England unexpectedly raised rates by 50 bps to combat the U.K.’s highest core inflation since 1992 at 7.1%.
- Australia and Canada’s Central Banks both surprised the markets with 0.25% rate hikes.
What We Are Doing
It was nice to see other stocks besides the mega-cap stocks rally in June. For the markets to continue their upward trend, we need to see greater breadth. However, with the S&P 500 trading at 19 times forward earnings, the stock market might have limited upside ahead. We prefer to take a more defensive tilt until either valuations’ come down further or until we feel the Fed is closer to winning their fight against inflation.
The banking issues will likely lead to a tightening of credit and the resumption of student loan payments will also likely have a small impact on consumer spending. We are underweight in small caps and neutral on value vs growth. We have maintained an overweight to money markets and alternatives.
However, with rates finally rising again this year we will look to begin going out further on fixed income duration. We will continue to watch the economic dynamic carefully to take advantage of opportunities as they present themselves.