- A debt ceiling showdown, FOMC meeting, and the hype around AI all influenced a busy month for the markets. Yet overall, it was a mixed month for stocks as the NASDAQ surged (5.9%), the S&P 500 remained about flat (0.4%) and the Dow lost (-3.2%).
- Although, tthe S&P 500 is up 9.6% YTD, the S&P 500 equal weighted index is down 0.6%. The widest dispersion since 1999. This means that this market leadership is extremely narrow with most all returns coming from the largest companies.
- Only 3 out of 11 sectors were positive, Technology, Communication Services and Consumer Discretionary.
- After much political posturing, an agreement was made at the last minute to suspend the debt ceiling until 2025. The markets have cleared this hurdle for now but still face several challenges ahead. The focus now moves to next month’s FOMC meeting.
- The Fed raised interest rates in June by 0.25%, bringing the Fed Funds rate to 5% - 5.25%. At the meeting Powell indicated they may pause in June but that they will be data dependent going forward. Over the course of the rest of the month, between several Fed Official’s commentaries and strong employment data, the markets changed from pricing in several rates cuts this year beginning as early as Sept., to now only one at the end of the year.
- The unrelenting strength of the U.S. consumer led by a tight labor market has so far held off the highly anticipated recession. While this is good news, there are some signs that this may be weakening, as well as a possible contributing factor preventing the Fed from easing anytime soon. (More below in Economic Data).
- Earnings for Q1 are down for the second quarter in a row at -2.2%. However, this is significantly better than expectations to start the quarter of a 6.7% decline. As of now, analysts are projecting an earnings decline for Q2 of -6.4% before rebounding in Q3 and Q4.
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 need to lay off more of their labor force to maintain margins in a slowing economy.
- The S&P 500 may be over-valued at 18.4 times forward earnings.
- Additional bank failures and commercial real estate defaults.
- Further Geopolitical tensions.
- The Jobs report showed that 253k jobs were added in April vs 180k expected. The unemployment rate dropped back down to a 50- year low of 3.4%.
- Private business in the US created 296k jobs in April, significantly beating expectations of 148k. As expected, the services sector added 229k of them.
- The number of job vacancies unexpectedly increased to 10.1 million in April vs 9.375 million expected.
- Initial jobless claims rose to 264,000, their highest level in 1.5 years.
- Personal spending rose 0.8% in April up from 0.1% in Feb and March.
- Core PCE rose 4.7% April from the year prior, greater than the 4.6% expected.
- Core CPI in April rose 0.4% MoM and 5.5% YoY.
- PPI in April rose 0.2% MoM vs 0.3% expected.
- The Small Business Optimism Index came in at its lowest level since 2013. Most respondents reported declines in sales and earnings, restricted access to credit.
- Retail sales rose 0.4% MoM in April vs 0.8% expected.
- US Manufacturing PMI slipped further into contraction in May coming in at 46.9.
- Eurozone inflation eased more than expected to 6.1% in May, down from 7% in April.
- The Bank of England raised rates 0.25% to 4.5%.
What We Are Doing In The Stock Market
The suspension of the debt ceiling hasn’t changed our overall outlook much. We still believe that the stock market is not correctly pricing in the continued pressure on earnings that most companies will be faced with over the next several quarters. Mega-cap stocks have outperformed for a myriad of reasons, including being seen as a safe haven during economic stress, as well as due to the hype around artificial intelligence.
However, history has shown that high P/E stocks can be significantly hurt during a recession. We prefer to take a more defensive tilt until either valuations’ come down further or until we feel the Fed’s fight against inflation is close to finished. The banking issues will likely lead to a tightening of credit, especially hurting small/mid-size businesses.
We are underweight small caps and neutral on value vs growth. We have maintained an overweight to money markets and alternatives. We will continue to watch the economic dynamic carefully to take advantage of opportunities as they present themselves.
If you would like us to review your existing portfolio or discuss where to allocate capital in today’s market, please visit www.TalkToFreedom.com to schedule a call.
What We Are Doing In Real Estate
The dramatic rise in interest rates over the past 9 months has dictated a change in our investing strategy. The big “value-add” workforce housing deals are no longer financeable at attractive returns for our investors. We are looking for more conservative new construction Class A properties with immediate consistent cash flow and fixed rate agency debt.
We are also looking at converting motel/hotels into multifamily housing. We believe we can buy this type of property at significantly distressed pricing utilizing very low leverage and undertake a full renovation and still deliver our investors above average IRR’s.
If you would like to discuss investing in our real estate deals, please visit www.TalkAboutRe.com to schedule a call.