Authored by :
Michael G. Dow, CAIA, CFA, CPA, Chief Investment Officer
Julien R. Frazzo, Director of Risk Management and Securities Research
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The Quick Facts
- The S&P 500 is up 9.2% for the year after gaining 1.6% in April
- Large & Mega caps outperforming Small & Mid caps
- Earnings are coming in better than feared for the first quarter
- We are nearing the end of the Federal Reserve’s (“Fed”) hiking cycle
- Market-based predictions for the Fed Funds rate are pointing to Fed rate cuts in 2H23
- Debt ceiling-induced volatility is likely to increase before cooler heads prevail as we get closer to the deadline
The S&P 500 is up +9.2% for the year after gaining +1.6% in April, thanks to roaring year-to-date rallies in shares of Amazon, Google-parent Alphabet, Microsoft, and other growth and technology stocks that command heavy weightings in market-weighted indexes.
Beneath the surface, however, areas of the market tied to economic sentiment such as transport, semiconductors and small-cap stocks dropped in April, while so-called defensive sectors are outperforming. Investors cited growing caution among market participants faced with a thicket of concerns, ranging from fears of a possible U.S. default this summer to worries that the Fed’s aggressive monetary tightening could bring on a recession.
Earnings have come in better than feared for the first quarter. With just over half of the S&P 500 having reported, earnings are on pace to have declined -1.9% for the first quarter from the year earlier period, according to Refinitiv. That is a smaller decline than the -5.1% drop expected at the start of April. The forward 12-month PE for the S&P 500 is 18.1x, which is slightly below the five-year average (18.5x), but above the 10-year average (17.3x), according to FactSet.
Meanwhile, data published last week showed an acceleration in consumer spending in the first quarter as U.S. GDP (Gross Domestic Product) increased at a 1.1% annualized rate. It is hard to have a recession when consumers’ incomes are rising, and they are spending more on both goods and services.
April Asset Class Performance
On a total return basis, the beaten-down Technology and Consumer Discretionary sectors have been the winners thus far in 2023 (+21.5% and +25.2%, respectively), while the Financials sector has unsurprisingly suffered throughout the U.S. regional bank crisis (-2.5%). April was a mixed bag, with 7 of the 11 sectors in the green. April total return numbers show ~5% dispersion, from -1.2% for Industrials to +3.7% for Consumer Staples.
Large-cap Value stocks outperformed Growth by 50 basis points for the month, with the Russell 1000 Value index up 1.5%. The outperformance of Value over Growth remains a major longer-term investment theme in an environment where long-dated cashflows of growth companies are discounted at higher rates. The ESG segment of the market, as measured by the MSCI USA ESG Select Index, was up 0.6% in April, trailing the S&P 500 by about 1%. Over the last three years, the ESG index is up 48.3% and just 0.4% behind the S&P 500 on a total return basis.
Inflation has apparently peaked but remains elevated. Shelter was the primary contributor on the way up and should soon help drive further disinflation. Market data for rents and home prices had suggested a turnaround in shelter prices was coming soon, and the latest data for March finally showed the first slowdown in the Consumer Price Index (CPI) for shelter since it started accelerating. March core PCE (Personal Consumption Expenditures) was up 0.3% MoM, in line with consensus, and little changed from the February reading. The core PCE Price Index is the Fed’s preferred inflation measure, and with the recent readings remaining elevated, it is likely the Fed will stick with its rate-hike cycle and hold rates higher for longer.
We are nearing the end of the Fed’s hiking cycle. But disinflation alone is not enough to cause a pivot in policy, which is why it is important to highlight the ongoing strength in the labor market that may frustrate interest rate doves. When looking at prior Fed cycles, the amount of time between the last hike and the first cut is variable, but unemployment is a critical determinant. Historically, when the unemployment rate has risen by an average of 30 basis points from the cycle low (10 to 40 basis-points range), the Fed begins to cut rates. However, this time around, joblessness is troughing at an ultra-low level. As such, the Fed is likely to tolerate a greater increase in unemployment before cutting rates.
The yield on the benchmark U.S. 10-year Treasury closed April at 3.42%, below the October peak of 4.24% and 45 basis-points lower than at the beginning of the year. The yield on the shorter-term 2-year Treasury declined by 42 basis points from the beginning of the year and now yields 4.01%. The yield curve remains inverted, with the U.S. 2-year Treasuries yielding 58 basis points more than 10-year maturities as compared to a 55 basis-point inversion at the beginning of the year.
Oil prices, as measured by the WTI Crude Oil, rose by 1.5% in April to $77/bbl. WTI traded as high as $123.70 back in March 2022, a 14-year high. Gold spot prices broke out to new highs and closed 1.1% higher in April at $1,990/Oz. Cryptocurrencies were also up in April. Bitcoin and Ethereum were up 3.4% and 4.1% for April, respectively, bringing their YTD total returns to 77.4% and 57.8%. The U.S. dollar ticked lower on the expectation that the Fed will slow the rate of interest rate hikes as inflation pressures ease. In April, the U.S. Dollar Index (DXY) declined by 0.8%.
Interest rate volatility has been constant since the Fed began its rate-hiking cycle last year. While equity investors look to the CBOE Volatility Index (or VIX), bond investors focus on the ICE BofA MOVE (MOVE) Index, which measures bond market volatility. Each depicts a very different mood. The MOVE Index remains elevated compared to historical averages, which reflects the highly uncertain rate environment. The VIX, on the other hand, is trading at historically low levels, closing April at 15.6.
Chart of the Month – Fed Funds Futures
Fed funds futures are financial instruments that allow investors to speculate on the direction of the Fed’s key interest rate, the federal funds rate. The federal funds rate is the interest rate at which banks lend to each other overnight to meet reserve requirements.
Investors can use fed funds futures to hedge against interest rate risks or to speculate on the direction of interest rates. For example, if an investor believes that the Fed will raise interest rates in the future, they may buy fed funds futures contracts to profit from the expected increase. Conversely, if an investor believes that the Fed will lower interest rates, they may sell fed funds futures contracts to profit from the expected decrease.
Fed funds futures are closely watched by economists and financial analysts as an indicator of the market’s expectations for future interest rates.
The Fed manages the economy based on a “financial conditions framework.” That is, by easing or tightening financial conditions, the Fed can achieve their desired macroeconomic outcomes. Currently, the central bank is explicitly tightening financial conditions to slow economic growth to fight inflation. We expect the Fed will continue to raise rates until something – either inflation, or the economy – breaks.
Investors have spent months betting that a shift in the economy will cause the Fed to pivot. Now that something is broken (the regional banks), we believe it is more likely that the Fed will soon change course. Market-based predictions for the Fed Funds rate are pointing to Fed rate cuts in 2H23, a major reassessment.
Quote of the Month
“The biggest risk of all is not taking one.” – Mellody Hobson
Major Asset Class Dashboard
Important Disclosure: This report is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. All investments involve risks, including the loss of principal. Investors should consult with their financial professional before making any investment decisions. Past performance is not a guarantee of future results.
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