Review the latest Weekly Headings by CIO Larry Adam.
Key Takeaways
- Fed rate cuts have been delayed, not derailed
- Labor demand is gradually easing, with minimal damage
- S&P 500 earnings revisions have been supportive
This weekend brings us one of the most prestigious horse-racing events of the year. This year, over 160,000 people will fill the stands at Churchill Downs to watch 20 horses compete in the 150th annual Run for the Roses. The event promises to be filled with the usual pomp and circumstances – colorful and flashy hats, mint juleps, high fashion and celebrities galore. And just like fans worldwide are trying to handicap this year’s Derby winner, investors have spent countless hours trying to handicap some major events in the financial markets this past week. Here’s a recap of the important drivers, along with our views on how things will play out over the rest of the year:
- Fed rate cuts have not been scratched | The Fed held rates steady at a top rate of 5.5% for the sixth consecutive meeting this week. While no move was expected, the resilient economy and hotter inflation surprises had the market bracing for the Fed to deliver a hawkish message when Powell took the podium after the FOMC meeting. That did not happen, and Powell’s comments were more dovish than expected. While Powell was peppered with repeated questions about whether current policy settings are restrictive enough given the economy’s strong performance, he pushed back against the possibility of the Fed raising rates again – music to the markets ears! Current policy settings may just need more time to work. Cuts remain on the table, but policymakers will need to wait for more evidence that inflation is moving sustainably to 2% or for the labor market to crack.
Our View: Powell’s messaging at the press conference is consistent with our view that rate cuts have been delayed, not derailed. We agree that rates are unlikely to move higher and still pencil in two to three rate cuts by year end.
- Fed Labor Market Is Still On Pace | There is no denying that the underlying strength of the economy has been powered by the labor market. In fact, job growth has remained remarkably robust, averaging 233k per month over the last year. However, this morning’s job report showed a slight cooling, with payrolls rising only 175k – the smallest gain in six months. Slowing, but at a very gradual pace. Other job market indicators also suggest that labor demand is softening. For example, the JOLTS survey saw job openings fall to their lowest level since February 2021 and the quits rate, which measures the number of people who voluntarily leave their jobs, fell to 2.1% – its lowest level since August 2020. In addition, the employment sub-indices of the ISM surveys have fallen into contractionary territory.
Our View: Labor demand should ease further in the months ahead as the market rebalances from its pandemic-era extremes. But job losses should be minimal, with the unemployment rate remaining near historically low levels.
- Earnings season is in the homestretch | The bulk of 1Q24 earnings season is behind us with 82% of the S&P 500 market cap having reported. Thus far, S&P 500 earnings have been solid – albeit with some winners and losers. S&P 500 earnings are on pace to rise for the third consecutive quarter, up 4.6% YoY. Both the percentage of companies beating (79%) and the magnitude of bottom-line beats (+8.4%) are above the 10-year average, and margins increased for the first time in four quarters. The strength in earnings was driven primarily by the mega-cap tech space, with some weakness beyond those names. Case in point: a composite of mega-cap tech (or MAGMAN – which makes up 25% of the earnings weight of the S&P 500) is on pace to grow its earnings ~50% YoY as continued business investment in AI and cloud-related products support the bottom line. Earnings for the rest of the S&P 500 are on pace to decline ~2%, suggesting that much of the tech-related rally has been justified.
Our View: While valuations are near cyclical highs, the results from the 1Q24 earnings season leave us confident that future earnings can drive the equity market higher over the next 12 months. As a result, we reiterate our $240 earnings forecast (~10% EPS growth from 2023) with a sector focus on Tech-related areas, Industrials and Health Care.
- Inflation sprint not the start of a new trend | After a few hotter than expected inflation reports (three-month annualized CPI: +4.6% vs. +1.9% at the start of the year), investors have become concerned that the downward trend in inflation is no longer intact. Data this week further exacerbated this concern, with the Employee Cost Index climbing at its fastest pace (+1.3%) in six quarters in 1Q24 and the prices paid sub-index in ISM manufacturing rising to the highest level since June 2022.
Our View: We have long said that the downward move in inflation toward the Fed’s 2% target would not occur in a straight line. Yes, the stubbornly hot inflation prints have been disappointing, but there are other indicators that suggest inflation should move lower. First, softer labor demand is likely to dampen wage growth. Second, consumer spending is becoming more discerning, which was on display in the earnings reports for McDonalds and Starbucks. Third, crude oil prices are moderating (down ~10% from their recent peak). This, plus the upcoming seasonal peak in gas prices, should help drive inflation lower.
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